On June 7, 2001, President Bush signed The Economic Growth and Tax Relief Reconciliation 2001 which enacted yet another series of tax law adjustments. The new laws are fairly comprehensive, rather complicated, and take effect over an eight year period, with all changes reverting to existing 2001 tax law on January 1, 2011. Furthermore, President Bush has proposed a major restructuring of the tax code, the centerpiece being the elimination of individual income taxes on dividends paid by corporations (please see our analysis of the Bush plan on our website: www.martinwallcpa.com).

This ever changing tax code has confused taxpayers, as well as many tax and financial professionals. We have watched the financial news with an endless parade of so-called experts harping on particular aspects of the tax law changes which have limited applicabilty. Uncertainty about the tax code and the economy make having a comprehensive tax and financial strategy ever more important. Accordingly, we have prepared this summary of tax law changes to help you better understand what is going on so we can jointly plan for maximizing tax savings on a year by year basis, while giving consideration to the future changes.

For purposes of filing your 2002 tax returns, please review the following highlighted changes for 2002 and let us know if anything in particular applies to your circumstances. Although the tax law changes are more comprehensive then presented below, the following discussion is adequate to explain the major changes for 2002. For a more detailed discussion about your particular circumstances, please contact our office to setup an appointment.

In 2001, the tax bracket percentages were: 10%, 15%, 27.5%, 35.5% and 39.1%. These rates are being reduced for 2002 and will be: 10%, 15%, 27%, 35%, 38.6%. The income brackets where these tax rates take effect have been slightly adjusted to compensate for inflation. In 2003 these rates will remain the same. A further decrease of 1%, for the top three tax bracket will occur in 2004 and, again, in 2006 (except that the top bracket will be reduced by 2.6% in 2006 versus 1% for all other tax brackets). The declining marginal tax rates are summarized in the table below:

Tax Year	Marginal Tax Rates
2001	10.0%	15.0%	27.5%	35.5%	39.1%
2002	10.0%	15.0%	27.0%	35.0%	38.6%
2003	10.0%	15.0%	27.0%	35.0%	38.6%
2004	10.0%	15.0%	26.0%	34.0%	37.6%
2005	10.0%	15.0%	26.0%	34.0%	37.6%
2006	10.0%	15.0%	25.0%	33.0%	35.0%

Traditional IRA

The new tax law increases both the amount that can be contributed to a Traditional IRA as well as the adjusted gross income (AGI) limitations qualifying for IRA contributions. A Traditional IRA allows the taxpayer to deduct contributions from adjusted gross income, and qualified withdrawals are taxed as ordinary income. In contrast, a Roth IRA contribution cannot be deduced and is not taxed when withdrawn after reaching retirement age.

Effective in 2002, taxpayers may contribute $3,000 to an IRA account, up from $2,000 in 2001. Additionally, a single taxpayer who is an active participant in an employer-sponsored retirement plan will be able to contribute to a Traditional IRA, in full, if their AGI is under $34,000 (but can make a partial contribution until AGI reaches $44,000), up from 2001 levels of $30,000-$40,000. For married filing jointly taxpayer, in 2002, AGI limits increases to $54,000-$64,000, up from $50,000-$60,000 in 2001. For 2003, these AGI limits will increase to $40,000 to $50,000 (single filers) and $60,000 to $70,000 for married filing joint filers.

The federal government will be allowing even higher contribution limits to IRA accounts in 2004 and beyond. As stated above, the maximum contribution for a single taxpayer in 2002, 2003 and 2004 will be $3,000. In 2005, 2006 and 2007 the maximum contribution will be set at $4,000. Finally, 2008, a single taxpayer will be allowed contribute $5,000. Joint filers, subject to a major exception (one spouse who participates in an employer sponsored plan earns in excess of $160,000), will be allowed to each contribute the above amounts regardless of whether both spouses are gainfully employed.

These contribution and AGI limit increases will allow more people to fund Traditional IRAs (the type that are deductible as an adjustment to gross income on a tax return). Be aware that additional complexities exist, with respect to the contribution rules, if one spouse participates in an employer sponsored plan and one does not.Accordingly, please seek our advice prior to setting up and/or funding of an IRA if you are in this situation.

Special Increased IRA Funding For Those Over 50

The new tax laws for 2002 include the implementation of "catch up" IRA contributions for those 50 and above. This will enable those over 50 years of age to contribute to an IRA beyond the limits previously described in order to help for retirement. The table below summarizes the contribution limits for single taxpayers (double it for joint filers).

Roth IRAs

As in the past, a taxpayer may fund a Roth IRA (a type of IRA which is not a deduction but rather grows income tax free and is not subject to taxation upon distribution) even if they are a participant in an employer-sponsored retirement plan. In order to fund a Roth IRA in full, a single taxpayer’s AGI must be under $95,000. A "phased out" (prorated contribution on a sliding scale of income) contribution amount is available until AGI reaches $110,000. For married filing joint taxpayers the AGI "phase out" range is $150,000 to $160,000. Roth IRAs are subject to the same contribution limits as traditional IRAs. Also, you may fund both a Roth IRA and a Traditional IRA in the same year as long as the total of the contributions does not exceed the above limits.

If a taxpayer contributes to a retirement plan or IRA, it might be possible to claim an additional credit for doing so. The income limits are absolute and not subject to "phase outs" as is the case with so many other items in the tax code.

