Though 2001 was the year Congress rewrote a big chunk of the nation's tax law, many of the changes didn't take effect until last year. That means this filing season is the first time taxpayers have been able to use some new benefits.
Most of the changes tweak various amounts, ceilings and deadlines. While individually modest and easy to miss, together they can add up to real money for taxpayers who are able to take full advantage of them.
Not all the new provisions are minor. For example, rates will go down another click -- half a percentage point in every bracket except the 10 percent, which remains the same. But the Internal Revenue Service has built those cuts into the tax tables, so taxpayers are unlikely to miss out on them.
The smaller changes tend to be concentrated in specific categories -- such as education, retirement, health care, and low-income taxpayers' benefits. So the key this year is to read the directions carefully and to double-check if it seems you might fit into one of the favored groups.
One other cautionary note: The District, Maryland and Virginia, like many other cash-starved states, have "decoupled" various aspects of their tax rules from the federal government's. That means taxpayers should not automatically assume that if there's a federal benefit there's a state one, too. And vice versa.
"The trick this year is not as much the federal returns as the state returns," said Arthur Auerbach of McGladery & Pullen, certified public accountants in Alexandria. "Things are treated differently on the state returns."
Among the favored categories at the federal level are:
Retirement: The maximum contribution to a traditional or Roth IRA was bumped up to $3,000 last year, from $2,000 in 2001, and to $3,500 for workers aged 50 and up. This means that many couples could sock away $6,000 or $7,000 between them. This is deductible if neither of you has a retirement plan at work, or if you do have an employer-sponsored plan, but are under certain income limits.
If you don't qualify for a deduction, you still may be able to contribute to a Roth IRA, which is not deductible but is tax-free in retirement. You can make a full contribution to a Roth if you are single and your modified adjusted gross income is less than $95,000, or if you are married filing jointly and your income is less than $150,000.
And it isn't too late to make a 2002 IRA contribution -- the deadline is the due date of your return, not counting extensions.
Another retirement benefit is the "saver's credit," which can be taken by low-income taxpayers for contributions they make to an IRA or for money they put aside in a 401(k) or similar retirement plan. Couples with incomes up to $50,000 can get something, though not the full amount. So can heads of household with incomes up to $37,500.
The credit is nonrefundable, meaning that you don't get any cash back if the credit exceeds what you owe in tax. But it ranges up to 50 percent of the amount you saved, to a ceiling of $2,000. The result is a maximum credit of $1,000 for some working families.
This credit is new for 2002, and not widely known. A recent survey by H&R Block found that 83 percent of Americans had never heard of it. But it is very advantageous. It gives you a credit for saving dollars that may have been pretax in the first place -- as in contributions to a 401(k) plan. Or it provides a current tax benefit for a Roth IRA where none had been available before.
Education: Numerous new or improved breaks for education -- and educators -- went into effect in 2002.
For the first time, elementary- and secondary-school teachers have been granted a modest deduction to help make up for all the classroom supplies and materials they inevitably end up buying out of their own pockets. The deduction, up to $250, is "above the line," meaning that you don't have to itemize deductions to take it. It can be used for books, computer equipment and other supplies. It cannot, however, be taken for the cost of "non-athletic supplies" for health and physical education -- apparently because some lawmakers feared it might go to subsidize sex education. The deduction is available to counselors, principals and teachers' aides as well as teachers, but in all cases the taxpayer must have spent at least 900 hours working in school last year.
Then there are the new benefits for students and their families.
First, the provision that limited the student-loan deduction to interest paid in the first 60 months that payments are required was repealed. Second, the income limits have been eased. Now you can deduct up to $2,500 in student-loan interest if your income is as much as $50,000 for a single taxpayer or $100,000 for a married couple filing jointly. The deduction phases out above that.
There is now also a deduction of as much as $3,000 for tuition and related fees paid by you, your spouse or your dependent. This one is also "above the line" and is available for single taxpayers with incomes up to $65,000 and married couples filing jointly with incomes up to $130,000. But the deduction is coordinated with the Hope and Lifetime Learning credits to prevent you from double-dipping.
And there's another twist: the deduction is not available to anyone who can be listed as a dependent on the tax return of another, typically the student's parents. This requirement, however, does not apply to the credits. This can benefit well-to-do families, in which the parents are over the income limits, but their children are not and have enough income to pay taxes. The parents leave the child off their return, allowing him or her to claim the credit. The parents' taxes may go up a bit, but with the student taking the credit the family may, on net, be better off. Taxpayers in this situation need to run the numbers both ways.
