If you are a high-income taxpayer, you may be familiar with what was called the "stealth tax."  This was the sneaky way that Congress raised your effective tax rate by reducing your itemized deductions and reducing or even eliminating your deduction for personal exemptions. 

I won't go into the detailed amount calculations, but rather give you the big picture.  This stealth tax will be cut by one-third beginning in 2006 and through 2007.  For 2008 through 2009 it will be reduced by two-thirds.  After 2009, it will be completely eliminated. 

The marriage penalty is the quirk in the tax law whereby two  people will pay more income tax on the same income if they are married as compared to each person filing a single (unmarried) tax return. 

There isn't much relief in this new tax law except for fairly low income couples.  The relief provision, which begins in 2005, consists of two pieces:  1)  the standard deduction for a married couple is gradually increased to twice the standard deduction for a single tax payer & 2) the 15% tax bracket for married joint filers is gradually increased to twice that for single taxpayers.  

There have been several qualitative and quantitative changes to tax incentives related to education costs. 

Education Savings Accounts (formerly called Education IRA's) have had several important changes beginning in 2002:

• Annual contribution limit increased to $2,000 from $500.  (Contribution is still not deductible from taxable income.) 
• Higher income taxpayers will be allowed to fund these accounts.  Upper income limitation for married joint taxpayers is increased to $190,000 - $220,000 from $150,000 - $160,000.
• Contributions can be made by April 15th of the following year.  (Old deadline was by December 31st of the current year.)
• Funds in the account can be used for elementary and secondary school expenses, not just post-secondary expenses.
• Age 18 restriction is eliminated as is the age 30 mandatory distribution rule where the beneficiary has "special needs" to be defined later in tax regulations.
• The 6% excise tax on contributions has been eliminated when education savings account contributions are made in the same year that contributions are made to a qualified state tuition program on behalf of the same beneficiary.

Qualified Tuition Programs (aka Section 529 Plans):
Under current law, these are state-sponsored college savings programs that allow parents or other taxpayers a tax-favored way to save for higher education.  Earnings accumulate tax deferred and are taxable to the beneficiary when distributed and used for qualified education costs.  Here are the improvements to these plans:

• Beginning in 2002, distributions from qualified state programs used for education costs will be tax-free.  Same treatment beginning in 2004 for distributions from qualified plans maintained by private institutions.
• Starting in 2002, private institutions will be able to maintain these plans.
• A transfer of credits (or other amounts) from one qualified tuition program to another for the same beneficiary will not be considered a distribution, as long as there is no more than one transfer within the 12-month period.
• Taxpayers will be able to claim education tax credits  (HOPE credit & Lifetime Learning credit) in the same year as a distribution from a Section 529 plan as long as the distributions are not used to pay the same expenses for which the taxpayer is claiming the credit.
  

New Deduction for Higher Education Costs:
Beginning in 2002, there is a new deduction for qualified higher education costs.  You don't have to itemize deductions to take it either.  However, you cannot take this deduction and also use the existing education credits (HOPE & Lifetime Learning) for the same student.  This deduction lasts for only four years, 2002 - 2005.  After 2005 it's gone.  (Remember that quaint talk about tax simplification?)  Like most of these new breaks, you can only use it if your income is under specified limits.  See the details in the table below:

Year	Maximum Deduction	Income Limit (Adj. Gross Income)
2002 - 2003	$3,000	$130,000 Joint filers $  65,000 Others
2004 - 2005	$4,000*	$130,000 Joint filers $  65,000 Others

* A reduced deduction of $2,000 is available during 2004 -2005 if your adjusted gross income is between $130,000 and $160,000 joint, or half as much for other filing statuses. 

 

Student Loan Interest Deduction:
Although student loan interest has been allowed as a deduction for some time, the new law reduces and/or eliminates some of the hoops you have to go through to take this deduction.  The annual maximum deduction of $2,500 has not been changed.  Here is a brief summary of the changes effective in 2002:

• Voluntary payments now qualify
• The loan no longer has to be within the first 60 months of required payments
• The maximum income limits (adjusted gross income) have been increased to $50,000-$65,000 for unmarried taxpayers and $100,000-$130,000 for married taxpayers

Bottom line is:  if you are paying a student loan, be sure to re-check your eligibility for this deduction in 2002.

Increased IRA Contribution Amounts
(Traditional IRA's and Roth IRA's):
After twenty years at  $2,000 per year, the maximum annual addition to IRA's are being increased.  Also, for taxpayers age 50 and over, even higher "catch-up" contribution limits are being phased in.  The following table shows the maximum annual contribution by year:

 

Maximum Annual Contribution to IRA Accounts (Traditional & Roth)
Year	Under Age 50	Age 50 & Over
2001	$2,000	$2,000
2002	$3,000	$3,500
2003	$3,000	$3,500
2004	$3,000	$3,500
2005	$4,000	$4,500
2006	$4,000	$5,000
2007	$4,000	$5,000
2008	$5,000	$6,000

 

Increased SIMPLE IRA Contribution Limits:
If you participate in a SIMPLE IRA where you work, the maximum amount of your compensation you can elect to put in the retirement savings plan is increasing.  Similar to regular IRA accounts above, if you are age 50 or over, you will have even higher annual limits.  The table below summarizes the yearly SIMPLE IRA contribution upper limits:

Maximum Annual SIMPLE IRA Contributions
Year	Under Age 50	Age 50 & Over
2001	$6,500	$6,500
2002	$7,000	$7,500
2003	$8,000	$9,000
2004	$9,000	$10,500
2005	$10,000	$12,500

 

Increased Contributions to 401(k), 403(b) & SAR-SEP Plans:
If you participate in any of these employer retirement plans where you work, the new law increases the amount of your salary that may be contributed on a pre-tax basis.  If you are age 50 or over, you can make even larger "catch-up" contributions.  The table below shows the annual maximum contribution limits:

Maximum 401(k), 403(b) & SAR-SEP Contributions
Year	Under Age 50	Age 50 & Over
2001	$10,500	$10,500
2002	$11,000	$12,000
2003	$12,000	$14,000
2004	$13,000	$16,000
2005	$14,000	$18,000
2006 & After	$15,000	$20,000

 

Increased Employer Retirement Plan Deductions:
Under the old law, employer contributions to a profit-sharing plan or stock bonus plan were limited to 15% of the employee's compensation.  Also, employee elective contributions to a 401(k) plan were counted as employer contributions for this calculation. 

Beginning in 2002, the employer contribution limit is increased to 25%.  Also, employee elective contributions will no longer be counted as employer contributions in this calculation. 

The maximum annual addition to an employee's account in a 401(k) or profit-sharing plan is increased.  (This is the combined employee elective contribution and the employer paid amount.)  Also, the maximum employee compensation that can be taken into account in calculating contributions is increased.  The table below summarizes the changes:

Increased Employer Plan Contribution Limits
Year	% Limit	Maximum Compensation	Maximum Annual Addition
2001	25%	$170,000	$35,000
2002	100%	$200,000	$40,000

The maximum compensation limit will be indexed for inflation annually. 

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