Rex L. Crandell
cpa, mba, attorney
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Rex L. Crandell cpa, mba, attorney
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TAX NEWS & VIEWS 2004 By Rex L. Crandell, CPA, MBA, JD, CFI, ATTORNEY AT LAW Enrolled to practice before the IRS and the U.S. Tax Court Licensed Real Estate/Mortgage Broker
MORE NEW TAX LAW INFORMATION. More new tax law news
and information is available by contacting the author Rex L. Crandell at 800 464-6595 or 925 934-6320, Alchemy@Astound.net or at www.rexcrandell.com. 1) STOCK DIVIDEND INCOME FOR INDIVIDUALS WILL BE TAXED AT THE LOWER CAPITAL GAINS TAX RATES [IRC §1(h)] Under the prior law, dividend income was considered ordinary income taxable at rates up to 38.6% of your dividend income. As of 01/01/03, dividend income will be taxed at the capital gains rate by applying the 15% tax bracket. Tax on dividends will now be calculated on Schedule D. However, dividend income will not be allowed to offset capital loss transactions. The lower capital gains tax rates will not subject income to an Alternative Minimum Tax (AMT) adjustment. Hopefully the stockbrokers will do the recordkeeping and tell the taxpayer which dividends qualify for the new tax treatment. Watch for a new Form 1099-Div for year 2003. Non-Qualifying Dividend Income Examples: Day traders, real estate investment trusts (REITs), royalty trusts, money market dividends, credit union, insurance company dividends. In addition, S corporation dividends do not qualify, because it is not double-taxed income. Qualified dividend income is excluded from the "investment income" for the investment interest expense. There is an election to allocate some of the dividend income for treatment as investment income to allow the use of investment expenses. 2) LONG TERM CAPITAL GAINS TAX RATES ARE REDUCED FROM 20% TO 15% STARTING ON 05/06/03 [IRC §1(h)] Long Term Capital Gains Tax Rate Schedule:
3) INDIVIDUAL TAX RATES ARE REDUCED IN 2003 [IRC §1] Schedule of Reduced Tax Rates:
4) WHEN TO CLAIM THE TUITION DEDUCTION AND WHEN TO CLAIM THE EDUCATION CREDIT.
5) STATE ELECTRONIC TAX FILING REQUIRED STARTING WITH 2003 TAX RETURNS [R&TC §18621.9] Starting with the 2004 tax-filing season, tax preparers must e-file all individual tax returns or pay a penalty of $50 per return for each return that they should have e-filed. This new requirement applies to all tax preparers who prepared more than 100 California personal tax returns during 2003 and who use tax preparation software in 2004. It appears that the state is passing the cost of tax processing out to the consumer because e-filed returns have many more processing steps that must be absorbed by consumers. The state claims the benefits of less governmental processing costs and faster refunds to taxpayers. A taxpayer (but not the tax preparer) can opt out of the new e-file requirement by preparing Form FTB 8454 each year.
6) NEW METHOD FOR PAYING SALES & "USE" TAXES ON STATE INCOME TAX RETURNS [SB 1009,Ch. 03-718) Starting with 2003, every state tax return will have a line where non-professional retail sellers can pay their Sales & "Use" Tax. Who does this apply to? Basically everyone. If an item that you purchased would have been subject to sales tax if you purchased the item in California, then it is subject to "Use" tax if purchased from an out-of-state retailer. Some out-of-state retailers do charge sales tax to California customers, so the consumer will not take any additional steps. However, if the out-of-state retailer did not charge sales tax on the purchase, then the purchaser is responsible for reporting and paying the "Use" tax to the state. Sales & Use Tax are synonymous terms for the same concept. They are both calculated at the same tax rates. A retailer collects sales tax. The user pays "Use" tax. If you bought items for "use" in California, then there is a responsibility to pay the "Use Tax" to the state. It does not matter if the items were purchased by mail order, phone order or over the Internet. The state is now making it easier to pay the tax, which has always been due, when you file your personal or business tax returns. This procedure does not change the requirement that a retail business operating in the state must register with the State Board of Equalization and obtain a resale permit. It appears that the new procedure will bring the issue to the awareness of many consumers who may have mistakenly believed you could avoid paying sales tax if you buy a product from out-of-state.
