Tax Newsletter 2002

This year’s big news is the Economic Growth and Tax Relief Reconciliation Act 2001 (EGTRRA) and the pervasive new tax rules following the tragic events of 9/11 (September 11, 2001). IRS and all Washington have reacted more quickly and strongly after 9/11 than I have ever seen, more strongly than since World War II.

EGTRRA (pages 1-3) is the biggest tax law in decades. Planning will save big big taxes in the general areas of education and pensions. Families with children will benefit. The Estate Tax decreases, and then disappears in 2010. The deemed sale election for capital gain property is also a big tax saver, in the right situations. EGTRRA is very complicated. The major changes beyond 2002 will need major clarification, which will occupy Washington for many years.

Washington is arguing over the so-called Economic Stimulus Act. The Republicans want business incentives, such as repeal of corporate AMT and enhanced depreciation to spur investment. The Democrats want immediate benefits for low income and displaced workers. Whatever Washington’s compromise, it is not here now, as this newsletter goes to press.


The Republicans stormed into office in 2001. For the first time in almost half a century, Republicans controlled Washington - the Presidency, the House, and the Senate. As kids in a candy shop, the Republicans went hog wild with political pork and one-sided laws. The republican dominated conference committee went one step too far when it eliminated $450Billion education benefits. Senator Jim Jeffords (R-Vermont) was so offended that he bolted to the Democrats. The Senate Republicans lost their majority and lost control of the Senate.

So EGTRRA is the Cinderella tax act of the 21st century. After Jeffords bolted, the Republicans did not have the 60 votes needed under the Byrd rules to be permanent. So EGTRRA expires in 10 years. At midnight on December 31, 2010, EGTRRA disappears, and, as Cinderella’s carriage, turns back into a pumpkin.

It's one big fraud on the American people, said Rep Charles B Rangel (D-NY, Ways and Means Committee Chair), who accused Republicans of packing it with every kind of gimmick and sleight of hand I have ever seen. You have a little bit of sugar hiding a pot full of fiscal irresponsibility, said Rep Sander Levin (D-Michigan). We now have a large tax cut, but little tax reform, said Alan Reynolds, Cato Institute senior fellow and Kemp Tax Reform Commission past research director.

EGTRRA’s $1.35Trillion tax cuts will be the biggest in over 20 years, if EGTRRA lasts through 2010. EGTRRA is back end loaded, with most of the tax cuts occurring in the later part of its 10 year life. $57Billion in tax cuts occur in 2001. The wealthier taxpayers wait, then get most of the benefits. By increasing its cost and worsening its tilt toward the very wealthy, Republicans have made this bill more fiscally irresponsible, less fair. Once again middle-class working families get left behind, said Tom Daschle (D-S Dakota), Senate majority leader.

Get a 2001 refund of $300-600 in advance, based on your 2000 return. If you did not qualify based on your 2000 return, you will get a second chance to qualify for 2001. If you do not qualify in 2001, you do not have to give back any refund you received based on 2000. Problems abound with this unusual refund program. Congress wrote the law quickly and poorly. IRS has had numerous problems in issuing 95 million refund checks by December 31, 2001. IRS criminal investigators have tried to stop tax scammers who charge to help you get your refund. Callers have overloaded IRS telephone lines with millions of telephone calls asking about their refunds.

Each tax bracket decreases ½% in 2001, the start of a slow decline in rates over five years. The lowest, 15%, bracket, starts in 2005 to include more joint married filers, reducing slightly the marriage penalty. But AMT rates do not decrease (page 4).

The deemed sale election for capital gain property is a huge tax saver, in the right situations. This election is a holdover from the 1997 tax act. Pretend to sell capital gain property to yourself as of January 1, 2001. Pay the tax now. Make this election by your final extension, October 15, 2002. Congress meant that you can qualify for the new 18%, 5 year, capital gains rate. The big immediate benefit might be to offset a capital loss. Or to unlock passive or AMT or net operating loss carryforwards. Or to force capital gain treatment in 2001 if you would be taxed at a higher rate in a future year.

