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5 ways to use your 2003 taxes to cut your 2002 taxes A bevy of breaks for education, for your kids and for your retirement require that you plan today to take advantage tomorrow. Here are the areas to watch. By Jeff Schnepper The new tax bill that Congress passed and President Bush signed in 2001 offers a delectable menu of tax-planning choices that can help you cut your taxes. So, let's look at 2002, when the bulk of the tax law starts to take effect and how it might affect you this year and in 2003.
Here are five areas where good tax planning will get you tasty breaks and where you should search to trim tax bills. Rate reductions Many of us will get another a tax rate cut for this year, and the rate change will hold in 2003. Here’s how the rates change.
Your job now is the employ the classic tax-trimming strategy:
Education benefits Congress listened to calls for tax breaks to take the bite out of educating your kids. Most take effect in 2002. So get ready to use them. Here’s a rundown. Education IRAs. In 2002, the Education IRAs have been significantly changed and made into quite a nice tax break. The annual limitation on contributions is now $2,000, up from $500 in 2001. Expenses that qualify for the IRA have been expanded to include both elementary and secondary school expenses. This means that you can invest substantially more on a tax-deferred basis, and that you can use the money on expenses other than college costs. Two other important changes: You can earn as much as $220,000 a year and still qualify for some of the break, and starting in 2002, you can roll over unused Education IRA funds to other family members, provided they are under age 30, without penalty. Breaks for Hope or Lifetime Learning credits. Dollars coming out of an Education IRA will no longer count as income against your eligibility for a Hope or Lifetime Learning Credit, two other popular tax breaks for education. The one caveat: The distribution can’t be used for the same educational expenses for which the credit was claimed. Section 529 plans. These plans that let you save money for college on a tax-deferred basis have become much more attractive. Prior contributions were tax-deferred with distributions being taxed at the child’s lower rate if used for qualified college expenses. In 2002, qualified distributions are not just tax deferred but are completely tax-free! For more information on 529 plans, check the College Savings Plans Network Web site. (See link at left.) Also, check out Terry Savage’s article "Save for college and beat the tax man" for additional details. Student loan interest. In 2002, the 60-month limit on the deductibility of student loan interest is repealed. The exclusion for employer-provided education assistance is not only made permanent, but is extended to graduate education. Education expense deductions. In 2002, if you have an adjusted gross income of not more than $65,000 ($130,000 on a joint return), you’ll be allowed an above-the-line deduction for up to $3,000 in qualified higher education expenses paid. Above the line means you don’t have to itemize your deductions. What you should do now. Fund a Section 529 Plan as soon as possible. The income deferred this year magically becomes tax exempt on Jan. 1, 2002. Plus, you get the additional time to compound gains before withdrawal. Retirement benefits The new tax law made extensive changes to retirement planning with provisions changing every year for the next 10 years. This year, of course, you can make the contributions you always have made to 401(k) and other accounts. Don’t stop now. Next year, if you want, you can increase those contributions -- and save money on your taxes. Increases for 401(k) contributions. For 2002, limits for contributions to 401(k) accounts, SARSEPs (a tax-deferred retirement plan for companies with 25 or fewer employees) and for Section 403(b) annuities rise to $11,000 from $10,500; Section 457 Plan limits increase from $8,500 to $9,000. The dollar limit for defined-contribution plans increases to $40,000 (from $35,000 in 2001 and $30,000 in 2000). For the self-employed. As of January, if you’re self-employed, you’ll be able to contribute an amount roughly equal to 20% from the business into a qualified profit-sharing retirement plan. Because profit-sharing contributions are discretionary, rather than mandatory as under money purchase plans, many self-employed people will no longer have to contribute to combination plans each year to reach the maximum. This added flexibility gives you more control over your finances. IRA contribution limits go up. IRA contribution limits are up 50% from $2,000 in 2001 to $3,000 for 2002 through 2004. If you’re age 50 or older, you can make an additional “catch up” contribution of $500. That increases the 2002 IRA limit to $3,500. These catch-up provisions were designed as a matter of fairness to women, many of whom presumably spent time out of the workforce to raise children and who, as a result, had little to no earned income in some years. But workers of either sex can make catch-up contributions even if they have worked continuously. The new law also created a temporary nonrefundable retirement tax credit. You can receive a credit of up to 50% of the amount you save, up to a $1,000 credit on $2,000. Depending on your adjusted gross income, your credit ranges from 10% to 50%, with no credit allowed on a joint return with adjusted gross income over $50,000 ($25,000 for singles). Tax breaks related to kids The tax law does a lot for kids -- even if it did little to solve the logic problem of the marriage penalty in two-income families. The child care credit. The new tax law increased the child tax credit for children under age 17 to $600 for 2001 and 2002. The new law makes the credit, a dollar-for-dollar reduction in your tax, refundable up to 10% of your earned income in excess of $10,000. If you have three or more children, you’re allowed a refundable credit for the amount by which your Social Security taxes exceed your earned income credit, if that amount is greater than the refundable credit based on your earned income in excess of $10,000. Starting in 2002, the refundable portion of the tax credit will not constitute income and will not be treated as a “resource” for purposes of determining eligibility or the amount or nature of any benefits or assistance under any federal or state program financed by federal funds. This makes sense. If the objective of the credit is to put dollars in the pockets of those in need, our magnanimous government shouldn’t reduce eligibility for assistance because taxpayers qualify for the credit. Adoption assistance. The new tax law also permanently extends the exclusion from income for employer-provided adoption assistance. The maximum exclusion is increased to $10,000 per child, including special needs children. The new law also permanently extends the adoption credit for children other than special-needs children and increases the maximum credit to $10,000 per eligible child. It also permanently allows the adoption credit against the alternative minimum tax. Earned income credit Starting in 2002, the new law also simplifies the earned income credit for low-income taxpayers by increasing the qualifying phase-out amount by $1,000 and by excluding non-taxable compensation from the definition of “earned income” for calculation purposes. What should you do now: Maximize your retirement contributions and make them as soon as possible. It only hurts to delay the compounding of income. Unfortunately, our congressional mandarins have still left this as one of the most convoluted and complicated provisions in our tax code. It’s sad that those who can least afford it are compelled to retain two lawyers, a CPA, and a mechanic from Ohio with the gift of prophecy to determine if they can qualify for this negative income tax. It’s a provision that’s still in need of major revision. Many of the changes for 2002 involve changes in limits and are purely numerical in nature. But, unless you know the rules, you can’t effectively play the game. But be careful, these limits are designed to change each year, and many will be different in 2003. 
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