Tax Changes for Individuals
2002 Changes

Standard Mileage Rate

For 2002, the standard mileage rate for the cost of operating your car, van, pickup, or panel truck is increased to 36 ¹ /2 cents a mile for all business miles.

Car expenses and use of the standard mileage rate are explained in chapter 4 of Publication 463, Travel, Entertainment, Gift, and Car Expenses.

Social Security and Medicare Taxes

For 2002, the employer and employee will continue to pay:
1) 6.2% each for social security tax (old-age, survivors, and disability insurance), and
2) 1.45% each for Medicare tax (hospital insurance).

Wage limits. For social security tax, the maximum amount of 2002 wages subject to the tax has increased to $84,900. For Medicare tax, all covered 2002 wages are subject to the tax. For information about these taxes, see Publication 15, Circular E, Employer’s Tax Guide.

Survivor Benefits for Public Safety Officers

For tax years beginning after 2001, a survivor annuity received by the spouse, former spouse, or child of a public safety officer killed in the line of duty will generally be excluded from the recipient’s income regardless of the date of the officer’s death. Survivor benefits received before 2002 are excludable only if the officer died after 1996. For more information, see Public safety officers, in Publication 559, Survivors, Executors, and Administrators.

Retirement Planning Services

Beginning in 2002, if your employer has a qualified retirement plan, qualified retirement planning services provided to you (or your spouse) by your employer will not be included in your income. Qualified retirement planning services include retirement planning advice and information. However, the value of any tax preparation, accounting, legal, or brokerage services provided by your employer will still be included in your income. For more information about benefits your employer will not include in your income, see Fringe Benefits in Publication 525, Taxable and Nontaxable Income.

Tax Benefits for Education

The following paragraphs explain the changes to tax benefits for education.

Employer-Provided Educational Assistance

The tax-free status of up to $5,250 of employer-provided educational assistance benefits each year for undergraduate-level courses was scheduled to end for courses beginning after 2001. This benefit has been extended indefinitely and, beginning in 2002, it also applies to graduate-level courses. For more information, see chapter 7 in Publication 970, Tax Benefits for Higher Education.

Qualified Tuition Programs (QTPs)

Beginning in 2002, changes apply to what were formerly known as qualified state tuition programs. For more complete information on QTPs, see chapter 8 in Publication 970, Tax Benefits for Higher Education.

Name change. Qualified state tuition programs are renamed qualified tuition programs (QTPs).

Distributions from state-maintained QTPs. A distribution from a QTP established and maintained by a state (or an agency or instrumentality of the state) can be excluded from income if the amount distributed is used for higher education. Previously, the beneficiary was required to pay tax on any earnings from a QTP unless the earnings were tax-free under some other provision of the law.

QTPs maintained by educational institutions. You can make contributions to a QTP established and maintained by one or more eligible educational institutions. Any earnings distributed before January 1, 2004, will be taxable.

Previously, contributions could only be made to a QTP established and maintained by a state (or an agency or instrumentality of the state).

Rollovers of QTPs to family members. For purposes of rollovers and changes of designated beneficiaries, the definition of family members is expanded to include first cousins of the beneficiary.

Rollovers of QTPs without changing the beneficiary. Amounts in a QTP can be rolled over, tax free, to another QTP set up for the same beneficiary. However, the rollover of credits or other amounts from one QTP to another QTP for the benefit of the same beneficiary cannot apply to more than one transfer within any 12-month period.

Qualified expenses. Calculation of the amount that is considered reasonable for room and board expenses has been changed. You must contact the educational institution for their qualified room and board costs.

Special needs beneficiaries. The definition of “qualified higher education expenses” has been expanded to include expenses of a special needs beneficiary that are necessary for that person’s enrollment or attendance at an eligible institution.

Coordination with Coverdell ESAs. You can make contributions to QTPs and Coverdell ESAs in the same year for the same beneficiary. Previously, you could only make contributions to one program or the other.

Coverdell ESAs - (Formerly Education IRAs)

Beginning in 2002, the following changes apply to Coverdell education savings accounts (Coverdell ESAs). For more complete information on Coverdell ESAs, see chapter 4 in Publication 970, Tax Benefits for Higher Education.

Maximum contribution. The most you can contribute each year to a Coverdell ESA is increased from $500 to $2,000.

Income limits. If you file a joint return, the amount you can contribute to a Coverdell ESA will be phased out (gradually reduced) if your modified adjusted gross income (MAGI) is more than $190,000 but less than $220,000. You will not be able to contribute to a Coverdell ESA if your MAGI is $220,000 or more. This is an increase in the phaseout range for married taxpayers filing joint returns (which was between $150,000 and $160,000 in 2001).

