By Richard R. Hammar, J.D., LL.M., CPA

© Copyright 2002 by Church Law & Tax Report.  All rights reserved.  This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service.  If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Church Law & Tax Report, PO Box 1098, Matthews, NC 28106. Reference Code: m27 c0103

53 Important Changes

Article summary. On June 7, 2001, President Bush signed a massive new tax law known as the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"). While EGTRRA's most prominent feature is a $1.35 trillion tax-cut package, the new law also makes more than 440 other changes to the Internal Revenue Code. Many of these changes took effect in 2002, and those that have the greatest relevance to ministers and church treasurers are summarized in this article. There were other significant tax developments that occurred in 2002, including several important court cases and IRS rulings. These developments are summarized in this article as well.

Key point. An unprecedented feature of EGTRRA is a "sunset" provision that revokes all of the hundreds of tax law changes at the end of 2010 unless Congress votes to extend them. If Congress fails to take action, then the tax law in effect in 2001 will be reinstated. Because many taxpayers, in all income brackets, will increasingly rely on many of the tax law changes in the new law, it is inconceivable that Congress will allow all of the changes to expire at the end of 2010. It is reasonable to assume that many of the changes will be permanently adopted by Congress, but not necessarily all of them.

Tax Law Changes Made by EGTRRA

A. Individual Income Taxes

1. Reduction in income tax rates. Income taxes are computed by applying the applicable income tax rates to taxable income. EGTRRA created a new 10% income tax bracket effective for taxable years beginning in 2001. The 10% rate bracket applies to the first $6,000 of taxable income for single individuals, and $12,000 for married couples filing joint returns. This $6,000 increases to $7,000 and this $12,000 increases to $14,000 for 2008 and thereafter. The taxable income levels for the new low-rate bracket will be adjusted annually for inflation for taxable years beginning after December 31, 2008.

The 15% income tax bracket begins at the end of the 10% bracket. It is also adjusted in order to minimize the effect of the so-called "marriage penalty."

The pre-EGTRRA income tax rates of 28%, 31%, 36%, and 39.6% are phased down over six years to 25%, 28%, 33%, and 35% as described in Table 1.

Table 1: Income Tax Rate Reductions

Tables 2 and 3 show the amounts of taxable income that are taxed at the 10%, 15%, 27%, 30%, 35%, and 38.6% brackets in 2002.

Table 2: Income Tax Rates for 2002 (Single Persons)

Table 3: Income Tax Rates for 2002 (Married Persons Filing Jointly)

Tables 4 and 5 show the tax rates and corresponding income levels for the year 2006, when the rate cuts are fully effective. Note that the income levels in these tables are projected amounts.

Table 4: Income Tax Rates for 2006 (Single Persons)

Table 5: Income Tax Rates for 2006 (Married Persons Filing Jointly)

Table 6 shows the federal income tax that would be paid by a married couple filing jointly under several different levels of taxable income, in 2001 (without the EGTRRA tax reductions), in 2002 (with the EGTRRA tax reductions for that year), and in 2006. Note the following: (1) The table only reflects federal income taxes. Social Security and state and local taxes are not included. (2) The 2006 taxes use estimated amounts of taxable income that will be needed to trigger the corresponding tax rates. The actual taxes in 2006 may be slightly different.

Table 6: The Bottom Line-Tax Savings
Under Different Scenarios

2. Elimination of the "marriage penalty." When two persons are married, they often pay more taxes than if they had remained single and filed individually. There are two reasons. First, their combined income may put them in a higher tax bracket; and second, the standard deduction for a married couple is less than the standard deductions for two single persons. These two consequences are generally referred to as the "marriage penalty." EGTRRA reduces this penalty in the following two ways:

#1--income tax rates

The income tax rates prior to EGTRRA (15%, 28%, 31%, 36%, 39.6%) each applied to a specific range of taxable income, with higher amounts of income triggering higher tax rates. As a result, two wage-earners generally paid more in taxes if they were married than if they remained single since their income was combined for purposes of applying the tax rates. The tax code "penalized" them for marrying. EGTRRA minimizes the effect of the marriage penalty by increasing the 15% income tax rate for a married couple filing a joint return to twice the size of the corresponding rate for a single person filing a single return. The increase is phased-in over four years, beginning in 2005. Therefore, this provision is fully effective (i.e., the size of the 15% income tax rate bracket for a married couple filing a joint return would be twice the size of the 15% tax rate bracket for single persons) for taxable years beginning after

December 31, 2007. Table 7 summarizes the phase-in of this new rule.

Table 7: Increase in Size of 15% Rate for Married Couples Filing a Joint Return

#2--the standard deduction

The standard deduction for married persons filing jointly is increased, beginning in 2005, to minimize the marriage penalty. Table 8 summarizes this change.

Table 8: Increase in the Standard Deduction

3. Increase and expand the child tax credit. Prior to EGTRRA an individual could claim a $500 tax credit for each qualifying child under the age of 17. In general, a qualifying child is an individual for whom the taxpayer can claim a dependency exemption and who is the taxpayer’s son or daughter (or descendent of either), stepson or stepdaughter, or eligible foster child. The child tax credit is phased-out for individuals with income over certain thresholds. Specifically, the credit is reduced by $50 for each $1,000 (or fraction thereof) of modified adjusted gross income (AGI) over $75,000 for single individuals or $110,000 for married individuals filing joint returns. Modified AGI is the taxpayer’s total gross income plus certain amounts excluded from gross income (such as the foreign earned income exclusion). The length of the phase-out range depends on the number of qualifying children. The child tax credit is not adjusted annually for inflation. However, EGTRRA increases the child tax credit to $1,000, phased-in over ten years, beginning in 2001 (see Table 9).

Table 9: Increase in the Child Tax Credit

4. Expansion of dependent care credit. A taxpayer who maintains a household that includes one or more qualifying individuals may claim a nonrefundable credit against income tax liability for up to 30% of a limited amount of employment-related expenses. Eligible employment-related expenses are limited to $2,400 if there is one qualifying individual or $4,800 if there are two or more qualifying individuals. Thus, the maximum credit is $720 if there is one qualifying individual and $1,440 if there are two or more qualifying individuals. A qualifying individual is (1) a dependent of the taxpayer under the age of 13 for whom the taxpayer is eligible to claim a dependency exemption, (2) a dependent of the taxpayer who is physically or mentally incapable of caring for himself or herself, or (3) the spouse of the taxpayer; if the spouse is physically or mentally incapable of caring for himself or herself. The 30% credit rate is reduced, but not below 20%, by 1 percentage point for each $2,000 (or fraction thereof) of AGI above $10,000.