7) PENSION PLAN CONTIBUTION LIMITS
CATCH-UP CONTRIBUTIONS for persons age 50+ (assuming you are behind in retirement funding)
8) ANNUAL GIFT TAX EXCLUSION FIXED AT $11,000 [IRS Rev Proc 2002-70] 2001 Gift Tax Exclusion (per giver) $10,000 2002 Gift Tax Exclusion (per giver) $11,000 2003 Gift Tax Exclusion (per giver) $11,000 Gifts above the specified levels would require filing a Gift Tax Return, Form 709. There may or may not be any current tax due on the gift transfer. Gift giving to your family and heirs is not a tax deduction. 9) ESTATE & INHERITANCE TAX IMPOSED ON MARKET VALUE OF DESCENDENTS’ ESTATES THAT EXCEED NEW LIMITS
10) ITEMIZED DEDUCTIONS start to be phased out at an AGI that exceeds $139,500 for 2003. FICA withholding on wages maximum for year 2003 is $87K. 11) FICA MAXIMUM. For year 2004 the FICA wage-withholding maximum will be $87,500. There is a Social Security Income (SSI) benefit calculator located at: http://www.ssa.gov. There is a breakeven calculator for clients that want to determine if it is better to start the SSI income at age 62 or at age 65. A person can do his or her own online calculations. 12) AVOID UNDERESTIMATION OF ESTIMATED TAX PENALTIES. No Estimate tax is required until the federal tax due exceeds $1,000 for the year. 13) ALTERNATIVE MINIMUM TAX GRADUALLY INCREASES TO EFFECT MORE TAXPAYERS. The AMT exemption amount was increased from $35,750 in 2001 & 2002 to the higher $40,250 for 2003 and 2004. This assumes that the exemption is not phased out because of a person’s high income. By the year 2010, it is projected that one out of four taxpayers will be required to file AMT on their annual income tax returns. You need a computer to compute AMT tax liabilities because of its complexity. For example, if a person doubles up paying two years of real estate tax at one time, this extra tax deduction may create the imposition of the Alternative Minimum Tax (AMT) among other adverse effects and phase-outs. The author considers this situation as the "Yin and the Yang" of tax benefits planning. If there is a tax benefit; there may be a negative AMT tax impact. For complexity reasons, it is not possible to do mental projections of AMT tax consequences anymore. 14) TAX CREDITS FOR DEPENDENT CARE. The Dependent Care credit is now 35% on the first $3,000/$6,000 of employment related expenses. The phase out for dependent care benefits start at $15,000 of AGI. The result it is still limited to a credit of 20% credit for higher income taxpayer’s. It is better to claim an cafeteria plan from your employer and exclude the benefits, for the higher income clients. 15) CHILD TAX CREDIT. The 2003 & 2004, the Child Tax Credit is $1,000. This is up from the 2001 & 2002 amount of $600. The IRS has been sending advance child credit checks to some taxpayers. If the taxpayer did not get the $400 rebate then the person should claim the full $1,000 on the 2003 tax returns. Taxpayers can look up on http://www.IRS.GOV to see if advance payment of $400 was 2003. If one spouse claimed the child and got the rebate check, then the other parent claims the full $1,000 on this year’s tax return. The IRS’s unofficial answer is that the 2002 claiming parent will not have to repay the extra funds to the IRS or to the other spouse claiming the child for 2003. The author considers this area is ripe for controversy between the IRS and taxpayers. 16) EARNED INCOME CREDIT FRAUD. Low-income individuals with a dependent may qualify for the Earned Income Credit. This is a tax credit than can be refunded to the taxpayer, even if they had no tax withholding during the year. The IRS feels that there is fraud in 1/3 of all Earned Income Credit claims. Thus IRS will start sending notices to get verification. The IRS will require a Form 8836 and prove a birth certificate, and proof that the child lived with you for at least six months. The proof that the child lived with you can come from schools, church, and RLC thinks that the other spouse may be able to sign off. 17) ALIMONY DEDUCTION OR INCOME. Qualifying alimony is a deduction from gross income from the spouse that makes the payment and is considered income to the receiving spouse. Voluntary Alimony is not deductible. It can be a written agreement between the spouses to qualify for deduction. Indirect alimony (i.e. making the house payment) that is shown in the divorce decree will qualify, as long as the payments stop at death or remarriage. If the payments do not terminate at death, then the payment will be considered a property settlement and not be deductible by the payer. 18) CLAIMING A TAX DEDUCTION FOR DEPENDENTS. A tax deduction is available for dependents if the custodial parent, as long as parent pays over half of the support of the dependent. A custodial parent is defined as the person named in the divorce decree to be the primary care giver of the child. Even if the court order says otherwise, the custodial parent can use the release Form 8332 to transfer the dependency tax benefit to the non-custodial parent. Then the non-custodial parent would attach the IRS Form 8332 to their tax return in support of the dependency deduction. A multiple support agreement (Form 2120) can be used if several persons are paying for the care of one person. The agreement allows one of the persons to claim the dependency exemption. 19) SELF-EMPLOYED HEALTH INSURANCE PREMIUMS. The Self-Employed Health Insurance deduction is now 100% deductible above the line in 2003. It is claimed on page one of the Form 1040 and is not reduced by 7.5% of Adjusted Gross Income like other medical expenses on Schedule A of Form 1040. The Self-Employed Health Insurance deduction includes the long-term Medicare B insurance payments. 20) MEDICAL EXPENSE DEDUCTIONS. Breast surgery is deductible. Lasik eye surgery is deductible. Teeth whiting costs are not deductible as medical expenses. Nonprescription drugs are not deductible. Cosmetic Surgery is not deductible. Egg donor expenses qualify for medical expenses, including the legal expenses for the egg donor program. 21) EDUCATION TAX CREDITS. The lifetime Learning credit is now 20% of $10,000 in qualified education expenses. This amount is up from $5,000 in 2002. The phase out is still the same, and set too low, so most taxpayers do not get the credit. The student can use the credit if the parent cannot claim the credit. The parent can claim the child exemption and the child can claim the Lifetime Learning Credit, assuming that parent paid over half of the child’s support during the year. 22) HIGHER EDUCATION TUITION DEDUCTION. The Higher Education Tuition Deduction is limited to $3,000 and is treated as an above the line deduction. After the adjusted gross income reaches $65,000 for the Single Filing Status or $130,000 on a married filing joint tax return, there is no credit left to claim. If the Tuition Deduction is claimed, then the taxpayer cannot claim the Hope or Lifetime Learning Credit. 