How new tax law affects you with tax saving tips

With much fanfare on June 7, 2001, President Bush signed into law one of the largest tax cuts seen in years. But what did this sweeping tax cut do for you? The short answer is that if you plan wisely, youíll reap significant savings from these changes. Here are ten tips for taking advantage of the tax cuts.

1. Shift Your Income to Your Children.

The new 10% rate bracket in effect for 2002 and thereafter will provide greater tax savings to your entire family if you shift income-producing assets to your children. A child age 14 or older will be able to take advantage of this 10% rate, just as you will.

Example: If your child reports $7,750 in income in 2003 that you would otherwise report, your child would pay $700 in tax on that income ($7,750 less the child's $750 exemption is $7,000, taxed at 10%). Contrast this with what you would pay on the same income at, say, 35%: $2,712.50.

So now when you move income-producing assets to your children you take advantage of the lower income tax rates. While this general strategy has always been attractive, the new 10% rate makes this strategy even more appealing.

2. Increase your 401(k) or 403(b).

These retirement plans allow you to defer taxes on the money you put into them. Starting in 2002, the maximum amount you can put into your employerís 401(k) or 403(b) plan starts increasing. The limit is now $12,000, and it sharply increases for the next four years according to the following schedule:


Deferral Limit







2006 and later


Every dollar you shift from your salary into the plan saves you tax dollars. For example, if your annual salary for 2003 is $80,000, a deferral of $12,000 will save you $3,000 in taxes if your marginal tax rate is 25%. If it makes sense for your overall financial picture, defer as close to the maximum as possible, especially if your employer matches a portion of your contribution.

3. Make Those Charitable Donations during the year they will be most effective.

If youíre planning on making a sizeable charitable contribution, make it during the year you are projecting the most income. The higher your tax bracket, the more benefit you will get from your deduction.

If youíre in the 35% tax bracket, a donation of $15,000 in 2003 saves you $5,250 in tax dollars. The same donation in a 25% tax bracket would save you only $3,750 -- a $1,500 difference.

4. Think Twice about Exercising Nonqualified Stock Options.

If you received nonqualified stock options from your employer, consider your other income before exercising them. Try to exercise them during a year when your income keeps you in the new lower brackets.

5. Buy Business Equipment Now.

If you have been planning to buy some equipment for your business, make those purchases this year. Youíll get an additional 30% depreciation in the first year, on top of any Section 179 deduction you can take on your purchase! Plus, youíll get 50% bonus for purchases made after May 5, 2003. Hereís an example:

Your business purchases, and starts using, office equipment for $150,000 on May 6, 2003. You may take in 2003:

  • A Section 179 expense deduction of $100,000, AND
  • The new bonus depreciation of $25,000 ($150,000 - $100,000 = $50,000 times 50%), AND
  • Normal first year depreciation calculated on the remaining cost of $25,000 (Probably - $5,000, a total depreciation deduction in the first year of $130,000)

6. Keep your Eye on the AMT.

The alternative minimum tax (AMT) rates didnít change along with the lower income tax rates. What did change, at least for years 2001 through 2004, is the AMT exemption amount.

In an effort to delay application of this parallel minimum tax to more and more taxpayers, Congress increased the exemption amount by $4,000 for married couples and by $2,000 for all others for this four-year period.

Most experts agree that the AMT laws must be revisited soon. This taxing system was originally developed to prevent certain people with high gross income and a lot of deductions from paying much less in tax than lower-income people with few deductions.

The best action you can take is to be proactive about your tax planning: evaluate the year's income tax liability before the end of the year and determine whether youíre subject to (or close to) AMT before you accelerate your mortgage or tax payments. Remember: Many of the expenses that you can claim as deductions on your regular tax return disappear on the AMT, making your income look a lot more substantial, and, possibly, increasing your taxes.

