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The Question:

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The Answer

Unfortunately, there is a trap that's built into this years' return. Line 47 of Form 1040 is for the "rate reduction credit". This is the credit that most taxpayers received last summer or fall, i.e., the check for $300, 500, or $600. The amount of the check was based on your filing status for 2000. It was a way to provide all taxpayers with an immediate benefit. Basically, it gave taxpayers the benefit of the new 10% rate. For example, if you're single you would have paid $900 on the first $6,000 of taxable income, because under the old law that was taxed at 15%. But the new rate on the first $6,000 is 10%. Thus, you should have received a check for $300 (5% of $6,000). If that was the amount of the check, you've got no worries. And, you don't have to enter anything on line 47.

On the other hand, if your income in 2000 was very low, you were not required to file, etc., you probably didn't receive a check, or received one for a smaller amount (say $400 and you filed married, joint in 2000). If that's your situation and assuming you have taxable income for 2001, you should be making an entry on that line. How much? Follow the instructions for your tax software or use the Rate Reduction Credit Worksheet in the instructions for line 47 (line 30 for Form 1040A or line 7 for Form 1040EZ).

What if you received a higher credit than what you're entitled to because of a change in status? For example, you got a check for $600 because you were married last year, but you're single for your 2001 return. You're in luck. You don't have to repay the extra amount.

If you didn't get a check because you owed the IRS money and they applied the credit to your unpaid balance, you should have received a notice and can't claim the credit. On the other hand, if you didn't get a check because you moved and didn't give the Service your new address, you can claim the credit on your 2001 return. Use the worksheet. If you got a check, but don't remember the amount on the check, you can call 1-800-829-4477 and follow the instructions.

Dependents were not eligible for advance payments or the Rate Reduction Credit, but they may get the benefit of the lower tax rate by completing the "Tax Computation Worksheet for Certain Dependents" in the tax instructions. However, if you were a dependent on another taxpayer's 2000 return but were not a dependent for 2001, complete the Rate Reduction Credit Worksheet to see how much, if any, credit you may claim.

While it sounds overly complicated, for most taxpayers it's straightforward. You don't to do anything. Only if you're a dependent, were a dependent, received a check for a lesser amount, or your filing status changed in 2001 do you have to worry amount either worksheet.

Third party designee. There's a new line on this years' return, above the signature area, that allows you to authorize the IRS to discuss your return with another party. That could be the tax preparer, a family member, friend, etc. If you use this option you (and your spouse if filing jointly) would be authorizing the IRS to call the designee to answer any questions that might arise during the processing of the return. In addition, you'll be authorizing the designee to give the IRS any information that is missing from your return, call the IRS for information about the processing of your return and the status of any refund or payment and respond to certain IRS notices that you have shared with the designee about math errors, offsets, and return preparation. The notices will not be sent to the designee. You are not authorizing the designee to receive any refund check, bind you to anything, or otherwise represent you before the IRS. The authorization cannot be revoked. However, it will automatically end no later than the due date (without regard to extensions) for filing your 2002 tax return. That's April 15, 2003.

Should you do it? If you and your spouse file a joint return, there may not be much benefit. One of you should be available to answer questions. On the other hand, it does make sense if both of you are frequently traveling or for your children who are still in school to designate a parent. It can be particularly useful for older individuals who are single. It could allow a child, relative, or close friend to assist them should they become ill or incapacitated.

Note. The designee must select a 5-digit PIN (personal identification number). The IRS will ask the designee for that number before discussing any information. If you want your tax preparer to be the designee, you only need enter "Preparer" in the same for the designee name.

Larger child tax credits. If you have at least one child who was under age 17 at the end of 2001, you may be able to take a credit of up to $600 for each qualifying child. That's up from last year's $500 credit.

Student loan interest deduction. If you paid interest on a qualified student loan, you may be able to deduct up to $2,500 of the interest. Caution. This benefit is phased out for taxpayers filing single or as head of household with AGI of more than $40,000 or for married taxpayers filing jointly with AGI of more than $60,000.

Schedule D simplified. If you've got capital gains and you're computing your taxes using Schedule D, you'll find it easier. The IRS has removed some 14 lines from the schedule.