23) BONUS DEPRECIATION DEDUCTIONS. This relates to personal property used in a trade of business. The "Qualifying Property" deduction is increased to 50% for 2003 tax returns (IRC 168k). This tax benefit is available after the taxpayer has claimed regular depreciation expenses. This deduction was only 30% for the 2002 tax year. The qualifying property must be personal property, purchased computer software or certain leasehold improvements. Real estate does not qualify for the additional first year depreciation. The bonus depreciation property must be the "original use" or new property. So if the property was previously owned, it will not qualify. It must be placed in business use prior the end of year 2004. The bonus depreciation deduction is to be deducted in addition to claiming the IRC Sec. 179 deduction. The bonus depreciation deduction is "deemed" to have been made (by the IRS), unless an election not to claim it is shown on the tax return. You can elect out of the bonus depreciation deduction for an entire class of assets. However, you cannot elect out for some assets in a class but not for other assets. You can claim 50% or 30% or nothing. These are the only choices. Thus, there is no discretion to claim any percentage desired. 24) BUSINESS AUTO DEPRECIATION LIMITS. The first year a luxury auto is placed in business use, the depreciation deduction was increased from $4,600 in 2002 to $7,650 for 2003. Used cars do not qualify for the additional Bonus Depreciation under IRC Sec. 168k. If the taxpayer purchased a business vehicle in year 2003 that weigh more than 6,000 pounds when empty, then the depreciation limits do not apply. This means that the full business use percentage cost of the vehicle is deductible in the year of purchase. If more information on which vehicles weigh more than 6000 pounds, there is more information available at www.intellichoice.com. At this location you can look up vehicle weight on a car-by-car basis. Do not assume that the Gross Vehicle Weight (GVW) published by car manufacturers is the weight to use in determining the 6,000 limit. The Gross Vehicle Weight is the maximum weight the vehicle can carry when loaded and not when it is empty. The empty weight is used for tax purposes. (IRS Reg. §1.274 5T(k) The Auto depreciation including the Sec 179, plus Bonus Depreciation (Sec. 168k), plus the additional year 1 rate of 20%. So, if the car is over 6,000 pounds, a business owner can write off of the first $100,000 for a 100% business use asset or vehicle. 25) LEASED BUSINESS VEHICLES. When a leased vehicle is used in a trade of business, the business expense is the cost of the lease less a factor for the non-deductible portion of the lease cost that is obtained from IRS Lease Inclusion Tables. The Lease Inclusion Tables start when a vehicle is valued at over $18,000 instead of the $15,200 number that is applied to "luxury" car depreciation limitations. There is a recapture provision for prior deprecation provision for vehicles used in a business for a short term of less than five years. This creates a tax problem when the vehicle is sold. The solution to this problem may well be to exchange rather than sell particular assets. 26) AUTO MILEAGE EXPENSE DEDUCTIONS. For tax year 2003, the deductible auto expense is 36 Cents per business mile. This expense is a business expense but includes a factor for Gas, Oil, Repairs and Maintenance. Therefore, only claim expenses for the business mileage or the actual business expense, but not both. The mileage deduction is fixed at 12 cents per mile for medical expenses and 12 cents per mile moving expenses. The auto deduction is limited to 14 cents per mile for charitable travel by vehicle for 2004. For 2004, the business mileage rate is 37.5 cents per mile. 27) DISABLED ACCESS CREDIT FOR BUSINESS EXPENSES TO HELP DISABLED PERSONS. The IRS Form 8826 is used to claim the credit for real property improvements to help disabled persons gain access to commercial buildings. The credit is 50% of expenditures for "eligible le Small Businesses" on eligible Disabled Access Expenditures" between $250 - $10,250. The credit is limited to a $5,000 per year. The credit can be used to offset other income taxes due. General-purpose medical equipment type of building improvements will qualify for the credit. In addition, American's With Disabilities Act (ADA) building improvements will also qualify for the Disabled Access Credit. 28) TAX FREE EMPLOYER FRINGE BENEFITS. An employer that pays up to $190 in free employee parking per year will not include the amount in the employee’s income. Mass Transit tickets purchased for employees will be a tax-free fringe benefit for the first $100 per year. 29) CRACK DOWN ON TAX SHELTERS. Both the IRS and the State Franchise Tax Board are stepping up enforcement actions against tax shelters and Sham Transactions. The IRS website shows a list of several common tax scams. The IRS website is http://www.irs.gov. There is a list of the Dirty Dozen tax Scams commonly encountered by IRS auditors. The list of tax scams includes several transactions were taxpayers use multiple business entities or trusts and then misclassify the nature of the transactions on the tax returns. Both the IRS and California have recently enacted a new strict penalty structure for offending taxpayers, shelter promoters and income tax preparers. 30) IRS STARTS CHARGING A FEE TO TAXPAYERS ATTEMPTING TO OFFER THE IRS LESS TAX THAN IS DUE, AS PAYMENT IN FULL. The federal Offer In Compromise form (also known as OIC) will now have a filing fee, whereas it has always been available to taxpayers, free of charge. The IRS started charging a $150 application fee for OIC’s filed after 11/11/03. 31) PAYING INCOME TAX OVER THE INTERNET. Both the IRS and the State Franchise Tax Board are allowing credit card payment of income taxes via the Internet. The user should be aware that the credit card transaction fee [normally paid by the merchant in a retail transaction] would be required to be paid by the taxpayer when paying taxes over the Internet. So, you might qualify for frequent flyer miles when paying your taxes with a credit card but it will be subject to this "user fee" expense. 32) CALIFORNIA’S NEW LONG TERM CAREGIVER CREDIT. There is
a Long-Term Care Credit Is a $500 credit for a person who is a caregiver that
meets certain tests for providing care to someone in their household. The credit
is for the caregiver not the person needing the care. The person needing care
must not be able to do three activities of daily living, considered a loss or
lack of functional capacity. A doctor’s certification and the caregiver cannot
have an Adjusted Gross Income of $100,000 or more. The new Form FTB 3504,
Long-Term Care Credit should be used by the caregiver to claim the tax credit.