EGTRRA makes the following changes in these rules, beginning in 2003:

1. It increases the maximum amount of eligible employment-related expenses from $2,400 to $3,000, if there is one qualifying individual (from $4,800 to $6,000, if there are two or more qualifying individuals).
   
2. It increases the maximum credit from 30% to 35% (the maximum credit is $1,200, if there is one qualifying individual and $2,400, if there are two or more qualifying individuals).
   
3. It modifies the phase-down of the credit. The 35% credit rate is reduced, but not below 20%, by 1 percentage point for each $2,000 (or fraction thereof) of AGI above $15,000. Therefore, the credit percentage is reduced to 20% for taxpayers with AGI over $43,000.
   

5. Marriage penalty relief and simplification relating to the earned income credit. Eligible low-income workers are able to claim a refundable earned income credit (EIC). The amount of the credit an eligible taxpayer may claim depends upon the taxpayer’s income and whether the taxpayer has one, more than one, or no qualifying children. EGTRRA makes the following changes in the EIC, beginning in 2002:

1. In the past, the earned income amount penalizes some individuals because they receive a smaller EIC if they are married than if they are not married. In order to minimize this penalty, EGTRRA increases the phase-out amount for married taxpayers who file a joint return. For married taxpayers who file a joint return, EGTRRA increases the beginning and ending of the EIC phase-out by $3,000. These beginning and ending points are to be adjusted annually for inflation after 2002.
   
2. EGTRRA simplifies the definition of earned income by excluding nontaxable employee compensation from the definition of earned income for EIC purposes. As a result, earned income includes wages, salaries, tips, and other employee compensation, if includible in gross income for the taxable year, plus net earnings from self employment. Housing allowances, and the annual rental value of church-provided parsonages, are examples of "nontaxable employee compensation" that in the past was included in the computation of "earned income" in calculating the EIC. The effect was to increase earned income and either disqualify many ministers for the EIC (because their earned income was too high), or reduce the value of the credit. By eliminating housing allowances and the annual rental value of parsonages from the definition of earned income, EGTRRA will make the EIC available to many more ministers, and will result in a larger credit for those who qualify for the credit.
   
3. EGTRRA simplifies the calculation of the EIC by replacing modified AGI with adjusted gross income.
   
4. EGTRRA provides that the "relationship test" is met if the individual is the taxpayer’s son, daughter, stepson, stepdaughter, or a descendant of any such individuals. A brother, sister, stepbrother, stepsister, or a descendant of such individuals, also qualifies if the taxpayer cares for such individual as his or her own child. A foster child satisfies the relationship test as well. In order to be a qualifying child, in all cases the child must have the same principal place of abode as the taxpayer for over one-half of the taxable year.
   

6. Phase-out of personal exemption reduction. In order to determine taxable income, an individual reduces AGI by any personal exemptions, deductions, and either the applicable standard deduction or itemized deductions. Personal exemptions generally are allowed for the taxpayer, his or her spouse, and any dependents. For 2002, the amount deductible for each personal exemption is $3,000. This amount is adjusted annually for inflation.

The deduction for personal exemptions is phased out for taxpayers with AGI over certain thresholds. For 2002, the thresholds are $137,300 for single individuals and $206,000 for married individuals filing a joint return (adjusted annually for inflation). The total amount of exemptions that may be claimed by a taxpayer is reduced by 2% for each $2,500 (or portion thereof) by which the taxpayer’s AGI exceeds the applicable threshold. For 2002, the point at which a taxpayer’s personal exemptions are completely phased-out is $259,800 for single individuals and $328,500 for married individuals filing a joint return.

EGTRRA repeals the personal exemption phase-out over five years, beginning in 2006. The phase-out is reduced by one-third in taxable years beginning in 2006 and 2007, and is reduced by two-thirds in taxable years beginning in 2008 and 2009. The repeal is fully effective for taxable years beginning after December 31, 2009. In explaining the reason for repealing the phase-out, a congressional conference committee noted that "the personal exemption phase-out is an unnecessarily complex way to impose income taxes and the hidden way in which the phase-out raises marginal tax rates undermines respect for the tax laws."

7. Increase the starting point for phase-out of itemized deductions. Taxpayers may choose to claim either the standard deduction or itemized deductions (subject to certain limitations) for certain expenses incurred during the year. The total amount of allowable itemized deductions (with a few exceptions) is reduced by 3% of the amount of the taxpayer’s adjusted gross income in excess of $137,300 in 2002. However, itemized deductions cannot be reduced by more than 80%. The starting point for the phase-out is adjusted annually for inflation. EGTRRA repeals this limitation on itemized deductions over a five-year period beginning in 2006. The limit on itemized deductions is reduced by one-third in taxable years beginning in 2006 and 2007, and by two-thirds in taxable years beginning in 2008 and 2009. The overall limitation is repealed for taxable years beginning after December 31, 2009.

B. Education

8. Modifications to “Coverdell education savings accounts.” Prior to EGTRRA taxpayers were allowed to create “education IRAs” for the purpose of paying the qualified higher education expenses of designated beneficiaries. Annual contributions to education IRAs could not exceed $500 per beneficiary (except in cases involving certain tax-free rollovers) and could not be made after the designated beneficiary reached age 18. The $500 annual contribution limit for education IRAs was phased-out for single taxpayers with modified adjusted gross income between $95,000 and $110,000. The phase-out range for married taxpayers filing a joint return was $150,000 to $160,000 of modified AGI. Individuals with modified AGI above the phase-out range were not allowed to make contributions to an education IRA established on behalf of any individual. Earnings on contributions to an education IRA generally were subject to tax when withdrawn. However, distributions from an education IRA were excludable from the gross income of the beneficiary to the extent that the total distribution did not exceed the “qualified higher education expenses” incurred by the beneficiary during the year the distribution is made.

