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2002 Tax Returns Reveal Share of Cheer, Drear
 

WASHINGTON - While Congress and President Bush debate future tax cuts, the news for taxpayers preparing their 2002 returns is a bevy of new incentives — to save for college and retirement, to file returns electronically and to plan for a more secure financial future.

Most taxpayers have already received a New Year’s greeting from the Internal Revenue Service in the form of a packet of income tax forms or a brochure on how to prepare and file forms online. Later this month, taxpayers will receive their W-2 forms summarizing last year’s wages.

New Democratic and Republican tax-cut proposals don’t affect the 2002 tax returns due April 15, but many taxpayers will see changes this tax season as a result of the complex, $1.35 trillion tax cut enacted in 2001. In fact, change will be the rule for the decade as the law’s 441 provisions are phased in each year through 2010.

For instance: For 2002, there’s a new deduction for college tuition and fees, and less paperwork for reporting dividend and interest income. Lower-income taxpayers will find a new credit for retirement savings, and lower-income working parents will find it easier to take a special credit to offset payroll taxes. Unlike deductions, which reduce the income on which tax is figured, credits reduce your tax dollar for dollar and are subtracted directly from tax owed.

Taxpayers who prepare their returns using a computer will find it easier and cheaper to file, thanks to an agreement between the Internal Revenue Service and some online tax preparers.

Not all the news is good. People who held on to losing mutual fund shares may be shocked to learn that they might nevertheless owe capital gains taxes on those losers. And homeowners who took advantage of 2002’s record-low interest rates to refinance mortgages need to be careful as they deduct mortgage costs.

Guides to the new tax provisions include IRS Publication 17, ‘‘Your Federal Income Tax 2002,’’ and Publication 553, ‘‘Highlights of 2002 Tax Changes,’’ available online at www.irs.gov or by calling (800) 829-3676.

Failure to keep up with each year’s available tax deductions comes at a steep price: Last year, for example, the General Accounting Office, Congress’ investigative arm, estimated that 2.2 million taxpayers overpaid their 1998 taxes an average of $438 per return — a total of $945 million — because they took the standard deduction instead of itemizing real estate taxes, charitable contributions, personal property taxes, mortgage interest and state and local income taxes.

Many taxpayers received bigger-than-usual refunds on their 2001 taxes, mostly due to a lowering of tax rates and expanded child tax credits. The $500 per-child credit went to $600, and many parents were able to take an additional refundable child tax credit that decreased as income rose.

But the Treasury Department said more than 600,000 taxpayers who appeared eligible for the refundable credit didn’t take it. The IRS notified these taxpayers of their possible eligibility late last year and advised them to file an amended 2001 return if they qualified.

For 2002 returns, it’s easier for working parents to qualify for the earned-income credit, which refunds some, all or even more than the taxes taken out of paychecks of lower-income workers during the year. New rules allow taxpayers to subtract tax-exempt income from the figure on which the credit is calculated.

People who took advantage of lower mortgage interest rates to refinance their homes will have to be careful in taking deductions for mortgage costs, especially if they refinanced.

Mortgage interest is generally deductible in the year paid. But when it comes to ‘‘points’’ — a point is a lender’s fee equal to 1 percent of the loan principal — only those for the portion of the refinancing that funded home improvements can be fully deducted for 2002. Mortgage closing costs aren’t deductible.

Taxpayers faced with college costs will find a new $3,000 deduction for higher education tuition and fees, two tax credits that apply to education costs, and new provisions that allow distributions from qualified tuition programs like section 529s to be tax-free if used for qualifying education expenses.

Educators also get a new tax break: Teachers in public and private elementary and secondary schools can subtract up to $250 of qualified classroom expenses when figuring their 2002 adjusted gross income.

Taxpayers with an eye toward retirement will find it’s not too late to take advantage of several new tax provisions.

The limit on tax-deferred contributions to Individual Retirement Accounts has increased from $2,000 to $3,000, and 2002 contributions for eligible IRA contributions can be made as late as April 15, 2003, when tax returns are due. People 50 and older can make additional ‘‘catch-up’’ contributions of $500 to $1,000, depending on the type of retirement plan.

Previously, taxpayers with interest or dividend income of more than $400 had to file Schedule B or Schedule 1 with their 1040 or 1040A tax returns. For 2002, only taxpayers with more than $1,500 of interest or dividend income need to file those schedules.

Tax rates dropped for 2001, and the top four income tax rates fell again for 2002 — to 38.6 percent, 35 percent, 30 percent and 27 percent. The new 10 percent tax rate for 2001 is reflected in the 2002 tax tables, so there’s no need to make a separate computation — as there was for 2001 — to get that benefit.

Taxpayers who weathered the stock market’s downward spiral last year might not expect to pay a capital gains tax on stock or mutual funds, since those assets probably lost value. But a loss can only be claimed on an asset if the taxpayer disposed of the asset during 2002 for less than it cost.

Even then, the amount of net capital loss that may be subtracted on line 13 of form 1040 is limited to $3,000 for the year. Excess loss can be carried over to future tax years.

Taxpayers who held on to losing mutual funds might even have to pay capital gains tax on those losers if the fund’s portfolio manager sold some of a fund’s holdings during the year at a profit.

‘‘If you’ve got a portfolio that’s taken one heck of a slide this year, you don’t have a loss until you sell it,’’ said Don Roberts, an IRS spokesman. ‘‘All the ups and downs that occurred during the year don’t affect your taxes.’’

During the next few years the estate tax is being phased out, income tax rates will drop and contribution ceilings on retirement savings will rise. Such changes suggest taxpayers should look down the road a bit and figure out how best to take advantage of tax provisions that affect their financial future.

‘‘They’ve got to sit down and discipline themselves to do some planning,’’ Roberts said. ‘‘There’s a whole lot of stuff to take a look at.’’

By Eileen Putman
Associated Press (January 9, 2003)

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