[PRIOR ISSUES
FOLLOW]
TAX LAW CHANGES
FOR YEAR 2002 INCOME
TAX RETURNS
Depreciation Expense for Automobiles For business automobiles first
placed in service in 2002, the maximum first year depreciation is $7,660 under
IRC Section 179.
Roth
IRA Limits Increased The Roth IRA contribution limit has been
increased to $3,000 for 2002. Individuals age 50 or older may contribute $3,500
to a Roth IRA account.
Combined Contribution Increases to Traditional IRA's and Roth IRA's If your contributions are made to both your Roth IRA and your traditional IRA account, your contribution limit for 2002 is the lesser of: Ø $3,000 ($3,500 if your were age 50 or more in 2002) less all contribution (other than employer contributions under a SEP or SIMPLE IRA plan) for the year to all IRA's other than Roth IRA's or Ø Your earned compensation minus all contributions (other than employer contributions under a SEP or SIMPLE IRA plan) for the year to all IRA's other than Roth IRA's. Traditional IRA Rollover's Into Qualified Plans You can rollover a distribution from your traditional IRA made in 2002 into a qualified plan with the transaction being tax deferred. The part of the distribution that you can roll over is the part that would otherwise be taxable. All IRA rollover's should be done trustee to trustee and the taxpayer should not receive the funds directly. Possible Exception to the 60-Day Rollover Rule Normally, a rollover is tax free only if you make the rollover reinvestment by the 60th day after you received the distribution. Starting with distributions in 2002, the IRS may waive the 60-day requirement where it would be inequitable or not in good conscience to do so. Hardship Pension Distributions Beginning in 2002, no hardship distribution can be rolled over into an IRA account. EDUCATIONAL TAX BENEFITS Employer-Provided Educational Assistance The non-taxable status of up to $5,250 of employer provided educational assistance benefits each year for undergraduate type course has been extended indefinitely. The tax-free status has also been extended to graduate type classes. Qualified Tuition Programs (QTP's) Starting in 2002, there are various changes to what used to be referred to as Qualified State Tuition programs. The new name has be modified to be Qualified Tuition Programs (QTP's). Distribution from state-managed QTP's A distribution from a QTP established by a state (or state agent) can be excluded from in come if the amount that was distributed is used for higher education. Before the change, the beneficiary (student) was required to pay tax on any earnings from a QTP, unless the earnings in the account were tax-free under other provisions of the tax code. QTP's Maintained by an Educational Institution You are permitted to make contributions to a QTP established and maintained by one or more eligible educational institutions. Any earnings distributed prior to January 1, 2004, will be taxable. Previously, contributions could only be made to a QTP established and maintained by a state or an agent acting on behalf of a state. Rollovers of QTP's to Family Members When considering rollovers of funds and changes of the designated beneficiaries, the definition of qualifying family members is expanded to include first cousins of the beneficiary. Rollovers of QTP Funds Without Changing the Beneficiary Funds in a QTP can be rolled over to another QTP set up for the same beneficiary and not be taxed for the transaction. There is a limitation of one rollover each 12 months for rollovers to the same beneficiary. Qualified Disbursements from a QTP There has been a change in what is considered reasonable expenses for room an board for educational expenses. You must now contact the educational institution for their estimate of qualified room and board costs. Special Needs Beneficiary The definition of "Qualified Higher Education Expenses" has been expanded to include expenses of a special needs beneficiary that are necessary for that person's enrollment or attendance at an eligible institution. QTP's Combined with Coverdell ESA's You are permitted to make contributions to QTP's and Coverdell Educational Savings Accounts (ESA's) in the same year for the same beneficiary. Before the 2002 changes, you could only contribute to one program or the other. COVERDELL ESA's (Previously Called Education IRA's) Starting in 2002, the following changes were made to Coverdell Education Savings Accounts (Coverdell ESA's): Maximum Contribution. The limitation on the amount you can contribute annually to a Coverdell ESA is increased from $500 to $2,000. Income Limits. If you file a joint return, the amount you can contribute to a Coverdell ESA will be phased out (or gradually reduced) if you modified adjusted gross income (MAGI) is more than $190,000 but less than $220,000. ESA Contribution Deadlines. The final deadline on which you can make contributions to a Coverdell ESA for any year has been extended to the due date of your tax return for that year (not including extensions of time to file). In prior years, contributions were required to be made by December 31st. Qualified Expenses from an ESA The definition of Qualified Education Expenses has been enlarged to include elementary and secondary education expenses. Qualified elementary and secondary education expenses include expenses for: v Fees, Tuition, academic tutoring, special needs services in the case of a special needs beneficiary, books, supplies, and other equipment incurred in connection with enrollment or attendance as an elementary or secondary school student at a public, private or religious school. v Transportation, room and board, uniforms, and supplementary items and services ( including extended day programs) which are required or provided by a public, private or religious school in connection with such enrollment or attendance, and v The purchase of computer