1. Education IRAs are renamed “Coverdell education savings accounts” (Coverdell ESAs).
   
2. The annual limit on contributions is increased from $500 to $2,000. As a result, the total contributions that may be made by all contributors to one (or more) Coverdell ESAs established on behalf of any particular beneficiary is limited to $2,000 for each year.
   
3. The definition of "qualified education expenses" for which tax-free distributions may be made is expanded to include “qualified elementary and secondary school expenses,” meaning expenses for (1) tuition, fees, academic tutoring, special need services, books, supplies, computer equipment (including related software and services), and other equipment incurred in connection with the enrollment or attendance of the beneficiary at a public, private, or religious school providing elementary or secondary education (kindergarten through grade 12) as determined under state law, and (2) room and board, uniforms, transportation, and supplementary items or services (including extended day programs) required or provided by such a school in connection with such enrollment or attendance of the beneficiary. Computer software involving sports, games, or hobbies is not considered a qualified elementary and secondary school expense unless the software is predominantly educational in nature.
   
4. The phase-out range for married taxpayers filing a joint return is increased so that it is twice the range for single taxpayers. As a result, the phase-out range for married taxpayers filing a joint return is $190,000 to $220,000 of modified AGI.
   
5. The rule prohibiting contributions to an education IRA after the beneficiary attains age 18 does not apply in the case of a special needs beneficiary (as defined by IRS regulations).
   
6. Corporations and other entities (including tax-exempt organizations) are permitted to make contributions to Coverdell ESAs, regardless of the income of the corporation or entity during the year of the contribution.
   
7. Individual contributors are deemed to have made a contribution on the last day of the preceding taxable year if the contribution is made on account of such taxable year and is made not later than April 15 of the following year.
   
8. Taxpayers are permitted to claim a HOPE credit or Lifetime Learning credit for a taxable year and to exclude from gross income amounts distributed (both the contributions and the earnings portions) from a Coverdell ESA on behalf of the same student as long as the distribution is not used for the same educational expenses for which a credit was claimed.
   

9. Private prepaid tuition programs. Section 529 of the tax code provides tax-exempt status to “qualified state tuition programs,” meaning certain programs established and maintained by a state (or agency or instrumentality thereof) under which persons may (1) purchase tuition credits or certificates on behalf of a designated beneficiary that entitle the beneficiary to a waiver or payment of qualified higher education expenses of the beneficiary, or (2) make contributions to an account that is established for the purpose of meeting qualified higher education expenses of the designated beneficiary of the account (a “savings account plan”).

EGTRRA expands the definition of “qualified tuition program,” beginning in 2002, to include certain prepaid tuition programs established and maintained by one or more eligible educational institutions (which may be private institutions) that satisfy the requirements under code section 529. In the case of a qualified tuition program maintained by one or more private eligible educational institutions, persons are able to purchase tuition credits or certificates on behalf of a designated beneficiary but would not be able to make contributions to a "savings account plan" (as described in code section 529(b)(1)(A)(ii)). Except to the extent provided in regulations, a tuition program maintained by a private institution is not treated as qualified unless it has received a ruling or determination from the IRS that the program satisfies applicable requirements. Distributions from qualified tuition programs established and maintained by an entity other than a state used to pay for qualified higher education expenses are excluded from the recipient's taxable income beginning in 2004.

EGTRRA allows a taxpayer to claim a HOPE credit or Lifetime Learning credit for a taxable year and to exclude from gross income amounts distributed (both the principal and the earnings portions) from a qualified tuition program on behalf of the same student as long as the distribution is not used for the same expenses for which a credit was claimed.

10. Exclusion for employer-provided educational assistance. Employer-paid educational assistance is not included in the taxable wages of an employee if provided under a "section 127" educational assistance plan. Section 127 provides an exclusion of $5,250 annually for employer-provided educational assistance. Prior to EGTRRA the exclusion did not apply to graduate courses beginning after June 30, 1996, and it did not apply to undergraduate courses beginning after December 31, 2001.

EGTRRA extends the exclusion for employer-provided educational assistance to graduate education and makes the exclusion (as applied to both undergraduate and graduate education) permanent. This provision is effective with respect to courses beginning after December 31, 2001.

11. Deduction for qualified higher education expenses. In general, taxpayers cannot deduct the education and training expenses of either themselves or their dependents. However, a deduction for education expenses is allowed if the education or training (1) maintains or improves a skill required in a trade or business currently engaged in by the taxpayer, or (2) meets the express requirements of the taxpayer’s employer, or requirements of applicable law or regulations, imposed as a condition of continued employment. Education expenses are not deductible if they relate to certain minimum educational requirements or to education or training that enables a taxpayer to begin working in a new trade or business. In the case of an employee, education expenses (if not reimbursed by the employer) may be claimed as an itemized deduction only if such expenses meet the above described criteria for deductibility under section 162 of the tax code and only to the extent that the expenses, along with other miscellaneous deductions, exceed 2% of the taxpayer’s AGI.

EGTRRA permits taxpayers an “above-the-line” (page 1 of Form 1040) deduction for qualified higher education expenses paid by the taxpayer during a taxable year. Qualified higher education expenses are defined in the same manner as for purposes of the HOPE credit. In 2002 and 2003, taxpayers with AGI that does not exceed $65,000 ($130,000 in the case of married couples filing joint returns) are entitled to a maximum deduction of $3,000 per year. Taxpayers with AGI above these thresholds would not be entitled to a deduction. In 2004 and 2005, taxpayers with AGI that does not exceed $65,000 ($130,000 in the case of married taxpayers filing joint returns) are entitled to a maximum deduction of $4,000 and taxpayers with AGI that does not exceed $80,000 ($160,000 in the case of married taxpayers filing joint returns) are entitled to a maximum deduction of $2,000. This provision expires at the end of 2005.

