Death & Taxes

Even More Tax Breaks!

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By Roy Lewis
April 26, 2002

While we were all in the middle of tax season, Congress slipped in some new tax laws on us. In case you missed it, on March 9, 2002, President Bush signed into law a tax package that will provide some tax relief to individuals but much greater tax breaks for businesses over the next few years. The official name of the legislation is the "Job Creation and Worker Assistance Act of 2002" (H.R. 3090) and is anticipated to cost $42 billion over 10 years, according to the Congressional Joint Committee on Taxation.

The new law offers larger depreciation deductions for business assets purchased, extends various expiring tax breaks, makes numerous "technical corrections" to prior tax legislation, creates a new deduction for teachers and educators, and grants $5 billion in special tax breaks to revitalize the area of lower Manhattan devastated by the September 11 terrorist attacks.

Most of the new law provisions become effective in 2002. But a few benefits, including accelerated write-offs for business equipment, were made retroactive to the 2001 tax year, which will affect 2001 tax returns that have likely already been filed. So if any of the following tax breaks apply to you, make sure that you get more information in order to determine if you should file an amended tax return for 2001 (assuming that you've already filed your 2001 return by this time) and recoup a few more tax dollars.    

Let's take just a few minutes to look at the highlights of the new legislation. 

New tax break for teachers
Teachers and other education professionals (even administrators, in some cases) who use their own money to buy classroom materials get a new break. In the past, most teachers wound up without any tax break for such out-of-pocket expenses because they reported these expenses as "miscellaneous itemized deductions." As you may be aware, these types of deductions are only allowable to the extent that they exceed 2% of your adjusted gross income (AGI). If you didn't itemize your deductions, these expenses were lost altogether. 

Under the new law, effective in 2002 and 2003 only, elementary- and high-school teachers will be allowed to deduct up to $250 of supplies each year without having to itemize their deductions. Many teachers spend much more than $250 per year, but at least this new tax law will provide a small deduction (and associated tax savings). 

Expenses that qualify for the deduction include books, supplies, equipment, and computer hardware and software. Teachers, counselors, and principals -- kindergarten through 12th grade -- are eligible.

Bigger depreciation deductions
The biggest new benefit allows businesses to claim greater first-year write-offs for purchases of computers, machinery, and other equipment. Businesses are eligible to claim an additional first-year depreciation deduction equal to 30% of the cost of the equipment. This "bonus depreciation" applies to most types of business property -- except for real estate -- purchased between Sept. 11, 2001, and Sept. 10, 2004. This is in addition to the "expensing" election of Code Section 179 (referred to as the "Section 179 election to expense" in tax parlance).  

For example, consider a business that acquired $1 million in equipment in 2002. The business would be allowed an additional first-year depreciation deduction of $300,000. The remaining $700,000 of the adjusted basis would be recovered in 2002 and subsequent years under the usual depreciation rules. Additionally, to allow more small-business taxpayers to realize the benefits of the new bonus depreciation rules, the new law temporarily raises the ceiling on first-year depreciation for passenger autos from $3,060 to $7,660.

Because the depreciation provision was made retroactive to purchases since Sept. 11, 2001, many businesses that purchased equipment late last year will be eligible for extra tax deductions on their 2001 income tax returns. Those who already filed their 2001 return can take advantage of the new law benefit by filing an amended tax return.

Technical corrections
The new law makes numerous "technical corrections" to the Tax Relief Act of 2001 as well as some earlier tax bills.

  • "Catch-up" retirement plan contributions: Beginning in 2002, the Tax Relief Act of 2001 allows workers age 50 and over to make contributions beyond the normal limits to 401(k)s and similar employer retirement plans. The economic stimulus legislation allows individuals to start making these "catch-up" contributions at the beginning of the year in which they're scheduled to reach age 50. You don't have to wait until your birthday to start. For example, say, you're going to turn age 50 on Nov. 30, 2003. You'll be eligible to start making catch-up contributions to your 401(k) plan in January 2003.
  • Adoption credit: The new law clarifies how much of an adoption credit is allowed beginning in 2002 for expenses that were incurred in prior years. The Tax Relief Act of 2001 increased the adoption credit to $10,000 per child beginning in 2002, up from $5,000 ($6,000 for special needs children). But the 2001 tax act didn't clarify the dollar limits that apply for expenses incurred prior to 2002 for adoptions that didn't become final until after 2001. The issue is important for parents who incurred expenses before the adoption became final. In such cases, they need to wait until the year after the expenses were incurred to claim the adoption credit.
  • Education breaks: In another clarification of the 2001 tax act, the economic stimulus legislation makes clear that beginning in 2002, families are no longer automatically disqualified from claiming the Hope or Lifetime college tuition credit for a student in the same year that money is withdrawn from the student's education savings account (formerly known as an Education IRA, but recently renamed to Coverdell ESA).
  • SEP plans: The new law corrects a technical mistake in the 2001 tax act to reflect Congress' intent to increase the annual contribution limit to Simplified Employee Pension (SEP) plans. As a result, the SEP contribution limit for 2002 jumps from 15% to 25% of compensation, up to a maximum deposit of $40,000.

Reinstating expiring tax breaks
The new law extends a long list of temporary tax breaks that recently expired or were scheduled to expire this year, including:

  • Alternative minimum tax: Of most relevance to individuals is a provision that protects most personal tax credits, including the dependent-care credit and the Hope and Lifetime college tuition credits, from being reduced by the alternative minimum tax. The provision had expired at the end of 2001. The new law extends the protection through the end of 2003.
  • Medical savings accounts: The new law extends the pilot program for medical savings accounts through the end of 2003. The program was scheduled to expire at the end of 2002.

Other tax breaks
Other tax breaks that were extended include:

  • Work Opportunity Tax Credit
  • Welfare-to-Work Tax Credit
  • Clean-fuel vehicle deduction
  • Credit for the purchase of electric vehicles
  • Credit for producing electricity from wind, biomass, and poultry litter
  • Tax incentives for investment on Native American reservations

Form 1099 reporting
The new law allows banks, brokerage firms, and other issuers of Form 1099 tax information reports to send the year-end tax statements electronically if the recipient consents. These would include things like your interest and dividend income, and sales made in your brokerage account. So you can expect your favorite financial institution to be asking for your permission to send the 1099 online next tax season.

New York tax relief
The new law creates special "Liberty Zone" tax breaks to help revitalize the area of lower Manhattan devastated by the Sept. 11 terrorist attacks. The Liberty Zone is the area located on or south of Canal Street, East Broadway (east of its intersection with Canal Street), or Grand Street (east of its intersection with East Broadway). Some tax relief is also available for businesses whose workplaces were destroyed or damaged due to the Sept. 11 attacks and were forced to locate elsewhere in New York City.

Scratching the surface
This is just the tip of the iceberg. If you'd like to read more about the law in painfully greater detail, point your Web browser to the Joint Committee on Taxation explanation. 

Roy Lewis lives in a trailer down by the river and is a motivational speaker when not dealing with tax issues, and he understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks he owns as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though.

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