IRA deduction. For 2001 you can take an IRA deduction even if you're covered by a pension plan and your modified adjusted gross income is $33,000 or less ($53,000 if married filing jointly or qualifying widow(er)). If your income is over these limits, the deduction is gradually phased out. Once your income reaches $43,000 ($63,000, married filing joint), no deduction is allowed. NOTE. The higher limits for IRA contributions and the catch-up contributions for taxpayers age and older apply to 2002 and later years.

Mailing address. The IRS is undergoing a reorganization and changing the filing address for taxpayers in many areas of the country. Check carefully. Some changes seem incongruous. For example, taxpayers in Michigan file in Andover, MA if no payment is due and in Philadelphia, PA if tax is owed.

Standard mileage rate. The standard mileage rate for business use is 34.5 cents per mile for 2001. For rate for charitable uses is 14 cents per mile; for medical and moving the rate is 12 cents.

Alternative minimum tax - AMT. For 2001, the exemption amounts have been increased. For individuals filing married, joint, the amount is $49,000; for single individuals the exemption is $35,750; and for married filing separately, the amount is $24,500.

Capital gains tax rate. Some taxpayers may be able to take advantage of two changes in the capital gains tax for 2001. The first is the lowering of the rate to 8% for taxpayers who would have qualified for the 10% rate on capital gains (generally taxpayers with low income), but only if the property has been held for more than 5 years. The 10% rate continues to apply if the asset has been held for more than 1, but not more than 5 years. The second change is more complicated. Taxpayers can elect to recognize capital gains on assets held on January 1, 2001. If you do so, a new 18% capital gains rate will apply to those assets if held for more than 5 years after the date of the election. The tax break is so small, and the risks of a mistake so great that it probably doesn't make sense for most taxpayers. However, it could be a boon if on January 1, 2001 you were holding an asset that had appreciated only slightly in value. For example, you bought Madison stock in 1995 for $10,000. It was up substantially at the height of the market, but on January 1, it was back down to $10,200. You could recognize the $200 gain on your 2001 return and pay the $40 in tax (20% rate times $200 gain). If you hold the stock for more than 5 years from January 1, any gain (over the new basis of $10,200) will be taxed at only 18%. While you can make the election if you have a loss, you can't deduct that loss on your return. Making the election in that case makes sense only if the loss is very small and you're sure the stock will increase in value.

Businesses

Section 179 expense option. Instead of depreciating tangible personal property, you may be able to elect to expense up to $24,000 on your 2001 return. Be sure to enter the appropriate information on Form 4562 (Depreciation and Amortization).

Cash method of accounting. Two major changes in the method of accounting allowed by the IRS were issued, one in early 2001, the other in December 2001. The first directly affects taxpayers who are on a calendar year and filing a 2001 return. Many taxpayers who were required to use the accrual method of accounting because of the amount of their gross receipts may now be able to continue to use or switch to the cash method. For more details see Rev. Proc. 2001-10 (IRB 2001-2) and Notice 2001-76 (IRB 2001-52).

Mid-quarter convention. Because of the terrorist attacks in September, the IRS will allow taxpayers whose third or fourth quarter includes September 11, 2001 to make an election not to subject to the mid-quarter convention. Obviously, that includes calendar-year taxpayers. Taxpayers must make the election on their Form 4562 (Depreciation and Amortization) or Form 2106 (Employee Business Expenses) by writing "Election Pursuant to Notice 2001-70" on the top of the appropriate form. For more information see Notice 2001-74 in IRB 2001-49.

Mailing address. As mentioned above for individuals, the IRS is also changing the filing location for some taxpayers in certain districts. That includes regular (C), S corporations and partnerships. Be sure to check the instructions. Most taxpayers will file in either Cincinnati, OH 45999-0013 or Ogden, UT 84201-0013.

Direct deposit. Corporations may request that the IRS deposit its income tax refund directly into an account at any U.S. bank or other financial institution that accepts direct deposits. For details, see the instructions and new Form 8050, Direct Deposit of Corporate Tax Refund.

Paid preparer authorization. Corporate and partnership returns, as well as estates and trusts, now have a box that can be checked to authorize the IRS to discuss the return directly with the paid preparer. This authorization is limited to allowing the preparer to provide the IRS with missing information, respond to certain notices, discuss math errors and return preparation, and the status of any refund or payment related to the return. Like the third party designee authorization for individuals, check the box yes does not bind the taxpayer into any agreement with the IRS. While the authorization can't be revoked, it ends automatically on the due date (excluding extensions) for file your 2002 tax return.

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