Deductions on your 2002 Tax Return

Changes for 2002 Economic Growth and Tax Relief Reconciliation Act of 2001

submitted by Mark Van Benschoten, CPA
Nancy Watts, MBA, CPA
Norman Jones Enlow & Co.

Many of the provisions of the tax legislation passed by Congress in May 2001 did not take effect until 2002. If you're a married parent who socks savings in an individual retirement account or is paying back a student loan, some of the income tax changes will make your 2002 tax return look considerably different this year. Perhaps you own a business that provides childcare to employees. Maybe you are an employer and your employees participate in a pension plan. Here are some of the changes that you should know about followed by a list of the ten major changes that impact your 2002 tax return.

Some breaks for individuals
There are several new or changed tax credits. For married people filing jointly, the earned income credit phase-out point will be gradually increased, beginning in 2002, by $3,000.

The former $500-per-child tax credit is $600 in 2002, 2003 and 2004 and will continue increasing until it reaches $1,000 in 2010. (Other child-related changes are the dependent care credit, in which the maximum credit, the amount of qualifying employment-related expenses for which credits may be claimed, and the income threshold for phase-out of the credit will not increase until 2003 but you should begin to consider them now. Also, the credit for adoptions, including special needs children, has been made permanent and will increase to $10,000 per child.)

Education is becoming more affordable - at least tax-wise. The exclusion for employer-provided educational assistance will be expanded to include graduate-level education, effective for courses beginning after 2001. The maximum annual contribution to an education IRA (now called the Coverdell ESA) increases from $500 to $2,000 after 2001.

You can contribute more to an individual retirement account (IRA) as the maximum amount of tax-favored contributions to IRAs and Roth IRAs will gradually increase from the 2001 limit of  $2,000 to $3,000 in 2002, $4,000 beginning in 2005 and $5,000 in 2008. Individuals age 50 and older can make additional "catch-up contributions" to their IRAs of $500 in years 2002 through 2005 and $1,000 in 2006 and later.

The estate and generation-skipping transfer taxes have been repealed after 2009 (but watch out - they may be reinstated in 2011!). Beginning in 2002, the 5 percent surtax on estates will be eliminated and increases in exclusions from the estate tax will be phased in. For example, the exemption in 2002 is $1,000,000. By 2009 the exemption will be $3.5 million.

Pension plan perks
There are tax breaks for both the employer and employee participating in pension plans. The compensation limit that may be taken into account in applying the employer deduction rules increases from $170,000 to $200,000 beginning in 2002. Also, the dollar limit on annual elective deferrals under 401(k) plans, 457 plans, 403(b) annuities and salary reduction simplified employee pensions (SEPS) is increased to $11,000 in 2002, with $1,000 annual increments until it reaches $15,000 in 2006.

The annual benefit limit under a defined benefit plan is increased to $160,000 and indexed for inflation.

The new law eliminated the percentage-of-compensation limitations placed on contributions to qualified retirement plans.  The applicable percentage has been raised to 100 percent of compensation.

The minimum vesting standards of a participant's nonforfeitable right in the employer's matching contributions to a retirement plan have been accelerated.  This allows a shorter time for vesting in the employer's matching retirement contributions. The provision change is aimed at encouraging lower and middle income workers to participate in a retirement plan and accumulate savings more quickly.

The limit on deductible contributions by employers to defined contribution plans has been increased from 15 percent to 25 percent of compensation for covered employees.

Down the road, for post-2005 tax years, 401(k) plans and 403(b) annuities may allow participants to elect to have all or a portion of their elective deferrals to the plan designated as after-tax "Roth contributions."  If the employer's plan allows, the amount of deferral elected to be treated as a Roth contribution is included in income but distributions from this account, contributions and earnings alike, would not be taxable.  This option could allow a participant to consolidate money in one place and probably qualify more money for Roth contribution advantages than could be obtained through a Roth IRA.

Pension funding rules
A small employer can claim a credit equal to 50 percent of the start-up costs incurred in establishing or maintaining a new employee retirement plan. The credit is limited to $500 in any tax year.

When it's time to start reversing the process - receiving funds from your pension rather than putting them in - there are new rules, too. Qualified distributions from, and employees' after-tax contributions to, qualified retirement plans and annuities will generally be eligible for rollover into other types of qualified plans that accept rollovers or to an IRA.