Gimme A Break
Here are some tips for winning the annual battle with the IRS
April 15 is sneaking up. But don't be distracted by the political debate over tax cuts and a proposed revamping of retirement and other savings plans. At best, those will apply to income earned this year and thereafter. For now, there's still a chance to take advantage of already enacted tax cuts, indexing for inflation, and new provisions that could shave a few dollars off this year's debt to Uncle Sam, now due in six weeks.
As always, the demons of complexity continue to run amok. A new deduction for college expenses can ease the strain of tuition, but it adds to the confusing mix of breaks for education. On the other hand, there is a new touch of simplicity for many investors and savers. Only those who report over $1,500 of interest or dividends will have to specifically list each item on a separate form. The old threshold, unchanged since 1974, was $400.
Even today's modest inflation helps taxpayers. The standard deduction for couples who don't itemize inches up by $250 to $7,850, and exemptions for dependents are $3,000, up $100. The tax cut of 2001 brings a new top rate of 38.6 percent for 2002, replacing the old ceiling of 39.1 percent, and a new bottom rate of 10 percent applies to the first $6,000 of income for single filers and $12,000 for couples who file a joint return.
Home sweet home. The barriers to some benefits have been lowered. New IRS rules, for example, make it easier to escape tax when forced to sell your home soon after moving in. As before, people who sold a home in which they lived for at least two years can escape tax on $250,000 of profit--$500,000 for couples. Under a new clarification of the rules, you can duck all or most tax even if you moved before two years if the new address was necessitated by a job change--meaning your new place of work would have added at least 50 miles each way to your commute. Other possible exceptions: divorce or separation, being fired, a big drop in income after taking lower-paid work, moving to care for a relative, and even the addition of twins or triplets to your family.
Small new or expanded breaks can be worth pursuing. Teachers--kindergarten through high school--who dig into their pockets to buy classroom supplies now can deduct, whether they itemize or not, up to $250 of the outlays. Self-employed people who buy health insurance can save a few more bucks by generally deducting 70 percent of the cost. That's up from 60 percent for 2001. For 2003, the deduction will be 100 percent.
Last year's economic stimulus legislation provides an enhanced deduction to people who bought a car post-9/11 for business use. Their deduction for the first year of depreciation can now be as much as $7,660, up from $3,060 before the act. Missed out for 2002? This bonus will also apply to cars bought in 2003. People who bought on September 11 or later in 2001 can benefit by filing an amended 2001 return to claim the bonus depreciation.
Because larger SUVs weighing over 6,000 pounds, such as the Ford Expedition and Toyota Land Cruiser, fall under the rules for trucks, the depreciation write-off for these vehicles can be several times as much as for a car. But despite publicity over this potential bonanza, remember that the deduction rests on using the SUV for business.
Education can pay off for parents on their tax return. Starting for 2002, up to $3,000 can be deducted for college and vocational school tuition. One catch: The deduction can't be claimed for a student who also benefits from either of two older forms of relief--the Lifetime Learning credit ($1,000 for 2002; $2,000 for 2003) or the Hope credit ($1,500 for 2002 and 2003). Because the credits directly offset tax, they are usually a better choice than the deduction, which reduces the income upon which tax is paid. But the deduction, available even to nonitemizers, may be useful for upper-income parents who are barred from the credits--which begin to phase out for 2002 when income tops $41,000, or $82,000 on a joint return. The deduction, by contrast, is available until it ends abruptly when income tops $65,000, or $130,000 on a joint return.
Saving for school. The education IRA has been refurbished under its new name of Coverdell Education Savings Account, in honor of the late Sen. Paul Coverdell of Georgia. The top annual deposit for each future student beneficiary is now $2,000 instead of $500. And the funds can be used for kindergarten through college. There's no deduction for deposits, but withdrawals of earnings are tax free when used for tuition, lodging, books, and other items. Another plus: Tapping the account no longer bars using a Hope or Lifetime Learning credit for other costs. Eligibility to make deposits has been eased--it doesn't start to phase out until income tops $190,000 on a joint return (the old level of $95,000 on a single return remains). You can make a deposit by April 15 that counts for 2002, then make one for 2003.
Graduates facing the burden of student loans can take a yearly deduction of up to $2,500 for the interest. In a big easing, the interest is now deductible for as long as it takes to pay off the loan, not for only up to five years. Also, the income at which eligibility begins to phase out is increased to $50,000 for 2002, or $100,000 on a joint return. (Parents who took out loans may also qualify for this deduction.) And nonitemizers can claim student loan interest on top of the standard deduction. Marriage penalty: The overall maximum on a joint return is $2,500 even if both spouses are repaying loans.
When day care instead of education may be the big expense, an expanding tax credit can help parents who pay for child care so they can hold a job. For 2002 expenses, middle-income parents can typically take a credit of $480 for one child under age 13 and $960 for two or more. For 2003, the benefit will be bigger--at least $600 and $1,200, respectively, but higher when income is below $43,000. And here's a tip: Day camp in the summer, when necessary to allow parents to work, counts as a deductible expense.
Speaking of kids, building a family by adoption can yield a bigger tax credit. Starting with 2002, up to $10,000 can be subtracted from your tax bill to defray legal, travel, and other expenses to complete the process. That's double the previous allowance, and the credit now doesn't begin to phase out until adjusted gross income tops $150,000, up from $75,000.
Midnight moves. Last-minute tax savers? Self-employed people, including moonlighters, can put a sizable sum into a retirement plan this year, yet apply the deposit to cut 2002 tax. And the caps are higher than ever. Procrastinators have until April 15, or later with an extension, to set up a Simplified Employee Pension (SEP) or to contribute to an existing one. The deposit can be up to about 20 percent of their self-employment income. The payoff: a 2002 tax deduction of as much as $40,000. Similar amounts can still be added to a typical Keogh plan, but it's too late to set up a new one for 2002. Employees, too, can tap expanded last-minute options. Workers who are not in a 401(k) or other retirement plan at work--or whose income is under certain limits--can use a tax-deductible IRA to still fund a nest egg and also trim the amount of income hit by tax. April 15 is the deadline to open an account and make a $3,000 deposit that's tax deductible on 2002's return--$1,000 more than previously allowed; persons 50 or older can put in an extra $500. (A couple filing a joint return can put in twice these amounts even if only one spouse works.)
In the end, 3 out of 4 taxpayers get a refund--an average of $2,195 among early filers this year, $41 more than at this time a year ago. They could often get the cash faster by reducing the tax withheld from their paychecks--a work sheet with the W-4 you give your employer can help, as can publication 919, "How Do I Adjust My Tax Withholding?" (www.irs.gov or 800-829-3676). But many look forward to the rebate and prefer to play it safe. Getting a check from the treasury is a lot easier to digest than writing one.
To read our weekly tax column, go to www.usnews.com.
No-cost help
Online filing
Free! That's the latest come-on at the IRS's Web site--www.irs.gov--where you can browse a list of 16 online tax preparers currently offering no-cost electronic preparation and filing of returns. But watch out. If you don't meet income or other limitations, you will be asked to pay. Income caps of $27,000 to $33,000 are common, though one site welcomes anyone with income over $50,000, another people 50 or older. Included are biggies TurboTax, TaxACT, and H&R Block.
You may be bombarded to buy extras--such as more extensive tax advice, filing a state return, or taking out an instant loan to immediately cash in on a refund.
Last year, 36 percent of taxpayers filed electronically. The goal is 80 percent by 2007, but that seems optimistic to many.
This story appears in the March 10, 2003 print edition of U.S. News & World Report.