C. Estates and Gift Taxes

12. Phase-out and repeal of estate and generation-skipping transfer taxes. EGTRRA makes the following changes:

1. Beginning in 2011, the estate and generation-skipping transfer taxes are repealed.
   
2. After repeal, the "basis" of assets received from a decedent generally will equal the basis of the decedent (i.e., carryover basis) at death. However, a decedent’s estate is permitted to increase the basis of assets transferred by up to a total of $1.3 million. The basis of property transferred to a surviving spouse can be increased (i.e., stepped up) by an additional $3 million. As a result, the basis of property transferred to a surviving spouse can be increased (i.e., stepped up) by a total of $4.3 million. In no case can the basis of an asset be adjusted above its fair market value. For these purposes, the executor will determine which assets and to what extent each asset receives a basis increase. The $1.3 million and $3 million amounts are adjusted annually for inflation occurring after 2010.
   
3. From 2002 and through 2010, the estate and gift tax rates are reduced, the unified credit amount is increased, and the generation-skipping transfer tax exemption amount is increased. The new rate structure is summarized in Table 10.
   

Table 10: Unified Credit Exemption; Highest Estate and Gift Tax Rates

Note: Beginning in 2011, the top gift tax rate will be 40%, and, except as provided in the tax regulations, a transfer to a trust will be treated as a taxable gift, unless the trust is treated as wholly owned by the donor or the donor’s spouse under the grantor trust provisions of the tax code.

D. IRAs and Retirement Plans

13. Individual retirement arrangements (“IRAs”). EGTRRA increases the maximum annual dollar contribution limit for IRA contributions to $3,000 for 2002 through 2004, $4,000 for 2005 through 2007, and $5,000 for 2008. After 2008, the limit is adjusted annually for inflation in $500 increments. In addition, individuals who have attained age 50 may make additional "catch-up" IRA contributions. The otherwise maximum contribution limit (before application of the AGI phase-out limits) for an individual who has attained age 50 before the end of the taxable year is increased by $500 for 2002 through 2005, and $1,000 for 2006 and thereafter.

14. Increase in benefit and contribution limits. Prior to EGTRRA, annual additions to a defined contribution plan with respect to each plan participant could not exceed the lesser of (1) 25% of compensation, or (2) $35,000 (for 2001). Annual additions are the sum of employer contributions and employee contributions. Under a defined benefit plan, the maximum annual benefit payable at retirement was generally the lesser of (1) 100% of average compensation, or (2) $140,000 (for 2001). EGTRRA increases the $35,000 limit on annual additions to a defined contribution plan to $40,000. This amount is indexed in $1,000 increments. It also increases the $140,000 annual benefit limit under a defined benefit plan to $160,000. The dollar limit is reduced for benefit commencement before age 62 and increased for benefit commencement after age 65. These changes are effective in 2002.

15. Increase in compensation limitation. EGTRRA increases to $200,000 the limit that may be taken into account for purposes of determining contributions and benefits under a qualified plan, applying the deduction rules, and for nondiscrimination testing purposes. This amount is indexed in $5,000 increments. This provision took effect in 2002.

16. Increase in elective deferral limit. EGTRRA increases the dollar limit on annual elective deferrals an individual may make to a qualified cash or deferred arrangement (a “section 401(k) plan”), a tax-sheltered annuity (“section 403(b) annuity”) or a salary reduction simplified employee pension plan (“SEP”) to $11,000 in 2002. In 2003 and thereafter, the limits are increased in $1,000 annual increments until the limits reach $15,000 in 2006, with indexing in $500 increments thereafter.

17. "Roth contributions" to 403(b) annuity plans. EGTRRA allows a section 401(k) plan or a section 403(b) annuity to include a “Roth contribution program” that permits a participant to elect to have all or a portion of the participant’s elective deferrals under the plan treated as Roth contributions. Roth contributions are elective deferrals that the participant designates (at such time and in such manner as the IRS may prescribe) as not excludable from the participant’s gross income. The annual dollar limitation on a participant’s Roth contributions is the annual limitation on elective deferrals, reduced by the participant’s elective deferrals that the participant does not designate as Roth contributions. The plan is required to establish a separate account, and maintain separate recordkeeping, for a participant’s Roth contributions (and earnings).

A qualified distribution from a participant’s Roth contribution account is not includible in the participant’s gross income. A qualified distribution is a distribution that is made after the end of a specified nonexclusion period and that is (1) made on or after the date on which the participant attains age 59, (2) made to a beneficiary (or to the estate of the participant) on or after the death of the participant, or (3) attributable to the participant being disabled. The nonexclusion period is the 5-year taxable period beginning with the earlier of (1) the first taxable year for which the participant made a Roth contribution to any Roth contribution account established for the participant under the plan, or (2) if the participant has made a rollover contribution to the Roth contribution account that is the source of the distribution from a Roth contribution account established for the participant under another plan, the first taxable year for which the participant made a Roth contribution to the previously established account. A participant is permitted to roll over a distribution from a Roth contribution account only to another Roth contribution account or a Roth IRA of the participant.

This provision takes effect in 2006.

18. Nonrefundable credit to certain individuals for elective deferrals and IRA contributions. EGTRRA provides a temporary nonrefundable tax credit for contributions made by eligible taxpayers to a qualified retirement plan. The maximum annual contribution eligible for the credit is $2,000. The credit rate depends on the adjusted gross income (AGI) of the taxpayer. Only joint returns with AGI of $50,000 or less, head of household returns of $37,500 or less, and single returns of $25,000 or less are eligible for the credit. The credit is in addition to any deduction or exclusion that would otherwise apply with respect to the contribution. The credit offsets minimum tax liability as well as regular tax liability. The credit is available to individuals who are age 18 or over, other than individuals who are full-time students or claimed as a dependent on another taxpayer’s return.

The credit is available with respect to elective contributions to a section 401(k) plan, section 403(b) annuity, SIMPLE or SEP plans, and contributions to a traditional or Roth IRA. The rules governing such contributions continue to apply. The amount of any contribution eligible for the credit is reduced by taxable distributions received by the taxpayer and his or her spouse from any savings arrangement described above or any other qualified retirement plan during the taxable year for which the credit is claimed, the two taxable years prior to the year the credit is claimed, and during the period after the end of the taxable year and prior to the due date for filing the taxpayer’s return for the year. In the case of a distribution from a Roth IRA, this rule applies to any such distributions, whether or not taxable. The credit rates based on AGI are summarized in Table 11.

This provision is effective beginning in 2002. It expires at the end of 2007.

