All material in this publication may be reprinted freely. A citation to Your Federal Income Tax (2002) would be appropriate.

The explanations and examples in this publication reflect the interpretation by the Internal Revenue Service (IRS) of:

• Tax laws enacted by Congress
• Treasury regulations, and
• Court Decisions.

However, the information given does not cover every situation and is not intended to replace the law or change its meaning.

This publication covers some subjects on which a court may have made a decision more favorable to taxpayers than the interpretation by the IRS. Until these differing interpretations are resolved by higher court decisions or in some other way, this publication will continue to present the interpretations by the IRS.

All taxpayers have important rights when working with the IRS. These rights are described in Your Rights as a Taxpayer in the back of this publication.

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Introduction

This publication can help you prepare your tax return by taking you through each part of the return. It supplements the information in your tax form instruction booklet. It explains the tax law and will help you understand your taxes so that you pay only the tax you owe and no more.

The publication begins with the rules for filing a tax return. It explains who must file a return, which tax form to use, when the return is due, and other general information. It will help you identify which filing status you qualify for, whether you can claim any dependents, and whether the income you are receiving is taxable. The publication goes on to explain the standard deduction, the kinds of expenses you may be able to deduct, and the various kinds of credits you may be able to take to reduce your tax.

Throughout the publication are examples showing how the tax law applies in typical situations. Sample forms and schedules show you how to report certain items on your return. Also throughout the publication are flowcharts and tables that present tax information in an easy-to-understand manner.

The index in the back of the publication will help you find the information you need.

Some material that you may find helpful is not included in this publication but can be found in your tax form instruction booklet. It includes the following information.

• List of where to report certain items listed on information documents.
• List of mailing addresses for where to file returns.
• List of recorded tax information topics (TeleTax).

If you operate your own business or have other self-employment income, such as babysitting or selling crafts, see the following publications for more information.

• Publication 334, Tax Guide for Small Business (For Individuals Who Use Schedule C or C-EZ).
• Publication 533, Self-Employment Tax.
• Publication 535, Business Expenses.
• Publication 587, Business Use of Your Home (Including Use by Day-Care Providers).

For information on how you can get free IRS publications and forms, see How To Get Tax Help in the back of this publication.

IRS mission.   Provide America's taxpayers top quality service by helping them understand and meet their tax responsibilities and by applying the tax law with integrity and fairness to all.

Comments and suggestions.   We welcome your comments about this publication and your suggestions for future editions.

You can e-mail us while visiting our web site at www.irs.gov.

You can write to us at the following address:

Internal Revenue Service
Tax Forms and Publications
W:CAR:MP:FP
1111 Constitution Ave. NW
Washington, DC 20224

We respond to many letters by telephone. Therefore, it would be helpful if you would include your daytime phone number, including the area code, in your correspondence.

Important Changes for 2002

This section summarizes important tax changes that took effect in 2002. Most of these changes are discussed in more detail throughout this publication.

Changes are also discussed in Publication 553, Highlights of 2002 Tax Changes.

Free electronic filing.   You may be able to file your 2002 taxes online for free thanks to a new electronic filing agreement. See chapter 1.

10% tax rate.   The 10% tax rate is reflected in the tax tables and tax rate schedules. You do not have to make a separate computation or figure a credit to get the benefits of this rate.

Tax rates reduced.   The 27.5%, 30.5%, 35.5%, and 39.1% tax rates are reduced to 27%, 30%, 35%, and 38.6%, respectively.

Reporting interest and dividends.   Previously, if you had interest or dividend income of more than $400, you had to file Schedule 1 (Form 1040A) or Schedule B (Form 1040) with your tax return. Also, you could not file Form 1040EZ if you had more than $400 of taxable interest income. Beginning with your 2002 tax return, the $400 threshold amount is increased to $1,500. This means, for example, you can file Form 1040EZ for 2002 if your taxable interest income is $1,500 or less and you meet all the other requirements listed in chapter 1.

Retirement savings plans.   The following paragraphs highlight changes that affect individual retirement arrangements (IRAs) and pension plans.

New retirement savings contributions credit. If you make eligible contributions to an employer-sponsored retirement plan or to an IRA, you may be able to take a tax credit. See chapter 38.

Traditional IRA income limits. Generally, if you have a traditional IRA and are covered by an employer retirement plan, the amount of income you can have and not be affected by the deduction phaseout is increased. The amounts vary depending on filing status. See chapter 18.

Increased IRA contribution and deduction limit. Your maximum contribution (and any allowable deduction) limit is increased. The limit depends on your age at the end of the year. See chapter 18.

Rollovers of IRAs into qualified plans. For distributions after 2001, you may be able to roll over tax free, a distribution from your IRA into a qualified plan. See chapter 18.

Rollovers of distributions from employer plans. For distributions after 2001, you can roll over both the taxable and nontaxable part of a distribution from a qualified plan into a traditional IRA. See chapter 11.