The child tax credit increases in 2001 to $600 (from $500). This credit is now refundable for more very low income taxpayers. Employer provided child care facilities and services get a 25% tax credit, up to $150,000, starting in 2002. The dependent care credit increases to $3,000 (from $2,400) for one child, and to a maximum 35% (from 20%) of income for those with income less than $15,000.

Starting about 2005 the marriage penalty lessens just a little, and the stealth phaseouts of itemized deductions and personal exemptions slowly go away. Some tax reductions will sunset about 2005, such as AMT exemptions and higher education tuition deductions.


Section 529 tuition trusts are huge tax savers. The earnings are now totally tax free, so long as your beneficiary spends the money on higher education. You can designate virtually anybody as beneficiary, including yourself. If your beneficiary cannot spend the entire Trust, you can designate a new beneficiary from your extended family. You can even designate a beneficiary in a younger generation.

Education expenses are more broadly defined, including tuition, fees, supplies, some room and board, books, and equipment required for enrollment (e.g., computers, including internet access). Congress did not approve the Republican school voucher initiatives. Tuition trusts appear to meet many of the same goals, without the baggage of being called a voucher.

Private schools, in addition to states, can sponsor tuition trusts, starting in 2003. You can transfer between sponsors at any time.

Section 529 tuition trusts can be a no brainer, in the right circumstances. You control the Trust, but the Trust is not included in your Estate. The sooner you invest, the more tax free earnings accrue.

Check out California’s Tuition Trust at California’s trust, has fewer investment alternatives than other states. But California has not yet conformed to the complete Federal income exclusion for any other state’s trust.

Education savings accounts expand the old education IRA contribution to $2,000 (from $500). Many of the rules are similar to the tuition trust. In addition, your employer or closely held corporation can contribute without regard to the individual AGI limitation. And, more education expenditures qualify, including K-12 and vocational schools.

EGTRRA benefits education in many other smaller ways. Deduct college tuition, up to $3,000 in 2002; but this deduction sunsets in 2005. Deduct student loan interest forever (from 60 months). Contribute more freely to multiple plans in the same year. Employee benefit plans now cover college and graduate courses. Beware that most of these benefits phase out at higher income levels.


EGTRRA also benefits retirement plans, starting mostly in 2002. Contribute more with increased annual and total maximums. Transfer pension assets more easily between employers and your own IRA. Required minimum distributions are much simpler, and will usually require lower distributions.

Research your pension changes very carefully. The following rules and limits quickly get complicated.

IRA contributions increase starting in  2002 to $3,000 (from $2,000). Taxpayers over 50 years of age get $500 additional catch up contributions. Maximum 401K contributions increase to $11,000 (from $10,500). Joint filers with income less than $30,000 get a credit for retirement savings plans, in addition to the old deduction. Defined contribution limits increase to $40,000 (from $25,000), defined benefit plans to $160,000 (from $140,000), and Simple plans to $7,000 (from $6,000).

You can more easily borrow thru your sole proprietorship, partnership and S corporation retirement plan. Small businesses qualify for simpler rules and start up credits. Employers can deduct retirement planning services as an employee benefit. Congress gave IRS the authority to extend the maximum 60 day rollover rule in hardship cases.


All of these EGTRRA tax changes disappear on December 31, 2010. The Estate Tax presents especially complex planning issues because it decreases substantially as it phases in, then on January 1, 2011, as Cinderella’s pumpkin, reverts to 2001’s rates and rules.

You should revisit your estate planning, including wills and trusts, with me, your attorney, and other estate planners. But don’t destroy your current Estate planning just yet. The last time Washington killed the death tax, about 20 years ago, they reversed themselves in a few years. There are two presidential elections and five Congressional elections before 2011.

The new Estate tax exclusion increases in 2002 to $1Million (from $700,000), and by 2009 to $3.5Million (from $1Million). The future rule changes are more important for the bigger estates. Once the Estate tax disappears in 2010, the writeup at death disappears. Congress exempted smaller estates by an automatic $1.3Million basis step up, plus $3Million basis step up to a surviving spouse. Sellers will pay capital gains tax depending on carryover basis from the deceased. You must now keep detailed records for many generations.