technology, equipment or Internet access along with related services. This is only if such technology, equipment or services are to be used by the beneficiary and the beneficiary's family during any of the years the beneficiary is in school. These costs do not include expenses for computer software designed for sports, games or hobbies unless the software is predominantly educational in its function. Special Needs Beneficiaries You are permitted to contribute to a Coverdell ESA for a special needs beneficiary after his or her 18th birthday. You can also leave assets in a Coverdell ESA account for a special needs beneficiary after the beneficiary reaches the age of 30. Balancing Hope & Lifetime Learning Credit with the Coverdell ESA You are permitted to claim the Hope or Lifetime Learning Credit in the same year you make a tax-free distribution from a Coverdell ESA, provided the distribution from the Coverdell ESA is not used for the same expenses for which the credit is claimed. Before this 2002 change, you could not claim the Hope or Lifetime Learning Credit if you received a tax-free withdrawal from a Coverdell ESA and did not waive the tax-free treatment of the withdrawal. Combining Coverdell ESA's with Qualified Tuition Programs (QTP's) You can make contributions to your Coverdell ESA and Qualified Tuition Program in the same year for the same beneficiary. Before the 2002 change, you could only make contributions to one program or the other. New Deductions for Higher Education Expenses Starting in 2002, you can deduct qualified tuition and related expenses paid during the year for yourself, your spouse, or a dependent even if you do not itemize your deductions on Schedule A of Form 1040. What are qualified tuition and related expenses? Normally, qualified tuition and related expense are tuition and fees paid for you, your spouse or a dependent that you claim a dependency exemption that are required for enrollment or attendance at an eligible educational institution. Student activity fees an costs for course related books, supplies, and equipment are included in qualified tuition and related expenses only if the fees must be paid to the institution as a condition of enrollment or attending. What is an Eligible Educational Institution? They are any college, university, vocational school, or other post-secondary educational institution eligible to participate in a student aid program administered by the Department of Education. This definition includes the accredited public, nonprofit, and privately owned profit making post-secondary institutions. Ask the school that you are considering if they are an eligible educational institution for this tax benefit. Limitations and Adjustments to Qualified Expenses You are required to reduce your qualified expenses by the amount of any tax-free educational assistance that you received. Tax-free educational assistance includes the following: § Scholarships § Pell Grants § Employer provided educational assistance § Veterans' educational benefits § Any other non-taxable payments you received for education expenses. This classification does not include gifts, inheritances and bequests received. Expenses that do not qualify Qualified tuition and related expenses do not include the cost of the following items: § Insurance § Medical expense, including student health payments § Room and Board § Transportation § Similar personal expenses, living expenses or family expenses. This requirement still applies even if the fee is required to be paid to the institution as a condition of enrollment or attendance. Qualified tuition and related expenses normally do not include expenses that are for any course of instruction or other educational activity that involves hobbies, sports, games or any non-credit class. There is an exception to this proviso if the course of instruction or other education is part of the student's degree program then the expenses can qualify for this tax benefit. Deduction Limitation For tax years starting in 2002, you are permitted to deduct up to $3,000 that you paid for qualified tuition and related expenses as an adjustment or subtraction to your taxable income. Income Limits For tax years beginning in 2002, you a permitted to deduct up to $3,000 of qualified tuition and related expenses, if you modified adjusted income (MAGI) is not more than $65,000. The limitation is $130,000 on a married filing joint filing status. What is Modified Adjusted Gross Income (MAGI) ? Well, in this context, you MAGI is the adjusted gross income indicated on your tax return, plus any foreign earned income exclusion, foreign housing exclusion or deduction, including those generated from Puerto Rico and American Samoa. Interaction with credits and other deductions You are not permitted to deduct any amount for qualified tuition and related expenses during the year if: o A Hope Credit or Lifetime learning credit is claimed on expenses for the individual fro whom the tuition and related expenses were paid, or o You can deduct the expense on any other provision of the tax laws. Interaction with Income Exclusions You are required to reduce your qualified tuition and related expenses by the following: o Expenses you used to figure the amount of interest on qualified U.S. Savings Bonds that were excluded from income because you used it to pay qualified higher education expenses. o Expenses you used in the calculation of the amount of any tax-free withdrawals from Coverdell ESA, and o Expenses you used to calculate the portion of any distribution of earnings from a qualified tuition program (QTP) that you excluded from income because the earnings were used to pay the beneficiary's qualified higher education expenses. Eligibility Limitations You are not permitted to claim a deduction for qualified tuition and related expenses if any of the following apply: o Another taxpayer is