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Decoding 2002 taxes

Changes in the tax code affect everything from college costs to retirement savings. And, as rates decrease, more taxpayers must beware the Alternative Minimum Tax.

By HELEN HUNTLEY, Times Staff Writer

© St. Petersburg Times
published February 16, 2003


The holiday decorations are packed away, the Super Bowl festivities are over and the Gasparilla pirates have tossed their beads. Now it's time to move on to something considerably less fun: settling up with the IRS.

Tax time arrives this year with the usual blizzard of forms in the mailbox, along with enough new wrinkles in the tax code to keep professional preparers fully employed.

This year's changes are good news for retirement savers, low-income families and people saving toward or paying college expenses. The downside: Each change adds another layer of complexity to an already-daunting tax code.

The instruction manual for Form 1040 is now 126 pages, up from 56 in 1987 when the Tax Reform Act of 1986 was supposed to make life simpler for taxpayers. More than half of all returns are now signed by a paid tax preparer.

Most of the new tax breaks for 2002 returns come with income restrictions. Some interact with other tax breaks, so taking advantage of one may disqualify you from another. But if there is a chance you qualify, the new tax breaks are definitely worth a look.

For moderate- and low-income workers, the new Retirement Contribution Savings Credit is generating some excitement. A credit of up to $1,000 can be claimed for contributions to savings plans such as 401(k)s and IRAs. Because the deadline for 2002 IRA contributions isn't until the tax filing deadline of April 15, there is still time to make a contribution and cash in on the deal.

"There are some instances where you can fund a $1,000 IRA and it costs you $190," said Julie Rowan, district manager for H&R Block in St. Petersburg. That calculation assumes the lower income after deducting your IRA contribution entitles you to additional benefits such as a larger Earned Income Tax Credit.

"You can even get your refund quick, then use it to fund the IRA," Rowan said. "It's nice to be able to work with clients and help them save more tax dollars."

The saver's credit is largest -- 50 percent of the amount contributed -- for people with incomes less than $15,000 (single) or $30,000 (married.) A smaller credit is available for those with incomes of up to $25,000 (single) or $50,000 (married.)

Annual limits on all types of IRA contributions are larger this year. Those with earned income can contribute up to $3,000 to an IRA, plus an extra $500 if they are 50 or older. A 50-plus husband and wife could sock away $7,000 for 2002 and another $7,000 for 2003. Income limits and other rules still determine whether the contribution is deductible. Contribution limits also have been increased for other types of retirement savings plans.

Even if you don't qualify for any of the new credits or deductions, your taxes will drop slightly if your financial situation is the same as it was last year. That's because the standard deduction and personal exemption have been increased to account for inflation, and most tax rates are a little lower. For example, the old 28 percent tax rate fell to 27.5 percent for 2001 and dropped to 27 percent for 2002.

Although most aspects of tax preparation are more complicated, one group will find things a little easier. Savers who received $1,500 or less in interest income last year can now report it on a Form 1040EZ if they meet other qualifications to use the simple form. The previous limit was $400 in interest income.

Life also has gotten easier and more rewarding for some low-income families claiming the refundable Earned Income Tax Credit. The IRS has simplified the rules that apply when more than one worker might be able to claim the credit. In the past, if a parent and child lived with the child's higher-earning grandparent, the amount of the credit would be based on the grandparent's income. Now it can be based on the parent's even if the parent earns less.

"It's getting more money into households with lower incomes," said Rowan at H&R Block.

Another new tax break for lower-income households this year is a small reduction in the capital gains tax. For taxpayers in the 15 percent bracket, gains on the sale of investments held more than five years will be taxed at just 8 percent rather than the 10 percent rate that applies to assets held from one to five years. To calculate the tax, you have to use a special worksheet found in the instructions for Schedule D, one of the more complicated parts of the tax form.

Higher-income taxpayers will have to wait until 2006 before they get any benefit from the special rules for five-year holding periods.

In fact, higher-income taxpayers don't have much to get excited about this year.

"It's mostly just small changes in rates and other limitations," said Gregory Rosica, a CPA with Ernst & Young in Tampa. However, even small changes sometimes have a big impact if they put you over or under one of the many seemingly arbitrary IRS income limits.

"You continually have to look at things like the phaseouts of the itemized deductions and exemptions," Rosica said. Those are things people don't focus on and end up getting surprised by. The other thing you have to keep an eye on is the Alternative Minimum Tax. As the tax rates keep coming down over the next couple of years, we'll continue to see more people hit by the AMT. That's something that people tend to ignore."

The AMT is designed to make sure that nobody escapes the clutches of the IRS. It is based on a separate calculation that disallows personal exemptions and some deductions that can be used in the regular income tax computation. You pay the AMT amount if it is higher than your regular income tax liability. In the past, most people could safely ignore it because their regular tax bills were higher.

As Congress adds new credits and reduces tax rates for income tax calculations, more people find their regular tax bill is less than the AMT amount. Then what Congress has given them, the AMT takes away. Tax preparers now routinely calculate returns both ways. Unless the rules change between now and then, by 2010, about one-third of all taxpayers are expected to pay AMT rather than regular tax bills.

With or without the AMT, calculating what you owe is becoming more complicated every year.

"Tax preparation is too complicated to consider doing myself," said periodontist David Dolgin of Tampa. Although he is semiretired, he said his tax situation has become more complex. His tax return now takes into account Social Security payments, his wife's pension income, mandatory IRA distributions and the AMT.

"I appreciate my CPA's specialized knowledge and skill," he said.

One group that will be in need of more such specialized help is parents facing higher-education expenses. Several new education tax breaks go into effect this year, including the ability to take tax-free withdrawals from the Florida Prepaid College Plan, but parents must pick and choose among them (See related story, page x.)

Small-business owners also may benefit from professional help this year to make sure they are taking full advantage of a 30 percent depreciation bonus on the purchase of some types of business property, the five-year carryback period for net operating losses and other provisions that were part of last year's tax legislation.

Even before this year's tax forms have been completed, many people are looking to the future, speculating about the next set of tax law changes. Based on the proposals President Bush has sent Congress, the possibilities include elimination or reduction of the tax on stock dividends and elimination of or changes to the AMT.

"People are more focused on the upcoming potential changes," Tampa CPA Rosica said. "They're looking for tax planning opportunities if the law changes and how that will impact overall investment strategy."

-- Helen Huntley can be reached at huntley@sptimes.com or (7270 893-8230.

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