Lifetime gifts will be exempt only to $1Million, starting 2001. Bequests at death will become much less expensive than lifetime gifts over $1Million. Generation Skipping Tax decreases slightly, so wealthy families may use more Generation Skipping Trusts before 2010. Conservation gifts, such as real estate easements, will be excluded from your Estate.

California has a $1Billion problem. EGTRRA eliminates the state tax credit by 2010. California must replace this $1Billion with some other tax, or reduce expenditures. Voters added a prohibition against the old inheritance tax to the California Constitution. California has a few years to decide what to do.

IRS Reacts to 9/11

IRS and all Washington have reacted more strongly after 9/11 than I have ever seen, more strongly than since World War II. Congress has not declared war, yet the Federal government has assumed domestic war powers.

Normal disaster tax relief includes quick refunds by electing to deduct disaster losses in the prior year. The military get many filing and tax breaks, including reservists, new enlistees, and those who do not serve in the war zone.

IRS extended filing deadlines for anyone remotely effected by 9/11, not just those in the disaster areas. IRS allowed retroactive application of tax estimates to payroll tax, from income tax. IRS feels that businesses will make less profits, but still owe payroll taxes. IRS expanded tax exempt employee benefit plans to include personal, living, home-repair and funeral costs resulting from disaster and terrorism.

IRS relaxed enforcing its charitable deduction rules, which limit payments to the needy and the poor. But the disaster victims are not all needy or poor. Many families have received liberal death benefits. The World Trade Centers housed some very wealthy employees. Congress subsequently expanded the definition of charitable activity to include any 9/11 terrorism relief, even for the wealthy.

IRS expedited requests from new nonprofit groups that want to aid disaster victims and to become tax exempt charities. Check out the new charities at IRS’ complete list of charitable, tax exempt, organizations is at

Congress rushed to pass the Victims of Terrorism Tax Relief Act of 2001. Congress waived some income, payroll, and estate taxes from those who died as a result of the 9/11 disaster. Congress allowed any law enforcement agent to access your previously confidential income tax information in order to investigate terrorism, until December 31, 2003.

Tax Refunds

The Social Security Administration has just started to withhold social security payments to repay overdue student loans or income tax. The Federal government’s computers are tracking people better. IRS has withheld refunds for years to pay overdue income tax. IRS will also start to withhold refunds if your student loans are overdue.

IRS Commissioner Rossotti

IRS Commissioner Charles O Rossotti can do no wrong. Rossotti is IRS’ first highly experienced, high tech, manager, not a tax lawyer. His five year term expires in November, 2002. He says will not accept reappointment. The tax lawyers who have traditionally run IRS have run it into the ground.

Mr Rossotti deserves an A. He himself would agree that he has a long way to go, and I think that is a pretty healthy attitude. Senator Charles Grassley, Chair Senate Finance Committee.

I’m a big fan. I’ve seen the progress being made at the IRS. He’s got a tough job. This guy is capable of doing anything. Rep Amo Houghton, Chair House Ways & Means Sub Committee that Oversees IRS.

Mr Rossotti has done a good job under difficult circumstances. I’d give him an A for effort. But IRS gets a B or B Minus for actual results. Rep Rob Portman

I’m from the IRS…

If you get a telephone call from someone claiming to be from IRS, be very careful. IRS has recently begun to contact people by telephone before or instead of sending a letter. Even if you have given me a Power of Attorney, IRS may ignore it and contact you. IRS may not even notify me.

Do not give any confidential information over the telephone, unless you initiate the call. Scammers impersonate IRS and other legitimate organizations on the telephone. Scammers want your confidential information for credit card and identity theft. If the caller really does seem to be IRS, you should insist on a formal letter or a personal visit, so you can inspect a badge. You should refer them to me.



By 2011, 33% of all taxpayers (35 million) will pay Alternative Minimum Tax (AMT), up from about 1% (1 million) now. Most politicians complain vociferously about AMT, and get good publicity. But it would cost $700Billion through 2011 to eliminate AMT, says Donald W Kiefer, Director of the Department of the Treasury Office of Tax Analysis. Eliminating AMT seems too expensive.