entitled to claim an exemption for you as a dependent on his or her tax return. This rule applies even if the other taxpayer does not actually claim you exemption. o You are claiming a married filing separate tax filing status. o You are a nonresident alien and you have not elected to be treated as a resident alien for the tax year. When to Claim the Deduction? Normally, you can deduct only those expenses for a year that are connected with enrollment at an institution of higher education during the same year. However, you can deduct expenses paid in a year if they are for an academic period beginning within the year or during the first three months of the next tax year. Disclosure Requirements To be qualified to claim the deduction, you must show on your income tax return the name and social security number of the person that benefited from the expense payments. Student Loan Interest Deductions If you paid interest on a student loan during the year, you may be able to deduct the interest expense as an adjustment to your taxable income. Elimination of the 60 Month Deduction Limit. Starting in 2002, the requirement that you can only deduct student loan interest paid during the first 60 months that interest payments are required has been removed. Income Related Deduction Limits Beginning in 2002, the amount of the student loan interest deduction will be phased out, or gradually reduced, if you modified adjusted gross income (MAGI) is between $50,000 and $65,000 if your are using the single filing status. If you are using the Married Filing Jointly filing status, then the phase out range is between $100,000 and $130,000. Starting in 2002, you are required to add back any qualified tuition and related expenses to determine your income level for phasing out the student loan interest deduction. EARNED INCOME CREDIT Revised Definition of Earned Income Starting in 2002, earned income will no longer include nontaxable employee compensation. Nontaxable employee compensation includes amounts such as: 1) salary deferral fringe benefit plans 2) salary reductions (like 401k pensions), 3) exclusions, 4) excludable dependent care benefits and 5) excluded combat pay. Modified Adjusted Gross Income Requirement Removed Starting in 2002, you will not be required to figure modified adjusted gross income because the earned income credit will be calculated using your regular adjusted income and not modified adjusted gross income. Who Gets to Claim the Child Deduction type of Disputes For 2002, if two or more persons might be able to claim the same qualifying child, the qualifying child can only be claimed by the winner on the following list: 1) The parents, if they file a joint tax return 2) The parent, if only one of the persons is the child's parent 3) The parent with which the child lived the longest during the year, if two of the persons are the child's parent 4) The parent with the highest AGI if the child lives with each parent for the same amount of time during the year, or 5) The parent with the highest AGI, if non of the persons is the child's parent New Definition of Foster Child Starting in 2002, the definition of an eligible foster child has been modified. The child will have to live with you only for more than half of the tax year. Previously the child must have lived with you the entire year. Reduction of Earned Income Credit by the Alternative Minimum Tax Eliminated For 2002, your earned income credit will no longer be reduced by the amount of the Alternative Minimum Tax shown on your tax return. MISCELLANEOUS 2002 TAX LAW CHANGES Health Insurance Deductions for the Self-Employed. For tax year 2002, the deduction increases to 70% of the amounts paid for medical insurance or qualified long-term care insurance costs for the self-employed persons and their families. Starting in 2003, the deduction increases to 100% deductibility. You do not have to itemize your deductions to claim this tax benefit. Self-Employment Tax The maximum net income subject to the social security part (FICA) of self-employment tax is $84,000 for tax year 2002. Luxury Tax For tax year 2002, The luxury tax on a passenger vehicle that costs $40,000 or more is 3% of the total sales price exceeding the $40,000 base amount. Tax Withholding Rates Decreased For tax year 2002, the payor withholding rates have been decreased on the following transactions: o Gambling winnings withholding is decreased to 27% o Unemployment compensation withholding rate decreased to 10% o Backup withholding rate was decreased to 30% o Supplemental wage withholding tax has been decreased to 27% Adoption Tax Credit and Exclusion Increased Starting in 2002, the maximum child adoption credit and exclusion will increase to $10,000. Starting in 2003, an Adoption Credit or Exclusion of $10,000 will be allowed for the adoption of a child with special needs, even of the adopting parents have fewer expenses than the fixed credit. Starting in 2002, the modified adjusted gross income phase out of the credit starts at $150,000. The credit is completely phased out when the income level reaches $190,000 for the year. NEW CREDIT FOR CONTRIBUTIONS TO RETIREMENT PLANS AND IRAs. It is also known as the "SAVERS CREDIT." Starting in 2002, if you make eligible contributions (defined below) to an employer-sponsored retirement plan or to an individual retirement arrangement (IRA), you might be able to take a tax credit. The amount of the saver's credit you are able to claim, is based on the contributions you make and your credit rate. Your credit rate can be as low as 10% or as high as 50%, depending on your adjusted gross income and your filing status. The credit is limited to $1,000 per person per year. The following table illustrates the credit. The maximum contribution taken into account is $2,000 per taxpayer. On a joint return, up to $2,000 is taken into account for each spouse.