Contribution due dates. The final date on which you can make contributions to a Coverdell ESA for any year has been extended to the due date of your return for that year (not including extensions). If you are a calendar year taxpayer, you generally will have until April 15, 2003, to make your contribution for the 2002 tax year. In previous years, contributions were required to be made by December 31.

Correcting excess contributions. The 6% excise tax on excess contributions will not apply to any excess contributions withdrawn by June 1 of the following year if the earnings on the excess are also withdrawn. Previously, these amounts had to be withdrawn by the due date for the beneficiary’s return or, if no return was required, by April 15 of the following year.

Qualified expenses. The definition of qualified education expenses has been expanded to include elementary and secondary education expenses. Qualified elementary and secondary education expenses include expenses for:

• Tuition, fees, academic tutoring, special needs services in the case of a special needs beneficiary, books, supplies, and other equipment incurred in connection with enrollment or attendance as an elementary or secondary school student at a public, private, or religious school,

• Room & board, uniforms, transportation, and supplementary items and services (including extended day programs) which are required or provided by a public, private or religious school in connection with such enrollment or attendance, and

• The purchase of computer technology or equipment or Internet access and related services, if such technology, equipment, or services are to be used by the beneficiary and the beneficiary’s family during any of the years the beneficiary is in school (not including expenses for computer software designed for sports, games, or hobbies unless the software is predominantly educational in nature).

Special needs beneficiaries. You can continue to make contributions to a Coverdell ESA for a special needs beneficiary after his or her 18th birthday.

You can also leave assets in a Coverdell ESA set up for a special needs beneficiary after the beneficiary reaches age 30.

Coordination with Hope and lifetime learning credits. You can claim the Hope or lifetime learning credit in the year you take a tax-free distribution from a Coverdell ESA, provided the distribution from the Coverdell ESA is used for the same expenses for which the credit is claimed. Previously, you could not claim the Hope or lifetime learning credit if you received a tax-free withdrawal from a Coverdell ESA and did not waive the tax-free treatment of the withdrawal.

Coordination with qualified tuition programs (QTPs).

You can make contributions to Coverdell ESAs and qualified tuition programs in the same year for the same beneficiary. Previously, you could only make contributions to one program or the other.

New Deduction for Higher Education Expenses

Beginning in 2002, you may be able to deduct qualified tuition and related expenses paid during the year for yourself, your spouse, or a dependent, even if you do not itemize deductions on Schedule A, Form 1040.

Qualified tuition and related expenses. In general, qualified tuition and related expenses are tuition and fees paid for you, your spouse, or a dependent for whom you claim an exemption that are required for enrollment or attendance at an eligible educational institution.

Student-activity fees and fees for course-related books, supplies, and equipment are included in qualified tuition and related expenses only if the fees must be paid to the institution as a condition of enrollment or attendance.

Eligible educational institution. An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by Department of Education. It includes virtually all accredited, public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. The edu-institution should be able to tell you if it is an eligible educational institution.

Adjustments to qualified expenses. You must reduce qualified expenses by the amount of any tax-free educational assistance you received. Tax-free educational assistance includes:

• Scholarships,
• Pell grants,
• Employer-provided educational assistance,
• Veterans’ educational assistance, and Any other nontaxable payments (other than gifts, bequests, or inheritances) received for education expenses.

Expenses that do not qualify. Qualified tuition and related expenses do not include the cost of:

• Insurance,
• Medical expenses (including student health fees),
• Room and board,
• Transportation, or
• Similar personal, living, or family expenses.

This is true even if the fee must be paid to the institution as a condition of enrollment or attendance.

Qualified tuition and related expenses generally do not include expenses that relate to any course of instruction or other education that involves sports, games or hobbies, or any noncredit course. However, if the course of instruction or other education is part of the student’s degree program, these expenses can qualify.

Maximum deduction. For tax years beginning in 2002 and 2003, you may be able to deduct up to $3,000 you paid for qualified tuition and related expenses as an adjustment to income. For 2004 and 2005, you may be able to deduct up to $4,000.

Income limits. For tax years beginning in 2002 and 2003, you can deduct up to $3,000 of qualified tuition and related expenses if your modified adjusted gross income (MAGI) is not more than $65,000 ($130,000 on a joint return). If your MAGI is more than $65,000 ($130,000 on a joint return), you cannot take the deduction.