Congress needs to fix this problem immediately before we put families into ruin, said  Zoe Lofgren (D-San Jose), who held hearings and grabbed some good publicity. She refers to people who exercised and held incentive stock options. They lost money in the stock market. They owed AMT because they did not sell the in the same year.

AMT is a complex patchwork of odd preferences and limitations. AMT affects big families, single parents, wage earners, investors, and people in high tax states, like California. AMT is not indexed for inflation, as is the regular tax, so AMT will continue to grow. Kiefer notes that about 95% of people in the 36% tax bracket will have to pay the AMT because of [EGGTRA]. IRS added in 2001 a 1040A AMT worksheet to make sure that low income taxpayers pay AMT, too.

It is estimated that for the year 2010, 18 million additional individual income tax returns that will benefit from the rate reductions, increased standard deduction, expanded 15-percent rate bracket, and increased child tax credit would be affected by the alternative minimum tax. For these taxpayers, it could be expected that the interaction of the provisions with the alternative minimum tax rules would result in an increase in tax preparation costs and in the number of individuals using a tax preparation service. Congress’ Joint Conference Committee Report.

The alternative minimum tax has outlived its usefulness and should be repealed. The AMT is affecting people it was never intended to affect. The bottom line is that the AMT has outlived its usefulness and ought to be repealed, says Mary Schmitt, Deputy Chief of Staff of Congress’ Joint Committee on Taxation. The Committee recommends that Congress eliminate AMT. It also recommended income limits for IRA/RothIRA contributions, and removal of tricky phaseins and phaseouts, such as for personal exemptions. The American Bar Association tax section thinks that these are great ideas with little or no chance of becoming law.

You can get more information on AMT at, which is a special interest group that wants to reform the AMT.


California taxes are especially complex because the Legislature has not generally conformed California’s Revenue and Taxation Code to the Federal Internal Revenue Code since January 1, 1998. Congress made major tax changes in 1997, 1998, and 2001, including major tax cuts. California has not been willing to reduce expenditures or to raise other taxes to pay for general conformity. California’s lack of conformity contributes to higher tax preparation fees. Please appeal to your California legislator to conform.

Community property with right of survivorship is California’s new and very useful way to hold title to property. Title determines who gets property when you die. Most people do not understand that title is also a tax issue. This new method of titling passes the property to your spouse outside probate, while avoiding the extra tax you pay if the property is titled as joint with right of survivorship.

Your spouse’s community property gets a writeup in basis when you die. That is, the basis of your spouse’s community property becomes the new value at your death, even though your spouse did not die. Property titled as joint with right of survivorship does not get this writeup. If your family will pay Estate tax, you will save big bucks.

California passed a major new law that affects people who have income inside and outside California, effective January 1, 2002. The method of calculating California tax changes for income that must be divided between different states, such as for net operating losses, passive losses, carryover basis, IRAs, and depreciable property. Those especially affected include people who move into and out of California, and who have income in multiple states. Many will pay less tax. Some will pay more. If you think you might be affected, call me.

Capital Gains takes a double hit in California. Pay tax at the full 9.3% rate There is no reduced rate, as for Federal. Then pay Federal AMT, if your capital gain is big enough. California tax is a Federal AMT preference (left column).

California Independent Contractor Reporting began January 1, 2001, responding to Federal rules to collect child support. If you will owe a 1099 at the end of the year, you must report to California within 20 days of paying or agreeing to pay the contractor. Businesses must use Form 1099 to report payments for services over $600. CA has not penalized anyone yet.

A recent court case may save you some property tax. Proposition 13 limits tax increases to 2% per year. The Court outlawed the practice of County Assessors to increase your tax more than 2% to catch up for prior years when the increase was less than 2%. The appeals courts will certainly review this decision, because there is big money at stake. You should request a refund, while the 4 year statute of limitations is still open.

William M West prepares tax returns and plans to save tax for business, investors, and individuals.

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Last Updated 2-3-02
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