Form 8880 (Credit for Qualified Retirement Savings Contributions) will be used to calculate the amount of the credit. The credit will be reported on Line 49 of Form 1040. The credit is in addition to the exclusion of deduction from gross income for making elective deferrals and IRA contributions that are otherwise allowed. The credit is set to expire in 2007. Who is unable to claim the credit. You cannot claim the credit if any of the following apply to you: o You are under age 18. o You are a full-time student (explained later) o Someone else can claim you as a dependent, such as your parents. Eligible contributions. These include contributions to a traditional IRA or Roth IRA and salary reduction contributions to a 401(k) plan (including a SIMPLE 401(k)), a section 403(b) annuity, an eligible deferred compensation plan of a state or local government (a governmental 457 plan), a SIMPLE IRA plan, or a salary reduction SEP. They also include voluntary after-tax employee contributions to a tax-qualified retirement plan or section 403(b) annuity. Contributions reduced. Your eligible contributions are reduced by the total of these items: o Any taxable distribution from a qualified retirement plan or from an eligible deferred compensation plan that you receive during the testing period (defined later), and o Any distribution from a Roth IRA or a Roth account that you receive during the testing period and that is not a qualified rollover contribution to a Roth IRA or a rollover to a Roth account. A distribution from a Roth IRA that is not rolled over reduces your eligible contributions, even if the distribution is not taxable. Testing period. The testing period consists of the year for which you claim the credit, the period after the end of that year and before the due date (including extensions) for filing your return for that year, and the two tax years before that year. Maximum credit Limitation The amount of the credit in any year cannot be more than the amount of tax that you would otherwise pay (not taking into account any refundable credits or the adoption credit) in any year. If your tax liability is reduced to zero because of other nonrefundable credits, such as the Hope credit, then you will not be entitled to the Savers Credit this year. QUALIFIED PENSION PLAN CHANGES Deduction Limits Changed. Starting in 2002, the following deduction limits apply. Profit-sharing plans. The maximum deduction for contributions to a profit-sharing plan increased from 15% to 25% of the compensation paid or accrued during the year to your eligible employees participating in the plan. Compensation for figuring the deduction for contributions includes elective deferrals (pre-pension adjustments). Defined benefit plans. For plan years beginning in 2002, the maximum deduction for contributions can be as much as the plan's unfunded current liability. Elective deferrals. Elective deferrals will not be subject to the deduction limits that apply to qualified plans. In addition, elective deferrals are not taken into account when figuring the amount you can deduct for employer contributions that are not elective deferrals. Elective Deferrals (401(k) Plans). The limit on elective deferrals for participants in 401(k) plans (non including SIMPLE small business pension plans) increases to $11,000 for 2002. Catch-up contribution (Wow, its later than you think). For tax years beginning in 2002, a plan can permit participants who are age 50 or over at the end of the plan year to make catch-up contributions. The catch-up contribution limit for 2002 is $1,000. The catch-up contribution a participant can make for a year cannot exceed the lesser of the following amounts. o The catch-up contribution limit. o The excess of the participant's compensation over the elective deferrals that are not catch-up contributions. Limits on Contributions and Benefits. For beginning in 2002, the maximum annual benefit for a participant under a defined benefit plan increases to the lesser of the following amounts. · 100% of the participant's average compensation for your individual highest 3 consecutive calendar years. $160,000 (subject to cost-of-living increases after 2002). Beginning in 2002, a defined contribution plan's maximum annual contributions and other additions (excluding earnings) to the account of a participant increases to the lesser of the following amounts. o 100% of the compensation actually paid to the participant (up to a maximum of $200,000 for 2002) or o $40,000 SIMPLIFIED EMPLOYEE PENSIONS (SEPS) Deduction Limit Increased For plan years beginning in 2002, the maximum deduction for contributions to a SEP increases from 15% to 25% of the compensation paid or accrued during the year to your eligible employees participating in the plan. This is a nice new tax benefit for self-employed persons. Elective Deferrals (SARSEPs) Increases. Beginning in 2002, the limit on elective deferrals for participants in SARSEPs will increase, and participants who are age 50 or over at the end of the plan year may be able to make catch-up contributions. For information about the new limit and catch-up contributions, see Elective Deferrals (401(k) Plans) under Qualified Plans, earlier. Higher Limits for SIMPLE Plans The limit on salary reduction contributions to a SIMPLE plan increases to $7,000 in 2002. Catch-up contributions. Beginning in 2002, a SIMPLE plan can permit participants who are age 50 and over at the end of the plan year to make a $500 catch-up contribution. The catch-up contribution a participant can make for a year cannot exceed the lesser of the following amounts. o The catch-up contributions limit or, o The excess of the participant's compensations over the elective deferrals that are not catch-up contributions. 