 |
| |
 |
|
|
|
|
COVER STORY -
January 2002 by Linda and Douglas Donald Sidebar- WITH the dawning of a new year, it’s time for business owners to not only make their New Year’s resolutions, but to prepare for the tax season. There have been important changes relating to the Bush administration’s tax relief bill, as well as to other changes in legislation and regulations. On May 26, Congress passed the major tax cut bill. Significantly, the bill included several changes that improve retirement plans for participants and plan sponsors. Here are some of the highlights of the 2001 Tax Relief Act: Increased IRA Limits: The $2,000 contribution limit for Traditional and Roth IRAs will be increased to $3,000 for the years 2002 through 2004; $4,000 for 2005 through 2007; and $5,000 for 2008. After 2008, the increase is indexed for inflation limited to $500 increments. Increased 401(k) Plan and 403(b) Plan Limits: The $10,500 limit which a participant can contribute to a 401(k) or 403(b) plan in 2001 will be increased to $11,000 for 2002 and then in $1,000 annual increments to $15,000 by 2006 and thereafter. Pension Portability: Individuals will be able to roll over between 401(k)s, 403(b)s, 457s and IRAs. Previously, distributions from 401(k) plans could not be rolled to 403(b) plans (and vice versa), and 457 plan distributions could not be rolled to any type of plan. Older Workers Can Catch Up on their Contributions: An individual 50 years or older can contribute more to his 401(k), 403(b) or 457 plans than his younger coworkers. This “catch up” contribution will start at $1,000 in 2002 and will be increased by $1,000 annually to $5,000 in 2006 and thereafter. These additional contributions will not be subject to contribution limits or the nondiscrimination rules. IRAs Catch-Up Contribution Provision: A person 50 years of age or older will be able to contribute an additional $500 to his IRA in 2002 through 2005. In 2006 and thereafter, the individual may contribute an extra $1,000. Roth 401(k) and 403(b) Contribution Program: Starting in 2006, plan sponsors are able to amend their 401(k) or 403(b) plans to allow participants the option of making Roth contributions instead of the normal pre-tax elective deferrals. Roth contributions are after-tax contributions, but the earnings on the contributions, like Roth IRA earnings, will be tax-free if certain conditions are met. The limit on Roth 401(k) and 403(b) contributions will be the same as pre-tax elective deferrals. Tax Credits for IRA Contributions and Elective Deferrals: Beginning in 2002, workers who are in the low and middle income range will be eligible for a tax credit of up to $1,000 if they make contributions to IRAs, 401(k)s and certain other retirement plans. This credit is not available for any individual who is either under age 18 or is a dependent of another taxpayer. Education
IRAs Education IRAs were often overlooked in the past as meaningful savings alternatives simply because of the low $500 annual limit on contributions. Beginning in 2002, the annual limit increases dramatically to $2,000. There is no limit to the number of Education IRAs, as long as the combined annual contribution for each beneficiary does not exceed the annual limit. Starting in 2002, tax-free withdrawals can be used to pay for an expanded range of education expenses for elementary, secondary and higher education. The new expansive rules also include expenses for room and board, books and supplies, school uniforms, transportation, academic tutoring, and the cost of computers, peripheral equipment, educational software, and even Internet access charges when used for education purposes. Beginning in 2002, the phase-out range that often excluded high-income taxpayers has been increased, allowing more taxpayers to take advantage of these benefits. Other restrictions eliminate double dipping by requiring that college expenses used to claim the Hope Scholarship or Lifetime Learning tax credits cannot be used again to support tax-free withdrawals from Education IRAs. The Hope and Lifetime Learning tax credits provide much greater tax benefits because they are direct credits against tax. The 2002 deadline for making contributions to Education IRAs has been extended from the last day of the year to April 15th of the following year. This coincides with the deadline for traditional and Roth IRAs. Legislative
Changes to IRC Section 529 Both Congress and the President recognized the importance of using tax policy and incentives to encourage families to save for college. Indeed, the 529 plan may soon be considered a necessity for anyone saving for college. Some of the changes that were enacted effective in 2002 are: Tax-free Distributions: Qualified educational expense distributions made after Dec. 31, 2001 will be tax-free at the federal level. Simplified and Flexible Rollover between 529 Plans: Direct transfer or rollover from one 529 plan to another 529 plan will be allowed for the same beneficiary, limited to once every 12 months. Expansion of Room and Board Expenses: For a qualified student who is enrolled at least half time, qualified room and board expenses have increased from $2,500, for the student living off campus, and $1,500, for those living with their parents, to the full room and board cost set by each institution. Tax-free distributions will be the full invoiced amount calculated as part of the cost of attendance for federal financial aid purposes. Investment in an Education IRA and a 529 Plan in the Same Tax Year: In prior years this was not permissible and a tax penalty was imposed. Family Members Expanded to Include First Cousins: Member of the family is expanded to include first cousins of the original beneficiary for the purpose of a tax-free rollover and changes of designated beneficiaries. Coordination of 529 Qualified Distributions with the Expanded Tuition Tax Credit Available under the Tax Act: The taxpayer may claim a Hope or Lifetime Learning credit and exclude from taxable income withdrawals from a 529 plan as long as the distribution is not used for the same expenses for which the credit is claimed. In the last year, many more states have established 529 plans, and it is expected that all states will offer such a plan within two years. Because the plans may be vastly different, investors should do research to determine the program that best meets their personal needs. It is likely, but not certain, that many states may follow the federal rule and not tax withdrawals for qualified higher education expenses. In summary, the
combined effect of the tax relief changes makes Education IRAs and 529
plans more attractive. The savings depend in large part on how long
the accounts are left to grow tax-free before being used to pay for
qualified expenses. This means it is important to start contributing
sooner rather than later to build up accounts while the beneficiaries
are still young. Contact your Certified Public Accountant for more information
about the Tax Relief Act changes and how they affect you. Douglas and
Linda Donald, both Certified Public Accountants, are partners and officers
of Donald & Company, P.S.C., of Lexington. |
|
|
|
Copyright 1996-2002, by Kentucky Business Online. All rights reserved. Editorial content
is copyright 2002, Lane Communications Group The Lane Report is a trademark of Lane Communications Group. All other trademarks are the property of their respective owners. |
