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New tax laws that could affect your 2002 returns

Student loans
The amount of student loan interest you can deduct remains at $2,500 for 2002, but this year you're no longer limited to deducting interest paid during the first 60 months of the loan. So those long-term college loans should be a bit more tax valuable. You also can earn a bit more this year and still take the deduction: up to $65,000 if you're a single or head-of-household filer, twice that if married filing jointly. This tax break is available directly on both 1040 and 1040A forms, meaning a taxpayer doesn't have to itemize to take advantage of it.

Extra education-related deductions
Two more deductions for filers who don't itemize debut this year. One lets teachers write off some out-of-pocket expenses; the other is a deduction for tuition and other school fees. These tax breaks can cut a tax bill by letting the filer reduce overall income. The less income to tax, the lower the tax bill.

With the educator expenses deduction, teachers and other public and private school system employees can subtract from their incomes up to $250 they spent on classroom supplies. The amount is relatively small, but more taxpayers should be able to claim at least a portion of their school-related expenditures. In the past, educators could claim such costs only if they included them as miscellaneous itemized deductions on Schedule A. Even then, they couldn't be used unless all the filer's allowable sundry costs totaled at least 2 percent of adjusted gross income.

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Then there's the tuition and fees deduction. If you're eligible to claim this, you could reduce your taxable income by up to $3,000. You can count IRS-accepted higher education expenses for yourself, your spouse or a dependent. The deduction is not available, however, if you make more than $65,000 or if you used another tax break, such as Coverdell funds or the Hope or Lifetime Learning tax credits, to pay school costs.

Added adoption assistance
Although college costs for Junior may be down the road for adoptive parents, they still may be able to take some immediate breaks. The adoption tax credit helps defray up to $10,000 of adoption expenses, double the previous credit for costs associated with adopting a child who does not have special needs. This new amount also is available for adoptions of special-needs children, previously a $6,000 limit. And the income level at which the credit is reduced is doubled to $150,000.

Health insurance help for self-employed
If you started your own business on the side to boost income for your growing family, Uncle Sam offers more help here, too. As part of your business, did you pay for health care for yourself and your family? Then you can deduct 70 percent of those premium costs on your 2002 return. Don't forget to count premiums paid toward long-term care policies. You get a partial break here, too.

Lower your weight and taxes
Health conscious taxpayers have a new friend in the IRS. On 2002 returns, weight-loss programs in some instances can count as a deductible medical expense, joining the stop-smoking programs the agency OK'd a couple of years ago. But don't try to cheat on your calorie intake or the IRS. The diet program must be medically necessary. Acceptable situations include, for example, when a doctor recommends the regimen to reduce the health risks of obesity or hypertension. And the allowable expenses still must meet the 7.5 percent income threshold for medical deductions.

Home, sweet home tax breaks
Finally, the IRS has announced some changes that could put more dollars in homeowners' pockets when they sell.

Years ago, to avoid paying tax on the sale of a residence a homeowner had to use the sale proceeds to buy another house. In 1997, the law was changed so that up to $250,000 in sales gain ($500,000 for married joint filers) is tax free as long as the homeowner owned the property for two years and lived in it for two of the five years before the sale.

These time limits meant a person who sold before meeting the ownership and residency requirements owed tax on any profit. The IRS provides some tax relief if the sale is because of a change in the owner's health, employment or unforeseen circumstances. In these cases, the tax-free gain amount is prorated.

But many sellers remained out of luck because, in part, while the law allowed for a fractional exclusion due to "unforeseen circumstances," the IRS did not define that term. Now it has, listing events that often force homeowners to sell and under which they now can get some tax relief. They include:

  • Death
  • Divorce or legal separation
  • Job loss which entitles the homeowner to collect unemployment
  • Employment changes that make it difficult for the homeowner to meet mortgage and basic living expenses
  • Multiple births from the same pregnancy

These situations must involve the taxpayer, spouse, property co-owner or a family member living in the home. In addition, a partial exclusion can be claimed if the sale was prompted by residential damage from a natural or man-made disaster or the property was "involuntarily converted," for example, taken by a local government under eminent domain law.

Then there are folks who had to pay taxes on part of their sale proceeds because they worked from home. Previously, when you claimed a home-based business deduction, you owed tax on that percentage of your home when you sold. A $100,000 profit on a home where 20 percent of the space was dedicated to business meant taxes due on $20,000.

In December 2002, however, the IRS ruled that taxpayers no longer have to allocate gain between business and residential use if the business was conducted totally within the residence. So there's no tax problem if your office is in your spare bedroom.

But if the office is in the guest house in your backyard, the portion of your sale proceeds attributable to that separate structure would be taxable, even though the building was part of your overall home sale. And you still must pay tax on the gain equal to the total home-office depreciation claimed after May 6, 1997.

Homeowners who paid tax on a recent sale and find their circumstances now qualify for a partial exclusion should file an amended return. Tax law generally allows for amended returns within three years of the original filing, so taxpayers who reported gains on returns filed on April 15, 2000, or later are eligible to re-file.

-- Posted: Jan. 24, 2003
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See Also
PLUS: Old tax laws with new amounts
Tax breaks for staggering adoption costs
Getting the most from itemized deductions
Tax glossary
More tax stories

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