403(B) PLANS Increased limit on annual addition Beginning in 2002, the limit on annual additions has increased to the lesser of $40,000 of your includible compensation for your most recent year of service. Changes to the Limit on Annual Additions For years beginning in 2002, the alternative limits on annual additions have been repealed. Therefore, beginning in 2002, you cannot use any of the following to figure your limit on annual additions. o The year of separation from service limit. o The any year limit. o The overall limit. Includible compensation after termination. Beginning in 2002, your includible compensation for your most recent year of service will not include money received 5 years after termination of service with your employer. Increase in the limit on elective deferrals. For 2002, the limit on elective deferrals has been increased from $10,500 to $11,000. Catch-up contributions for persons age 50 or older. Beginning in 2002, if you are age 50 or older, you may be able to make additional catch-up contributions of up to $1,000 to your 403(b) account. Rollover options. Effective, for distributions in 2002, you can roll over, tax free, money and other property that would otherwise be taxable from an eligible retirement plan to a 403(b) plan. Additionally, you can roll over, tax free, money and other property that would otherwise be taxable from a 403(b) plan to an eligible retirement plan. ESTATE AND GIFT TAX CHANGES Estate Tax Applicable Exclusion Amount. The applicable exclusion amount is the amount on which the unified credit (applicable credit amount) is based. For 2002 an estate tax return for a U.S. citizen or resident needs to be filed only if the gross estate exceeds $1 million. This means that there is no inheritance tax of estates with a fair market value of less than $1 million for tax year 2002. Gift Tax Applicable Exclusion Amount. Beginning with gifts made in 2002, the applicable exclusions amount for lifetime gifts will be fixed at $1 million. Increased Annual Exclusion For Gifts. The annual exclusion for gifts of present interests made to a donee during the calendar year is increased to $11,000. If the gift is less than $11,000 then no Form 709, Gift Tax Return is required to be filed with the IRS. The annual exclusion for gifts made to spouses who are not U.S. citizens is increased to $110,000. Reduction of Maximum Estate and Gift Tax Rate. For estates of decedents dying, and gifts made, starting in 2002, the maximum rate for the estate tax and the gift will be 50%. Reduction of Credit for State Death Taxes. For estates of decedents dying in 2002, the credit allowed for state death taxes will be limited to 75% of the amount that would otherwise have been allowed. California Real Estate Sales Withholding Tax Starting on January 1, 2003, escrow agents will be required to withhold 3% of the sales price of all non-personal residence property sales. The 3% is only an estimated tax and excess tax withheld will be refundable. This includes rental properties, commercial properties and vacant land. A single family residence or a condominium that is rented out to non-family members will be considered a non-personal residence property and thus the new withholding tax will be applicable. The withholding tax will be extracted, even if the property was sold at a loss for the seller. Out of state sellers will be treated the same as California residents. If the seller does not owe any tax, then they will be able to claim a tax refund next year when they file their tax returns. If the sales price and existing encumbrances are so high that there is no cash available to the seller at close of escrow, then the seller will be required to contribute additional funds to allow the transaction to be completed. Escrow officers will be liable for the tax if they do not withhold the tax, so they will not be eager in assisting the seller to avoid the tax. The withholding tax will not be withheld when the seller signs a statement that they are selling their principle residence that they are living in. The tax does not apply if the seller is doing a deferred exchange of investment property under IRC §1031. In those rare occasions where the California real property sells for less than $100,000 then the withholding tax will not apply. If a seller does not owe tax on their tax returns from the sale of the non-residential property, then they will be giving the state an interest free loan to the state until they can recover their funds. The concept is supposed to help ease the state's budget deficit, although the supporting logic is still unclear. It is anticipated that US Constitutional challenges will be presented, in court, to attempt to invalidate the new tax withholding mechanism. California Conformity with Federal Tax Provisions On May 8, 2002, Governor Gray Davis signed assembly bill, AB1122. This law will be effective as of January 1, 2002. The new statute conforms California law to the Federal Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 and the Job Creation and Worker Assistance Act (JCWAA) of 2002. The effective date for California applicability is January 1 2002. The new state law, conforms California law to the provisions in these federal laws as they relate to, but are not limited to, pension and individual retirement accounts. Some of these provisions are as follows: 1) Increases the traditional and Roth IRA maximum annual contribution amount in 2002 to $3,000 ($3,500 for age 50 and over.) These amounts are increase in subsequent years to match the federal increases. 2) Allows spousal IRAs for non-working spouses based on the earnings of his or her spouse. 3) Increases the defined contribution pension limit from $35,000 to $40,000. 4) Increases the pension profit sharing percentage to 25 percent of compensation. 5) Increases the limit on compensation that may be taken into account under a pension plan from $170,000 to $200,000. 6) Increases to $11,000 the dollar maximum on annual elective deferrals under 401(k) plans, 403(b) annuities and salary reduction SEPs. After 2002 the limits are increased in $1,000 annual increments through 2006. The same increased limits apply to SIMPLE plans. 7) Allows "catch-up" contributions for 401(k) plans, 403(b) annuities, SARSEPs and 457 plans for individuals age 50 and older.
8) California
did not conform to the federal IRA "saver's credit" for IRA contributions.
MORE NEW TAX LAW INFORMATION. More new tax law news and
information is available by contacting the author Rex L. Crandell at 800
464-6595 or 925 934-6320,
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