Limit on elective deferrals. The maximum amount of elective deferrals under a salary reduction agreement that can be contributed to a qualified plan is increased to $11,000 ($12,000 if you are age 50 or over). However, for SIMPLE plans, the amount is increased to $7,000 ($7,500 if you are age 50 or over). See Publication 590, Individual Retirement Arrangements (IRAs), for more information.

Self-employed health insurance deduction.   The part of your self-employed health insurance premiums that you can deduct as an adjustment to income increased to 70%.

Educator expenses.   If you were an eligible educator, you can deduct as an adjustment to income up to $250 in unreimbursed qualified expenses you paid or incurred during 2002 for books, supplies (other than nonathletic supplies for courses of instruction in health or physical education), computer equipment, and other equipment and materials used in the classroom. See your form instructions for more information.

Interest on student loans.    Two changes apply to the deduction for student loan interest.

• The provision that limited your deduction to interest paid during the first 60 months that payments are required is repealed.
• The modified adjusted gross income phaseout amounts are increased.

For more information on the deduction for student loan interest, see Publication 970, Tax Benefits for Education.

Tuition and fees deduction.   You may be able to deduct as an adjustment to income up to $3,000 of qualified higher education tuition and related expenses you paid. The expenses can be for you, your spouse, or your dependent. See Publication 970.

Coverdell education savings accounts (ESAs).   Changes to Coverdell ESAs include the following.

• Contribution limit increased to $2,000 per beneficiary.
• The income phaseout increased for joint filers.
• Qualified education expenses include certain elementary and secondary school expenses.
• Age limits do not apply to special needs beneficiaries.
• Contributions may be made until April 15 of the following year.
• Tax free distributions can be used for special needs services.
• The definition of family member is expanded to include first cousins of the designated beneficiary.

See Publication 970 for more information.

Employer-provided educational assistance.   The exclusion from income of employer-provided educational assistance benefits for undergraduate-level courses has been extended through 2010. Beginning in 2002, the exclusion also applies to benefits for graduate-level courses. See chapter 29 for more information.

Qualified tuition programs (QTPs).   The qualified tuition program (formerly qualified state tuition program) is expanded to include programs established and maintained by one or more eligible educational institutions. Other changes that affect this program include the following.

• A distribution from a QTP established and maintained by a state (or an agency or instrumentality of the state) can be excluded from your income if the amount distributed is not more than your qualified higher education expenses.
• Amounts in a QTP can be rolled over, tax free, to another QTP set up for the same beneficiary. However, such a rollover cannot apply to more than one transfer within any 12-month period.
• The definition of family member is expanded to include first cousins of the designated beneficiary.
• The definition of qualified higher education expenses is expanded to include expenses of a special needs beneficiary necessary for that person's enrollment or attendance at an eligible institution.
• You can make contributions to a Coverdell ESA and a QTP in the same year for the same beneficiary.

See Publication 970 for more information.

Foreign earned income exclusion.   The amount of foreign earned income that you can exclude increased to $80,000. See Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad.

Benefits for public safety officer's survivors.   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. The provision applies to a chaplain killed in the line of duty after September 10, 2001. The chaplain must have been responding to a fire, rescue, or emergency as a member or employee of a fire or police department. See chapter 13.

Standard mileage rates.   The standard mileage rate for the cost of operating your car increased to 36½ cents a mile for all business miles driven. See chapter 28.

The standard mileage rate allowed for use of your car for medical reasons increased to 13 cents a mile. See chapter 23.

The standard mileage rate for use of your car for determining moving expenses increased to 13 cents a mile. See chapter 19.

Medical expenses.   You can include as a medical expense the unreimbursed cost of participation in a weight-loss program as treatment for a specific disease (including obesity). However, the cost of purchasing reduced-calorie diet foods is not a medical expense if these foods substitute for food you would normally consume to satisfy your nutritional requirements. See chapter 23.

Education credits.   You may be able to claim an education credit in the same year in which you take a tax-free withdrawal from a Coverdell education savings account or a qualified tuition program. However, the qualified higher education expenses you pay with these funds cannot be the same expenses for which you claim an education credit.

The amount of your education credit is reduced (phased out) if your modified adjusted gross income (MAGI) is more than $41,000 ($82,000 if you file a joint return). You cannot claim the credit if your MAGI is $51,000 or more ($102,000 or more if you file a joint return).

See chapter 36 for more information.

Tax benefits for adoption.   The adoption credit and the exclusion from income of benefits under an adoption assistance program are made permanent. In addition, the maximum adoption credit and exclusion amounts increased to $10,000. The modified adjusted gross income (AGI) limit has also increased. See Adoption Credit in chapter 38 and Publication 968, Tax Benefits for Adoption.

Earned income credit (EIC).   The following paragraphs highlight changes that apply to EIC. See chapter 37 for details.

• The maximum amount of income you can earn and still get the earned income credit increased.
• The maximum amount of investment income you can have and still be eligible for the credit increased.
• Earned income no longer includes nontaxable employee compensation.
• EIC is based, in part, on adjusted gross income (AGI), not modified AGI.
• New rules determine which person can claim a qualifying child when two or more persons may be able to claim the same child.
• An eligible foster child has to live with you for more than half of the year, instead of the whole year.
• EIC is not reduced by the amount of alternative minimum tax shown on your return.