For tax years beginning in 2004 and 2005, you can deduct up to $4,000 of qualified tuition and related expenses if your MAGI is not more than $65,000 ($130,000 on a joint return). If your MAGI is more than $65,000 ($130,000 on a joint return) but not more than $80,000 ($160,000 on a joint return), you can deduct up to $2,000 of qualified tuition and related expenses. If your MAGI is more than $80,000 ($160,000 on a joint return), you cannot take the deduction.

Modified adjusted gross income (MAGI). For purposes of this deduction, your MAGI is the adjusted gross income shown on your return plus any foreign earned income exclusion, foreign housing exclusion or deduction, exclusion of income for bona fide residents of American Samoa, and exclusion of income from Puerto Rico.

Coordination with credits and other deductions. You cannot deduct any amount for qualified tuition and related expenses for a year if:

• A Hope credit or lifetime learning credit is claimed with respect to expenses of the individual for whom the tuition and related expenses were paid, or
• You can deduct the expense under any other provision of the law.

Coordination with exclusions. You must reduce your qualified tuition and related expenses by:

• Expenses you used to figure the amount of interest on qualified U.S. savings bonds that you excluded from income because you used it to pay qualified higher education expenses,
• Expenses you used to figure the amount of any tax-free withdrawals from a Coverdell ESA, and
• Expenses you used to figure the portion of any distribution of earnings from a qualified tuition program (QTP) you exclude from income because the earnings were used to pay the beneficiary’s qualified higher education expenses.

Limits on eligibility. You cannot claim the deduction for qualified tuition and related expenses if any of the following apply.

• Another taxpayer is entitled to claim an exemption for you as a dependent on his or her return. This is true even if the other taxpayer does not actually claim your exemption.
• Your filing status is married filing separate return.
• You are a nonresident alien and you have not elected to be treated as a resident alien for the tax year.

Year of deduction. Generally, you can deduct only those expenses for a year that are in connection with enrollment at an institution of higher education during the same year.

However, you can deduct expenses paid in a year if they are for an academic period beginning within the year or during the first three months of the next year.

Student name and ID number. To take the deduction, you must show on your income tax return the name and taxpayer identification number (usually the social security number) of the person for whom the expenses were paid.

Termination. This deduction is not available for tax years beginning after 2005.

Student Loan Interest Deduction

If you pay interest on a student loan, you may be able to deduct the interest as an adjustment to income. For more complete information on the student loan interest deduction, see chapter 3 in Publication 970, Tax Benefits for Higher Education.

Elimination of 60-month limit. Beginning in 2002, the requirement that you can only deduct student loan interest paid during the first 60 months that interest payments are required is eliminated.

Limit on deduction based on modified adjusted gross income. Beginning in 2002, the amount of your student loan interest deduction will be phased out (gradually reduced) if your modified adjusted gross income (MAGI) is between $50,000 and $65,000 ($100,000 and $130,000 if you file a joint return). You will not be able to take a student loan interest deduction if your MAGI is $65,000 or more ($130,000 or more if you file a joint return). For 2001, the deduction was phased out if your MAGI was between $40,000 and $55,000 ($60,000 and $75,000 if you filed a joint return) and you could not take a student loan interest deduction if your MAGI was $55,000 or more ($75,000 or more if you filed a joint return).

Modified Adjusted Gross Income (MAGI). Prior to 2002, your MAGI for purposes of the student loan interest deduction was your adjusted gross income as shown on your return modified by adding back any:
1) Foreign earned income exclusion,
2) Foreign housing exclusion or deduction,
3) Exclusion of income for bona fide residents of American Samoa, and 4) Exclusion of income from Puerto Rico.

Beginning in 2002, you must also add back any deduction of qualified tuition and related expenses.

Meal Expenses When Subject to “Hours of Service” Limits

Generally, you can deduct only 50% of your business-related meal expenses while traveling away from your tax home for business purposes. You can deduct a higher percentage if the meals take place during or incident to any period subject to the Department of Transportation’s “hours of service” limits. (These limits apply to workers who are under certain federal regulations.) The percentage is 65% for 2002 and 2003. Business meal expenses are covered in chapter 1 of Publication 463, Travel, Entertainment, Gift, and Car Expenses.

Self-Employed Health Insurance Deduction

For 2002, this deduction increases to 70% of the amount paid for medical and qualified long-term care insurance for you and your family. After 2002, the deduction will increase to 100%. For more information, see chapter 7 in Publication 535, Business Expenses.

Earned Income Credit

The following paragraphs explain the changes to the earned income credit for 2002. The earned income credit for 2001 is explained in Publication 596, Earned Income Credit.

New definition of earned income. The amount of earned income credit you can claim is based, in part, on your earned income. For tax years after 2001, earned income will no longer include nontaxable employee compensation. Nontaxable employee compensation includes amounts such as salary deferrals and reductions, excludable dependent care benefits, and excluded combat pay.