Table 11: Credit Rates Based on AGI

19. Additional salary reduction catch-up contributions. The limit on elective deferrals under a 403(b) annuity plan is increased for individuals who have attained age 50 by the end of the year. The catch-up contribution provision does not apply to after-tax employee contributions. Additional contributions may be made by an individual who has attained age 50 before the end of the plan year and with respect to whom no other elective deferrals may otherwise be made to the plan for the year because of the application of any limitation of the tax code (e.g., the annual limit on elective deferrals) or of the plan.

The additional amount of elective contributions that may be made by an eligible individual participating in such a plan is the lesser of (1) the applicable dollar amount, or (2) the participant’s compensation for the year reduced by any other elective deferrals of the participant for the year. The applicable dollar amount under a 403(b) annuity is $1,000 for 2002, $2,000 for 2003, $3,000 for 2004, $4,000 for 2005, and $5,000 for 2006 and thereafter. Catch-up contributions are not subject to any other contribution limits and are not taken into account in applying other contribution limits. In addition, such contributions are not subject to applicable nondiscrimination rules.

This change took effect in 2002.

20. Revised limit on contributions to tax-sheltered annuities. EGTRRA repealed the “exclusion allowance” that used to apply to contributions to tax-sheltered annuities. As a result, such annuities are subject to the limits that apply to tax-qualified plans. A congressional conference committee explained this change as follows, "The present law rules that limit contributions to defined contribution plans by a percentage of compensation reduce the amount that lower and middle-income workers can save for retirement. The present-law limits may not allow such workers to accumulate adequate retirement benefits, particularly if a defined contribution plan is the only type of retirement plan maintained by the employer. Conforming the contribution limits for tax-sheltered annuities to the limits applicable to retirement plans will simplify the administration of the pension laws, and provide more equitable treatment for participants in similar types of plans."

This change took effect in 2002.

21. Increase in contribution percentage limit for defined contribution plans. Prior to EGTRRA section 415(c) of the tax code limited the annual additions that could be made to a tax-qualified defined contribution retirement plan on behalf of an employee to the lesser of $35,000 (for 2001) or 25% of the employee’s compensation. Annual additions included employer contributions, including contributions made at the election of the employee (through elective deferrals of salary), and after-tax employee contributions.

EGTRRA increased the 25% of compensation limit on annual additions under a defined contribution plan to 100%. According to the congressional conference committee, the 25% limit was repealed because it has operated to reduce the amount that lower and middle-income workers can save for retirement. Further, conforming the contribution limits for tax-sheltered annuities to the limits applicable to retirement plans generally will simplify the administration of the pension laws, and provide more equitable treatment for participants in similar types of plans.

This change took effect in 2002.

22. Provisions relating to hardship withdrawals. Prior to EGTRRA elective deferrals under a tax-sheltered 403(b) annuity could not be distributed prior to the occurrence of one or more specified events. One such event was the financial hardship of the employee, which IRS regulations defined as an immediate and heavy financial need for which a premature distribution was needed. The regulations provided a safe harbor under which a distribution would be deemed necessary to satisfy an immediate and heavy financial need. One requirement of this safe harbor was that the employee be prohibited from making elective contributions and employee contributions to the plan and all other plans maintained by the employer for at least 12 months after receipt of the hardship distribution.

EGTRRA directed the IRS to revise the regulations to reduce from 12 months to 6 months the period during which an employee must be prohibited from making elective contributions and employee contributions in order for a distribution to be deemed necessary to satisfy an immediate and heavy financial need.

The revised regulations took effect in 2002.

23. Rollovers of retirement plan and IRA distributions. EGTRRA provides that eligible rollover distributions from qualified retirement plans or section 403(b) annuities can be rolled over to any of these plans or arrangements. Similarly, distributions from an IRA generally are permitted to be rolled over into a qualified plan or section 403(b) annuity. Section 403(b) annuities are not required to accept rollovers.

24. Employer-provided retirement advice. EGTRRA contained a new exclusion for qualified retirement planning services provided to an employee and his or her spouse by an employer maintaining a "qualified plan." The term "qualified plan" is defined to include 403(b) annuities and several other types of retirement plans. This means that the value of retirement planning advice provided by a church that maintains a 403(b) plan does not constitute taxable income for payroll tax reporting purposes (i.e., it is not reported on Form W-2, Form 941, and there is no tax withholding on the value of such advice), and employees do not report the value of the advice as taxable income on their tax return. This new exclusion does not apply with respect to highly compensated employees (generally, those earning annual compensation of at least $90,000 in 2002) unless the services were available on substantially the same terms to each member of the group of employees who normally are provided education and information regarding the employer’s qualified plan.

The provision took effect in 2002.

E. Miscellaneous changes

25. Backup withholding. Employers are required to engage in "backup withholding" for payments made to self-employed workers who do not disclose their Social Security number. EGTRRA decreases the backup withholding rate to 30% in 2002 and 2003, 29% for 2004-2005, and 28% for 2006 and subsequent years. Table 12 summarizes the backup withholding rates.

Table 12: Backup Withholding Rates

Other Tax Law Developments of Interest to Ministers and Lay Church Employees

26. The Clergy Housing Allowance Clarification Act of 2002. In 1971, the IRS ruled that the nontaxable amount of a housing allowance designated by a church for a minister who owns a home cannot exceed either the minister’s actual housing expenses or the annual “fair rental value” of the home (furnished, plus utilities) In 2000, the Tax Court struck down the fair rental value limit as an unwarranted interpretation of the tax code. Warren v. Commissioner, 114 T.C. 23 (2000). The IRS appealed the Warren case to a federal appeals court. While the appeal was pending, the court openly questioned whether the housing allowance was an unconstitutional “establishment of religion.” In order to prevent the court from addressing the constitutionality question, Congress unanimously enacted the Clergy Housing Allowance Clarification Act in 2002. The Act amends the tax code to reinstate the annual fair rental value limit. In response to this legislation the IRS agreed to dismiss the appeal of the Warren case, and, as a result, the federal appeals court dismissed the case in August of 2002, thus ending the potential threat to the constitutionality of the housing allowance. However, the court left unanswered the question of whether an individual taxpayer has the authority to challenge the constitutionality of the housing allowance.