Health insurance credit.   If you are an eligible individual, you can claim a tax credit equal to 65% of the amount you pay for qualified health insurance coverage. See chapter 38.

Certain amounts increased.   Some tax items that are indexed for inflation increased for 2002.

Standard deduction. The standard deduction for taxpayers who do not itemize deductions on Schedule A (Form 1040) is higher in 2002 than it was in 2001. The amount depends on your filing status. See chapter 21.

Exemption amount. You are allowed a $3,000 deduction for each exemption to which you are entitled. However, your exemption amount could be phased out if you have high income. See chapter 3.

Limit on itemized deductions. Some of your itemized deductions may be limited if your adjusted gross income is more than $137,300 ($68,650 if you are married filing separately). See chapter 22.

Social security and Medicare taxes. The maximum wages subject to social security tax (6.2%) is increased to $84,900. All wages are subject to Medicare tax (1.45%).

Meal expenses when subject to hours of service limits.    If you are subject to the Department of Transportation's hours of service limits, the percentage of your business-related meal expenses that you can deduct has increased. For 2002 and 2003, you can deduct 65% if the meals take place during or incident to the period subject to those limits. See chapter 28.

Customer service for taxpayers expanded.   The Internal Revenue Service has expanded customer service for taxpayers. Through the agency's Everyday Tax Solutions service, you can set up a personal appointment at the most convenient Taxpayer Assistance Center, on the most convenient business day. See How To Get Tax Help in the back of this publication.

Important Changes for 2003

This section summarizes important changes that take affect in 2003 and that could affect your estimated tax payments for 2003. More information on these and other changes can be found in Publication 553.

Standard mileage rates.   For tax years beginning in 2003, the standard mileage rate for the cost of operating your car decreases to:

• 36 cents a mile for all business miles driven,
• 12 cents a mile for the use of your car for medical reasons, and
• 12 cents a mile for the use of your car for determining moving expenses.

Lifetime learning credit.   Beginning in 2003, the amount of qualified tuition and related expenses you may take into account in figuring your lifetime learning credit increases from $5,000 to $10,000. The credit will equal 20% of these qualified expenses, with the maximum credit being $2,000.

Student loan interest deduction.   Beginning in 2003, the modified adjusted gross income ranges for phasing out the student loan interest deduction may be adjusted annually for inflation.

Estimated tax safe harbor for higher income individuals.   For estimated tax payments for tax years beginning in 2003, the estimated tax safe harbor for higher income individuals (other than farmers and fishermen) has been modified. If your 2002 adjusted gross income is more than $150,000 ($75,000 if you are married filing a separate return for 2003), you must have deposited the smaller of 90% of your expected tax for 2003 or 110% of the tax shown on your 2002 return to avoid an estimated tax penalty.

Child and dependent care credit.   Significant changes to the child and dependent care credit take effect in 2003.

• The credit amount can be as much as 35% (previously 30%) of your qualifying expenses.
• The maximum adjusted gross income amount that qualifies for the highest rate increases to $15,000 (previously $10,000).
• The limit on the amount of qualifying expenses increases to $3,000 for one qualifying individual and $6,000 for two or more qualifying Individuals.
• The amount of income that is treated as having been earned by a spouse who is either a full-time student or not able to care for himself or herself increases. This amount increases to $250 a month if there is one qualifying individual and $500 a month if there are two or more qualifying individuals.

Tax benefits for adoption.   Beginning in 2003, the adoption credit and the exclusion from income of benefits under an adoption assistance program for the adoption of a child with special needs is $10,160 regardless of the amount of qualified adoption expenses. The modified adjusted gross income limit will be adjusted annually for inflation.

Retirement savings plans.   The following paragraphs highlight changes that affect individual retirement arrangements (IRAs) and pension plans.

Traditional IRA income limits. If you have a traditional IRA and are covered by a retirement plan at work, the amount of income you can have and not be affected by the deduction phaseout increases. The amounts vary depending on filing status.

Deemed IRAs. For plan years beginning after 2002, a qualified employer plan (retirement plan) can maintain a separate account or annuity under the plan (a deemed IRA) to receive voluntary employee contributions. An employee's account can be treated as a traditional IRA or a Roth IRA.

Limit on elective deferrals.The maximum amount of elective deferrals under a salary reduction agreement that can be contributed to a qualified plan increases to $12,000 ($14,000 If you are age 50 or over). However, for SIMPLE plans, the amount increases to $8,000 ($9,000 if you are age 50 or over).

Simplified rules for required minimum distributions. There are new rules for determining the amount of a required minimum distribution for a year beginning after 2002. The new rules, including new life expectancy tables, are in Publication 590, Individual Retirement Arrangements (IRAs).

Self-employed health insurance deduction.   You can deduct 100% of your self-employed health insurance premiums as an adjustment to income.

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