Congress also expanded what were once called education IRAs -- now known as Coverdell education savings accounts. These are investment/savings accounts funded with after-tax dollars whose proceeds can be used tax-free to pay education expenses. One advantage is that, unlike Section 529 college savings plans, Coverdell proceeds can be used to fund elementary and secondary education as well as college.
In addition, you can still claim one of the higher-education credits in the same year that you make a tax-free withdrawal from a Coverdell account. You just can't claim the credit for the same expenses you paid with the Coverdell money.
Beginning with 2002, the maximum annual Coverdell contribution is boosted to $2,000, and there is still time to make one, since the deadline has been extended to April 15. Couples with incomes over $190,000 cannot make a full Coverdell contribution, and those over $220,000 cannot make one at all. But planners suggest that families above these limits can have a lower-income relative or even the child make the contribution. The rules now allow a first cousin to be a designated beneficiary.
Then there's the long-standing, and oft-expiring, right to exclude from income the cost of education provided by an employer. That benefit has now been extended through 2010 and expanded to include graduate as well as undergraduate courses.
For more information on education breaks, look at IRS Publication 970, "Tax Benefits for Education."
Low-income workers: In addition to the saver's credit, a number of changes have been made in the Earned Income Tax Credit, which has become the government's main vehicle for assisting low-income working families.
The EITC remains unnecessarily complex and confusing, but its benefits make it well worth the effort for qualifying workers. Like all credits, it reduces taxes dollar for dollar. But in addition, it is refundable, meaning that if the credit exceeds the amount of tax you owe, you get the difference back in cash.
Important changes this year include an increase in the amount of income you can earn and still qualify, and an increase in the amount of investment income, such as interest on savings, you can have and still qualify. This year, couples with more than one child can earn as much as $34,178 and still qualify. In addition, any nontaxable employee compensation is no longer treated as earned income, making it easier to qualify.
One long-standing issue in the EITC is who can claim a child when two or more people are eligible to do so, such as unmarried parents or when a mother and grandmother reside together, making both potentially eligible. If eligible adults can't agree who will take the EITC for the child, the IRS provides "tiebreakers" designed to settle the issue. In addition, a foster child can now be claimed if he or she lived with you more than half the year, rather than for the entire year.
Experts note that low-income families may be eligible for the EITC, a per-child credit of $600, which is also refundable, and a child-care credit and the saver's credit, which are not refundable. There is a stacking order to these, and planners recommend that where possible workers take advantage of any pretax dependent-care benefits offered by their employers, which may allow them to skip the child-care credit and preserve the saver's benefit.
Health care: There are all sorts of odds and ends in this area.
If you were adversely affected by foreign competition -- for example, if you receive a certain pension benefit from the Pension Benefit Guaranty Corp. or are eligible to receive a trade-adjustment allowance -- you may be able to claim a refundable credit of up to 65 percent of your health-insurance costs.
If you participated in a weight-loss program as treatment for a specific disease, including obesity, you may claim as a deductible medical cost unreimbursed expenses -- not including low-calorie foods that replace regular foods. But remember, medical expenses are deductible only to the extent they exceed 7.5 percent of your adjusted gross income.
If you are self-employed, you may deduct 70 percent of your health insurance premiums as an adjustment to income.
Also, if you are self-employed or work in a small business, you may be able to start an Archer medical savings account. These combine a high-deductible medical insurance policy with an IRA-like savings account that is meant to be used for routine medical expenses. These accounts are allowable on an experimental basis. The formation of new accounts was to end at the end of 2002, but Congress extended the program through this year.
State taxes: Keep in mind that this is a rapidly changing environment. Just two weeks ago Virginia Gov. Mark R. Warner (D) signed legislation that allowed Old Dominion residents to get the full benefits available to federal taxpayers for victims of terrorism, and also to allow eligible educators to claim the deduction for personal expenditures for school supplies. Originally those wouldn't have been available to Virginians as a result of the decoupling of the state's tax laws from the federal ones.
Experts say taxpayers should read the state tax-form directions and booklets carefully -- and then check the states' Web sites to see if anything has changed since the booklets were written -- as it did in Virginia. If you can't find your state's Web site, you can go to the Federation of Tax Administrators
www.taxadmin.org -- click on "links," which calls up a map, and then click on your state name.