The Clergy Housing Allowance Clarification Act of 2002 reinstates the annual fair rental value limit as a matter of law, beginning in 2002. In other words, the fair rental value limit will not apply to any pre-2002 returns, with two exceptions: (1) ministers who applied the fair rental value limit in computing their taxes for 2000 or 2001 cannot submit an amended return for either year recomputing their taxes without reference to the fair rental value limit; and (2) ministers who received an extension of time to file their 2001 tax return (until August 15, 2002) must apply the fair rental value limit in computing their 2001 taxes.

27. The Tax Court ruled that a minister was exempt from self-employment taxes even though the IRS had no record that he submitted a timely Form 4361. Pastor B graduated from seminary in 1976 and was ordained in 1977. Since his ordination, Pastor B served as the senior pastor of a church. In March of 1977 Pastor B completed and signed Form 4361 in the presence of witnesses, and mailed it to the IRS. The IRS has no record that the Form 4361 was filed, and Pastor B did not keep a copy of the form that he submitted. The IRS audited Pastor B, and determined that he was not exempt from self-employment taxes. It relied on a provision in the income tax regulations specifying that an exemption is not effective until “approved” by the IRS. Pastor B appealed to the Tax Court. Both he and the IRS agreed that a Form 4361 filed in March of 1977 would have been timely. The only issue was whether the form was actually filed. The court concluded that Pastor B was exempt from self-employment taxes: “We found [Pastor B’s] evidence that he had filed for an exemption to be particularly credible. His testimony concerning the filing of the Form 4361 was straightforward and plausible. Further, his testimony was buttressed by the written statement of a witness who observed petitioner complete and sign the Form 4361 in 1977. With regards to whether the application was approved by [IRS], as required by the regulations . . . we believe that such approval must have been given. [Pastor B] consistently has not paid self-employment taxes on his ministerial earnings since 1977. . . . It seems highly peculiar that, if the approval had not been given, he would have filed for 21 years as being exempt without some dispute. Rather, it seems more likely that his file was misplaced at some point in time. Thus, we find that he prepared and filed the Form 4361 in 1977.” The court acknowledged that Pastor B could not produce a copy of the Form 4361 that he allegedly filed, but it concluded that neither the tax code nor regulations require ministers “to retain such a copy.” Abdallah v. Commissioner, T.C. Summary Opinion 2002-132.

28. Deduction for educator expenses. If you are an eligible educator, you can deduct as an adjustment to income up to $250 in qualified expenses. You can deduct these expenses even if you do not itemize deductions on Schedule A (Form 1040). This adjustment to income is for expenses paid or incurred in tax years beginning during 2002 or 2003. Previously, these expenses were deductible only as a miscellaneous itemized deduction subject to the 2% of AGI limit.

You are an eligible educator if, for the tax year, you meet the following requirements: (1) you are a kindergarten through grade 12: (a) teacher; (b) instructor; (c) counselor; (d) principal; or (e) aide. (2) You work at least 900 hours during a school year in a school that provides elementary or secondary education, as determined under state law.

Qualified expenses are unreimbursed expenses you paid or incurred for books, supplies, computer equipment (including related software and services), other equipment, and supplementary materials that you use in the classroom. For courses in health and physical education, expenses for supplies are qualified expenses only if they are related to athletics.

To be deductible as an adjustment to income, the qualified expenses must be more than the following amounts for the tax year: (1) The interest on qualified U.S. savings bonds that you excluded from income because you paid qualified higher education expenses; (2) any distribution from a qualified tuition program that you excluded from income; or (3) any tax-free withdrawals from your Coverdell education savings account.

29. Victims of terrorist attacks. The Victims of Terrorism Tax Relief Act of 2001 provides significant tax relief to persons affected by (1) the 1995 attack on the Alfred P. Murrah Federal Building in Oklahoma City; (2) the September 11, 2001 attacks on the World Trade Center, the Pentagon, and United Airlines Flight 93 in Somerset County, Pennsylvania; or (3) terrorist attacks involving anthrax occurring after September 10, 2001, and before January 1, 2002. Congress and the IRS have provided various additional forms of relief to victims of terrorism. See IRS Publication 3920 (Tax Relief for Victims of Terrorist Acts) for details.

30. Social Security average benefits for 2002. The maximum Social Security benefit for workers retiring at age 65 on January 1, 2002 increased to $1,660 per month ($19,920 per year). The average benefit is $874 per month ($10,488 per year) for all retired workers; $1,454 per month ($17,448 per year) for a retired couple who each receive benefits); $1,764 per month ($21,168 per year) for a widowed mother with two minor children; and $815 per month ($9,780 per year) for a disabled worker. See Table 13 for more details on changes in the Social Security program that took effect in 2002.

31. Increase in earnings subject to the self-employment tax. The self﷓employment tax rate (15.3%) did not change in 2002. However, the amount of earnings subject to tax increased. The 15.3% tax rate consists of two components: (1) a Medicare hospital insurance (HI) tax of 2.9%, and (2) an “old﷓age, survivor and disability” (OASDI) tax of 12.4%. There is no maximum amount of self﷓employment earnings subject to the Medicare hospital insurance (the 2.9% HI tax rate). The tax is imposed on all net earnings regardless of amount. For 2002, the maximum earnings subject to the OASDI portion of self﷓employment taxes (the 12.4% amount) increases to $84,900—up from $80,400 in 2001. Stated differently, persons who received compensation in excess of $84,900 in 2002 will pay the combined 15.3% tax rate for net self﷓employment earnings up to $84,900, and only the HI tax rate of 2.9% on earnings above $84,900. These rules directly impact ministers, who always are considered self﷓employed for Social Security purposes with respect to their ministerial services. Ministers should take these rules into account in computing their quarterly estimated tax payments.

Table 13: Social Security Changes

32. The standard mileage rate for business miles was 36.5 cents per mile for 2002. The standard mileage rate can be used to compute the cost associated with the business use of a car, provided that it is used in the first year the car is used for business purposes. In addition, employers can use the standard mileage rate to reimburse clergy and church workers for their business use of a car. Of course, ministers and other church staff members are free to deduct the actual costs associated with the business use of a car, but most do not because computing actual costs is much more time﷓consuming and inconvenient. The 36.5 cents per mile rate applied to all business miles driven in 2002.

