JOE R CHHABRIA

JOB CREATION AND WORKER ASSISTANCE
ACT OF 2002

July 30, 2002

Dear Clients and Friends,

On March 9, 2002, the President signed into law the Job Creation and Worker Assistance Act of 2002. It mostly benefits business and professional practices, and individuals as well in some cases.

Tax breaks for businesses and professional practices include the following changes:

...An additional 30% first year depreciation writeoff for most types of new nonrealty property acquired after Sept. 10, 2001 and before Sept. 11, 2004. For example, if a business or practice bought a new qualifying $10,000 machine normally depreciated over five years, the first year writeoff under the new law is $4,400. Under prior law, the maximum first year writeoff is only $2,000. The extra 30% first year writeoff also applies to certain types of interior improvements to leased nonresidential realty (such as an office building or factory).

...Additional depreciation of $4,600 on top of the normal first year depreciation allowed on new luxury autos bought for business purposes is effective for autos acquired after September 10, 2001 and before September 11, 2004. This applies only if the auto is used more than 50% for business, and is fully available only if the auto is used 100% for business. The net result is a larger up front deduction for those who buy new autos for use in their business or practice.

...The net operating loss (NOL) carryback period is increased from two or three years to five years, for NOL’s arising in tax years ending in 2001 or 2002. This change could create additional refunds for businesses suffering losses. Related changes help businesses with NOL’s avoid alternative minimum tax problems.

... Many tax breaks that expired at the end of 2001 are retroactively reinstated and extended for two years. These include the work opportunity tax credit and the welfare to work credit.

...A two year reprieve from an onerous rule that would have reduced an individual's personal nonrefundable credits (such as education credits) because of the alternative minimum tax (or AMT). Under the new law, for 2002 and 2003, you'll be able to use your personal nonrefundable credits to offset both your regular tax liability and your AMT liability.

...A crackdown on S corporation shareholders prevents them from increasing the basis of their stock in the entity (and thereby being able to deduct suspended losses) by debt that's forgiven and excluded from the corporation's income when the entity is bankrupt or insolvent.

...A number of changes, mostly favorable, deal with the enhanced retirement savings opportunities created by the 2001 tax law. For example, a change makes it clear that a person can make “catch up” contributions any time during the year he or she turns age 50, not just after the calendar date he or she attains age 50.

...For 2002 and 2003, there's a new up to $250 deduction for educators below the college level who spend their own money on books and other materials they use in the classroom. The new deduction is available to itemizers and non itemizers.

As a follow up to the letter to our clients and friends dated July 17, 2001 (visit www.joe@joechhabria.com) listed below are the top ten new tax changes effective in the year 2002.

A new 10% tax bracket is in. Other tax brackets have been reduced by one half percent. The current tax brackets are: 10%, 15%, 27%, 30%, 35%, and 38.6%.

The AMT (Alternative minimum tax) usually means a higher tax bill only if the “tentative minimum tax” (the tax found by applying the AMT rules) exceeds the regular tax bill. Nonrefundable personal credits for 2002 will be allowed only to the extent a taxpayer’s regular tax liability exceeds his or her “tentative minimum tax.” As a result, this credit limitation may reduce an individual’s nonrefundable personal credits and thus cause individuals to pay more tax even if he or she has no AMT liability. To better understand this, please go through the following examples:

Example 1: In 2002, the Greens’ regular tax is $7,400, and their tentative minimum tax $6,500. They have $1,200 in higher education credits and no other credits. Although they don’t owe AMT, they are able to claim only $900 of the education credits ($7,400 regular tax liability minus $6,500 tentative minimum tax).

Example 2: The facts are the same as in the prior illustration except that the Greens also have $1,200 in child credits. They pay a total tax after credits of $5,300. Their regular tax of $7,400 is offset by a $1,200 child credit and by $900 in education credits.

Example 3: In 2002, the Whites’ regular tax is $4,000, and their tentative minimum tax is $4,500. They have $1,000 in education credits and a $600 child credit. Since their tentative minimum tax exceeds their regular tax liability, they can’t claim any education credit for the year. However, they can use the full $600 child credit. Thus, their total tax after the child credit is $3,900 ($4,000 regular tax, plus $500 AMT, reduced by $600 child credit).

Qualified tuition programs (also called “Section 529 Programs”) generally allow taxpayers to buy tuition credits or certificates for their children or make contributions to an account set up to meet the qualified higher education expenses of their children. Distributions in 2002 from state- sponsored qualified tuition programs are tax-free if used for qualified higher education expenses (e.g., college tuition). The earnings part of such distributions made in 2001 was taxable to the child.

Coverdell education savings accounts (formerly known as Education IRAs) are liberalized significantly. The annual contribution limit for such an account is $2,000, up from $500 for 2001. Additionally, these accounts may now be used for a wide array of education expenses, such as elementary and secondary public, private, or religious school tuition and expenses, extended day programs, and computer purchases. Last year, the accounts could only be used for higher education type expenses.

For 2002, eligible taxpayers may claim a new deduction for higher education expenses. This deduction is available whether or not the taxpayer itemizes other deductions or claims the standard deduction. It's an up to $3,000 deduction for qualifying joint filers whose modified AGI (adjusted gross income) doesn't exceed $130,000 and for qualifying singles or heads of households whose modified AGI doesn't exceed $65,000.

Beginning in 2002, eligible lower income taxpayers may claim an annual tax credit (the saver's credit) for elective deferrals to qualified plans and IRAs (including Roth IRAs). The credit rate (50%, 20%, or 10%), which is applied against contributions of up to $2,000 per taxpayer, depends on filing status and AGI.

For 2002, the 401(k) elective deferral limit is $11,000 (up from $10,500 for 2001), and those age 50 or older can make extra, catch up contributions of $1,000 (if the plan permits catch up contributions to be made). These limits also apply generally to 403(b) annuities, salary reduction SEPs, and Sec. 457 (governmental) plans. Additionally, the maximum annual deferral limit in a SIMPLE plan is $7,000 for 2002 (was $6,500 for 2001), and those age 50 or older can make extra, catch up contributions of $500 (if the plan permits catch up contributions to be made).

For 2002, the maximum annual contribution to an IRA is $3,000 (it was $2,000 for 2001), and a taxpayer age 50 or older can make an additional catch up contribution of $500. Note that the higher IRA contribution limits also apply to Roth IRAs.

Workers who move from job to job have more flexibility when it comes to investing their retirement plan funds. Tax-free rollovers are permitted between more types of plans. For example, rollovers are now allowed between 403(b) plans and other types of eligible retirement plans, and after tax qualified plan contributions may be rolled over to an IRA. And more choices are available to surviving spouses who want to roll over a decedent's distributions. A surviving spouse may roll over a distribution from a qualified plan or IRA into an IRA or into a qualified plan, 403(b) annuity, or 457 plan in which the surviving spouse participates. Before 2002, a payout to the surviving spouse from the decedent's qualified plan or IRA could only be rolled over into another IRA.

A number of important rules have changed for individuals dying and gifts made in 2002:

... The annual per donee gift tax exclusion is $11,000 (it was $10,000 for 2001); $22,000 for spouses who split gifts (up from $20,000 for 2001).

... The unified credit exemption equivalent amount for both estate and gift tax purposes (the aggregate amount that can be transferred free of estate or gift tax during life or at death) is $1 million (it was $675,000 for 2001).

... The top estate and gift tax rate, and the GST (generation skipping transfer) tax rate is 50% (it was 55% for 2001).

Remember that I have only covered the high points of the complex new rules for 2002. Please feel free to call my office to discuss in detail how the changes may affect you, your family, and your business.