Elimination of modified adjusted gross income (AGI). For tax years after 2001, you will no longer need to figure modified AGI. Your earned income credit will be figured using your AGI, not modified AGI.

New rules for persons with same qualifying child. For tax years after 2001, if two or more persons may be able to claim the same qualifying child, the qualifying child can be claimed only by:

• The parents, if they file a joint return,
• The parent, if only one of the persons is the child’s parent,
• The parent with whom the child lived the longest during the year, if two of the persons are the child’s parent,
• The parent with the highest AGI if the child lives with each parent for the same amount of time during the year, or
• The person with the highest AGI, if none of the persons is the child’s parent.

New definition of foster child. For tax years after 2001, the definition of an eligible foster child is changed. The will have to live with you only for more than half of the tax year. Previously, the child must have lived with you the entire year.

Reduction of EIC by alternative minimum tax eliminated. For tax years after 2001, your earned income
credit will no longer be reduced by the amount of alternative minimum tax shown on your return.

Tax Benefits for Adoption Extended and Expanded

Under current law, you can take a tax credit for expenses paid to adopt a child. In addition, you can exclude from income certain amounts paid or reimbursed by your employer for qualifying adoption expenses under an adoption assistance program. Beginning in 2002, there are significant changes to the credit and exclusion.

Credit and exclusion now permanent. The credit, which was scheduled to end after 2001 (except for children with special needs), has been permanently extended. The exclusion, which was scheduled to end after 2001, has also been made permanent.

Amount of credit and exclusion increased. Beginning in 2002, the maximum credit and exclusion will increase to $10,000. Beginning in 2003, a $10,000 credit or exclusion will be allowed for the adoption of a child with special needs regardless of whether the taxpayer has qualifying expenses.

The income limit based on modified adjusted gross
income (modified AGI) will also increase. The following table shows whether the income limit will affect the credit or exclusion.

IF your modified AGI is     THEN the income limit
$150,000 or less            Will not affect your 
                            credit or exclusion.
$150,001 to $189,999        Will reduce your credit 
                            or exclusion.
$190,000 or more            Will eliminate your credit 
                            or exclusion.

More information. The adoption credit and exclusion are explained in more detail in Publication 968, Tax Benefits for Adoption. The January 2002 revision of that publication will reflect the changes in the law. This revision should be available by March 2002.

Electric and Clean-Fuel Vehicles

The maximum clean-fuel vehicle deduction and qualified electric vehicle credit are 25% lower for 2002 than they were for 2001. Both the credit and the deduction will be phased out completely by 2005. For more information about electric and clean-fuel vehicles, see chapter 12 in Publication 535, Business Expenses.

Self-Employment Tax

The self-employment tax rate on net earnings remains the same for 2002. This rate, 15.3%, is a total of 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).

The maximum amount subject to the social security part for tax years beginning in 2002 has increased to $84,900. All net earnings of at least $400 are subject to the Medicare part.

Certain Withholding Rates Decreased

For 2002, the withholding rates on the following items have been decreased.

1. Gambling winnings. The rate is decreased to 27%.
2. Unemployment compensation. The rate decreased to 10%.
3. Federal payments. Withholding on certain federal payments is voluntary. The elective rates are decreased to 7%, 10%, 15%, and 27%.
4. Backup withholding. The rate is decreased to 30%.
5. Supplemental wages. The rate is decreased to 27%.

Withholding on these items is discussed in chapter 1 of Publication 505, Tax Withholding and Estimated Tax.

Estimated Tax for Higher Income Taxpayers

For installment payments for tax years beginning in 2002, the estimated tax safe harbor for higher income individuals (other than farmers and fishermen) has been modified. If your 2001 adjusted gross income is more than $150,000 ($75,000 if married filing a separate return), you will have to pay the smaller of 90% of your expected tax for 2002 or 112% of the tax shown on your 2001 return to avoid an estimated tax penalty. The estimated tax penalty is explained in chapter 4 of Publication 505, Tax Withholding and Estimated Tax.

Tax-Exempt Bond Financing for Qualified Public Educational Facilities

Beginning in 2002, the private activities for which state and local tax-exempt bonds may be issued will be expanded to include providing qualified public educational facilities.

A qualified public educational facility is any school facility that is:

1) Part of a public elementary school or a public secondary school, and

2) Owned by a private, for-profit corporation under a public-private partnership agreement with a state or local educational agency.

The issuer of the bond should be able to tell you whether the bond is tax-exempt.

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