33. Inflation adjustments. For 2002, the following three “inflation adjustments” took effect:

Tax rates. The amounts of income you need to earn to boost you to a higher tax rate were adjusted for inflation.

Personal exemptions. The “personal exemption amount” (the amount you can deduct for yourself, your spouse, and each dependent) was adjusted for inflation. For 2002, the amount increased to $3,000 per person (up from $2,900 in 2001).

Standard deduction. The "standard deduction" (the amount you can deduct if you cannot itemize your deductions) increased to $7,850 for married couples filing jointly—up from $7,600 in 2001. It increased to $4,700 for single taxpayers—up from $4,550 in 2001. Single taxpayers who are 65 years of age or older, or blind, get a $1,150 increase in their standard deduction for 2002. Married taxpayers who are 65 years of age or older, or blind, get an $900 increase in their standard deduction for 2002.

34. Audit statistics. The General Accounting Office released a report in 2001 analyzing IRS audit rates. The results are summarized in Table 14.

Table 14: IRS Audit Rates for Individual Taxpayers: 1996-2000 (in thousands)

35. Health insurance deduction for the self-employed. Self-employed persons can deduct health insurance costs for themselves (and their spouse and children) as follows: 70% in 2002 and 100% in 2003 and thereafter. This deduction is not allowed in any year in which the self-employed person is eligible to participate in a subsidized health plan maintained by an employer of either the self-employed person or his or her spouse.

36. Foreign earned income credit. United States citizens generally are subject to federal income tax on all their income, whether derived in the United States or in a foreign country. However, citizens working in foreign countries may be eligible to exclude from their income for federal income tax purposes certain foreign earned income and housing costs. To qualify for these exclusions, the individual must either (1) be a resident of the foreign country for an uninterrupted period that includes the entire tax year, or (2) be present overseas for 330 days out of any 12 consecutive month period. The maximum exclusion for foreign earned income for 2002 was $80,000. This amount remains at $80,000 through 2007. In addition, the credit will be indexed for inflation beginning in 2008. This credit is claimed by many American missionaries serving in foreign countries.

37. Estimated tax requirements. A taxpayer is subject to a penalty for underpayments of estimated taxes. For 2002 tax returns the penalty is avoided if a taxpayer made timely estimated tax payments at least equal to (1) 100% of the previous year’s tax liability, or (2) 90% of the current year’s tax liability. For individuals with AGI of more than $150,000 for the previous year the "100% of last year’s tax liability" rule is changed to 110% of the previous year's tax liability in 2002 and thereafter.

38. Simplified definition of "highly compensated employee." A number of tax﷓favored rules do not apply if there is discrimination in favor of “highly compensated employees.” These include (1) simplified employee pensions (SEPs); (2) 403(b) tax﷓sheltered annuities (churches and qualified church﷓controlled organizations are exempt from this nondiscrimination rule); (3) qualified employee discounts; (4) cafeteria plans; (5) flexible spending arrangements; (6) qualified tuition reductions; (7) employer﷓provided educational assistance; and (8) dependent care assistance.

For 2002 a highly compensated employee is one who (1) was a 5% owner of the employer at any time during the current or prior year (this definition will not apply to churches), or (2) had compensation for the previous year in excess of $90,000, and, if an employer elects, was in the top 20% of employees by compensation. The $90,000 amount is adjusted annually for inflation.

39. Increase in "section 179" deduction. It is a basic principle of tax law that if a product is purchased for business use and has a useful life of more than one year, the full cost may not be deducted in the year of purchase but rather must be allocated over the useful life of the product and an annual ”depreciation" deduction claimed each year. Section 179 of the tax code, however, permits taxpayers to elect to deduct most if not all of the cost of business property in the year of purchase if certain conditions are satisfied. In 2002 and future years the deduction is limited to the following amounts:

40. Extend the phaseout of the luxury tax on automobiles. An excise tax is imposed on the sale of a “luxury automobile” whose price exceeds a threshold amount ($40,000 in 2002). The excise tax for 2002 is 3% of the purchase price in excess of this threshold amount.

41. "Luxury car" limits adjusted for inflation. Ministers and lay church employees who use the “actual expense” method of computing their car expenses can claim a deduction for depreciation. There are limits on the amount of depreciation that you can claim in any given year. These limits are known as the “luxury car” limits. The 2002 limits are summarized in the table below, along with the limits for 2001 (for comparison purposes).

“Luxury car” depreciation limits

For electric cars placed in service in 2002 these amounts are $9,180 for year one; $14,700 for year two; $8,750 for year three; and $5,325 each succeeding year in the recovery period.

42. Phase﷓out of personal exemption for high﷓income taxpayers. The personal exemption deduction (that you can claim for yourself and each dependent) increased to $3,000 in 2002 (up from $2,900 in 2001). In 2002 the personal exemption amounts are phased out for certain high﷓income taxpayers. For married taxpayers filing jointly, the phase﷓out begins when AGI exceeds $206,000. For single taxpayers, the phase﷓out begins when AGI exceeds $137,300.

43. New per diem rates for substantiating the amount of travel expenses incurred in 2002. The IRS allows taxpayers to substantiate the amount of their business expenses by using “per diem” (daily) rates. Taxpayers still must have records substantiating the date, place, and business purpose of each expense. There are separate rates for meals and lodging, and separate rates for “high﷓cost localities” and all other communities (see IRS Publication 1542 for a complete list). The IRS uses the federal "fiscal year" (October 1 - September 30) in computing per diem rates instead of the calendar year. A table summarizes the per diem rates for October 1, 2001 through September 30, 2002. The per diem rates for the period October 1, 2002 through September 30, 2003 were not available at the time of publication of this text.

Per Diem Rates through September 2002

New in 2003. The “lodging plus M & IE” per diem rate remains unchanged through September 30, 2003. However, the M & IE per diem rate increases to $45 for high-cost localities, and to $35 for all other localities.

In some cases using the per diem rates will simplify the substantiation of meals and lodging expenses incurred while engaged in business travel. However, a number of restrictions apply, and these are explained in Chapter 7 of Richard Hammar's 2003 Clergy Tax Guide.