For single taxpayers, the AGI limit is $25,000 to qualify. For married filing jointly, the AGI limit is $50,000. The credit can be as high as $1,000 and is based upon how much is contributed to the retirement plan or IRA and is also reduced as income increases to the AGI limit. For example, if a single taxpayer contributed $1,500 to an IRA and had an AGI of $16,000, the retirement savings tax credit would be $1,500 * 20% = $300.

There are other tax rules that can affect this calculation such as any withdrawals from any pension plans, a taxpayer’s age, dependency status and whether the taxpayer is a full time student.

This credit did not previously exist.

We have already discussed some of the new, favorable, tax rules concerning IRAs, however, if you are self employed there is even better news.

Formerly, the deduction was contributions to a profit sharing plan or Simplified Employee Pension (SEP) were limited to 15% of compensation. Beginning in 2002, the limit will increase to 25% of compensation. Maximum funding of any retirement plan (or combination of retirement plans) is $40,000 (with the exception of those taxpayers over 50 who can fund an additional $1,000 amount).

Additionally, there is now a simplified version of a 401(k) plan for small businesses. In the past, it had been very expensive to administer a 401k plan (which allows you to defer salary up to $11,000) for a small business. With the creation of the single 401(k) small businesses can now benefit from this type of plan.

The tax planning strategies, for the self employed, increase with these new rules and types of plans. It would appear to make even more sense then before to hire significant others in a self employed taxpayer’s business. Naturally, very careful planning needs to be done to insure that everything is executed correctly. Likewise, please speak with us prior to attempting to implement any such plans.

The part of your self-employed health insurance premiums that you can deduct as an adjustment to gross income increased from 60% in 2001 to 70% in 2002. In 2003 and beyond, the percentage deductible as an adjustment to gross income will be 100%.

New in 2002 (and beyond) is the ability for eligible educators (i.e. teachers) to deduct, as an adjustment to gross income, an amount up to $250 for unreimbursed qualified expenses paid or incurred in 2002 for materials used in the classroom. An "eligible educator" is an individual who, for at least 900 hours in a given school year, is an instructor, educator, counselor, principal in a school that provides elementary or secondary instruction (K-12) as determined under state law.

Formerly, all such unreimbursed business expenses needed to be claimed on Schedule A, Miscellaneous Itemized Deductions, and were subject to a "floor" of 2% of AGI. Any expenses in excess of $250 will still be treated in this manner.

Two new rules now apply to interest on student loans. In the past, there was a provision that limited the student loan interest deduction to only that interest which was paid during the first 60 months of the life of the loan. This requirement is now stricken and no longer applies. All student loan interest paid is eligible for deduction subject to the limitations discussed below.

The maximum deduction allowable for student loan interest remains at $2,500 however, the income "phase out" range which allows for the deductibility in whole or in part increases from $40,000 to $55,000 (single) in 2001 to $50,000 to $65,000 (single) in 2002. For married filing jointly the "phase out" range increases from $60,000 to $75,000 in 2001 to $100,000 to $130,000.

A taxpayer may now be able to deduct, as an adjustment to income (above the "line") an amount up to $3,000 for qualified higher education tuition and related expenses. Consistent with the various education tax credits, the amounts paid for dependents or a spouse can be claimed.

Naturally, also consistent with IRS practice, the deduction will be limited to adjusted gross incomes of under $65,000 (single) and $130,000 (joint) with no "phase outs". This is an absolute limit. Additionally, this deduction must be considered in comparison to the various educational credits also available (Hope Scholarship Credit, Lifetime Learning Credit). A taxpayer cannot claim both an adjustment to gross income and one of the credits. Careful consideration of the optimal choice is needed. Please let us know if you believe you are in this situation.

The standard mileage rate allowable in 2002 is 36.5 cents per mile (up from 34.5 cents per mile in 2001) for business travel. Oddly, the mileage rate is set to decline in 2003 to 36 cents per mile.

A taxpayer can now include, for the first time, as a medical expense eligible for deduction, the cost of a weight-loss program as treatment for a specific disease (including obesity).

As a reminder, smoking cessation programs are also deductible if prescribed by a physician. Any over-the-counter treatments (like nicotine gum and patches) are not considered deductible medical expenses (get a prescription for it).

Also, the rate per mile that is deductible for travel related to medical care is now 13 cents per mile in 2002 (up from 10 cents per mile).

The maximum adoption credit available in 2002 is increased to $10,000 (up from $5,000 in 2001). AGI limits apply to this credit. The full credit is available if AGI is under $150,000. The "phase out" range for this credit ends when AGI exceeds $190,000. This AGI limitation is the same for all filing statuses.

There are several other technical issues regarding this credit, most dealing with the timing of when expenses are paid and what expenses qualify. Please consult with us for more details.

The above summary of the tax law changes should be considered a brief overview. As with any tax law, the "devil is in the details." The above summary is only intended to have the reader become aware of the major changes in the tax law for 2002 and not to be considered a complete discussion on the subject.

We urge you to contact us prior to attempting implementation of the above comments. Each taxpayer(s) situation is just a little bit different and all the facts need to be assessed before any advice can be rendered.

We will keep you informed as the new tax law proposals, recently made by President Bush, either become enacted or modified. With tax law, one of the major consistent points is constant change. Fortunately, the government usually does not eliminate a tax "break" once enacted but rather adds more rules (and exceptions). We are currently in a very dynamic tax environment with the coming weeks and months to see much potential change. Please revisit our website to check for updates.

Thank you for your interest and continued support.