7. Rollover Your Pension Plan When Changing Jobs.

If you may be changing jobs this year, your options for moving your retirement funds have been expanded. Individual plans permitting; you are now allowed to roll your retirement funds over from one qualified plan, 403(b) annuity or section 457 plan to another such plan.

Itís tempting just to cash out retirement funds, but you will be faced with a steep early withdrawal penalty tax of 10%, plus regular income tax on the taxable portion of those funds if you do.

Transferring funds to an IRA is an attractive option, but if youíre set on having all of your funds in one place, check with the plan administrator of your new companyís plan to see if the new plan will accept rollover contributions.

You can also roll over after-tax contributions to qualified plans or IRAs (via direct transfer only). Previous law permitted only rollovers of pre-tax contributions.

Caution: Your after-tax contributions in an IRA account can't be rolled over to a qualified plan, 403(b) annuity, or a section 457 plan.

8. Take Advantage of the Expanded College Savings Vehicles.

Beginning in 2002, you can contribute $2,000 to an Education Savings Account each year for each student, which is a significant boost from the $500 per-year contribution limit in 2001.

If you contribute $2,000 to an Education Savings Account for 18 years and you earn an average investment return of 8%, youíll have over $80,000 saved for college costs!

The contribution isnít deductible on your tax return, but on the other side of the coin, distributions from the IRA at tuition payment time are tax-free as long as you have qualified educational expenses at least as much as the distribution.

In addition to the Education Savings Account, you can choose from among section 529 college tuition plans. These plans, typically offered in various forms by states, are now offered by private institutions. As with Education Savings Accounts, contributions to the plans arenít deductible, but withdrawals of funds to pay for educational expenses won't be taxable income either.

The year 2002 also brings a new deduction for educational expenses. The deduction will be around for four years, and can be as much as $4,000, depending on the tax year and your income level.

Both the Education Savings Account and the new deduction are available only to taxpayers with incomes that don't exceed certain limits.

9. Re-Evaluate your Estate Plans.

Estate taxes, otherwise known as "death" taxes, now start phasing out in 2002, and disappear completely in 2010, only to come back in full force in 2011.

The phase-out is accomplished by increasing the estate tax exemption, which is the value of your estate that can pass to your heirs free of federal estate taxes. The exemption is now $1 million for 2002 and 2003, increasing after that to $3.5 million before the estate tax is repealed.

So the estates of more and more individual taxpayers will escape estate taxation over the next ten years -- almost 40% in the first year of phase-out alone.

To get an idea of the magnitude of this change, consider that in 1997, the most recent year for which statistics are available, almost 43,000 estates paid over $16 billion in taxes.

The reduction and eventual elimination of estate taxes doesnít necessarily mean that you shouldnít think about setting up a living trust. Living trusts help to avoid costly and lengthy probates of estates, and while the value of your assets may not subject you to estate taxes, a living trust can ease the transition of your property to your heirs.

Remember that these trusts alone do not save you estate taxes. You need to take certain steps to evaluate your estate and plan for the transfer of your assets to your heirs, especially if youíre married. Traditional A-B trust provisions for married couples can be a valuable planning alternative. Consider investing some time and money in estate planning this year to determine what the best alternatives are for you.

10. Consider an IRA With the New Increased Contribution Limits.

The IRA contribution limit increases to $3,000 for 2002 through 2004, then $4,000 for 2005 through 2007, topping out at $5,000 in 2008.

If youíre 50 years old or over, the news gets better. The new contribution limits are increased and extra $500 for 2002 through 2005 and an extra $1,000 for years 2006 through 2008.

So it might be time to open an IRA account if you haven't done so before. The increased limits apply to both traditional IRAs and Roth IRAs, meaning that you have just as much flexibility as before, but more savings opportunity. However, if you have a limited amount of funds to put toward a retirement vehicle and you can choose between an IRA and your employerís 401(k) plan, consider whether your employer has a matching feature. You may want to channel contributions to the 401(k) plan to obtain the maximum matching possible first before making contributions to an IRA.


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