44. Revoking an exemption from self-employment (social security) taxes. Ministers had until April 15, 2002 to revoke an exemption from social security (the deadline was August 15, 2002 for ministers who received a four-month extension of time to file their 2001 tax return by filing a timely Form 4868 with the IRS). Many ministers who opted out of social security by filing a Form 4361 with the IRS have wanted to rejoin the program—often to qualify for Medicare benefits. In the past, ministers have not been permitted to revoke an exemption. The tax code specifies that such exemptions are irrevocable. However, in 1999 Congress enacted legislation allowing ministers to revoke an exemption from self-employment taxes by filing Form 2031 with the IRS by April 15, 2002. Ministers who filed the form had to begin paying self-employment taxes as of either January 1, 2000, or January 1, 2001. The window of time for revoking an exemption from self-employment taxes has closed, for now.

45. Substantiating contributions of property. A taxpayer claimed a substantial charitable contribution deduction on his income tax return. The IRS later audited his return, and challenged his deduction. The taxpayer claimed that the deduction was for contributions of various items of property he had made to local churches. His only support for these contributions, however, were "receipts" bearing the churches' letterhead and on which he had written descriptions and values for the donated items. This was not enough to substantiate the contributions, the IRS concluded. A federal appeals court agreed. It noted that "the taxpayer offered 'tax receipts' bearing the charities' letterheads on which he listed the items donated and their values," and concluded that these "self-generated receipts" were too unreliable to support a charitable contribution deduction. Tokh v. Commissioner, 2001-1 USTC 50,128 (7th Cir. 2001).

46. Tax treatment of frequent flyer miles no longer up in the air. Ever since the major airlines launched their "frequent flyer programs" several years ago there has been uncertainty concerning the tax treatment of frequent flyer miles—especially when those miles are earned by employees while engaged in business travel for their employer. Are employers required to report the "value" of these mileage awards as taxable income to employees? Or, is this a tax-free fringe benefit? The IRS recently provided official guidance. It announced, "Consistent with prior practice, the IRS will not assert that any taxpayer has understated his federal tax liability by reason of the receipt or personal use of frequent flyer miles or other in-kind promotional benefits attributable to the taxpayer's business or official travel. Any future guidance on the taxability of these benefits will be applied prospectively." The IRS cautioned that "this relief does not apply to travel or other promotional benefits that are converted to cash, to compensation that is paid in the form of travel or other promotional benefits, or in other circumstances where these benefits are used for tax avoidance purposes." A "promotional benefit" is a program that allows travelers to accumulate frequent flyer miles through rental car companies or hotels. These promotional benefits may generally be exchanged for upgraded seating, free travel, discounted travel, travel-related services, or other services or benefits. The recent IRS announcement does not address the tax status of such benefits. This means that the IRS could pursue a "tax enforcement program" against these benefits, but most experts view this as unlikely. For information regarding this announcement, call the IRS at (202) 622-4606. IRS Announcement 2002-18.

47. No contribution deduction for church school tuition. A federal appeals court rejected a married couple's claim that they could deduct 55% of the cost of their son's tuition at a religious school since religious instruction comprised 55% of the curriculum and constituted an "intangible religious benefit" that did not reduce the value of their charitable contribution. The court concluded, "Not only has the Supreme Court held that, generally, a payment for which one receives consideration does not constitute a contribution or gift . . . but it has explicitly rejected the contention . . . that there is an exception for payments for which one receives only religious benefits in return." The parents also argued that they could claim a charitable contribution deduction for the amount by which their tuition payments exceeded the market value of their son's education. They claimed that the value of the education their son received was zero since the cost of an education at a public school was "free," and therefore they could fully deduct the cost of their son's tuition since the entire amount exceeded the "value" of the education received. The court disagreed, noting that the value of their son's education was the cost of a comparable secular education offered by private schools. Further, the court noted that the parents presented no evidence of the tuition that private schools charge for a comparable secular education, and so there was no evidence showing that they made an “excess payment” that might qualify for a tax deduction. Sklar v. Commissioner, 2002-1 USTC 50,210 (9th Cir. 2002).

48. GAO report concludes more could be itemizing deductions. When computing federal income taxes, taxpayers may claim a standard deduction or itemize deductions. These deductions are subtracted from AGI in determining taxable income. Taxpayers generally claim the type of deduction that is larger, because this minimizes taxable income. In recent years, approximately 70% of taxpayers have claimed the standard deduction, while the other 30% have itemized. Members of Congress asked the General Accounting Office (GAO) to estimate how many taxpayers who are claiming the standard deduction would be better off itemizing deductions. The GAO examined 1998 tax returns and concluded that 2.2 million tax returns claimed the standard deduction though itemized deductions would have been higher, resulting in $1 billion dollars of overpaid taxes.

49. Congress considers Social Security change for retired ministers. In 1996, Congress amended the Internal Revenue Code to clarify that retired ministers do not pay self-employment (Social Security) tax on housing allowances and the annual rental value of a parsonage. However, a corresponding change was not made to the Social Security Act. As a result, while these benefits are not subject to self-employment taxes they are used to earn insured status under Social Security and to compute benefits under the Social Security program. The Social Security Program Protection Act of 2002 (H.R. 4070), which was passed unanimously by the House of Representatives on June 26, would amend the Social Security Act to conform it to the Internal Revenue Code, meaning that housing allowances and the annual rental value of a parsonage provided to retired ministers would not be considered in earning “insured status” or in computing the amount of Social Security benefits. The bill will now be considered by the Senate. If enacted, it will apply “to years beginning before, on, or after December 31, 1994.”

Example. Pastor John retired in 1999. This year he receives a $1,000 distribution each month from his church pension board. Half of this amount ($500) is designated as a housing allowance. Pastor John does not pay self-employment tax on the amount of his pension distributions that are designated as a housing allowance. However, under the Social Security Act, these same amounts are counted in earning “insured status” and in computing Social Security benefits. If the Social Security Program Protection Act of 2002 is enacted, the amount of Pastor John’s pension distributions that are designated as a housing allowance will not count in earning insured status or in computing Social Security benefits.

Example. Pastor Bob has always been exempt from self-employment (Social Security) tax because he filed a Form 4361 with the IRS in his first year of pastoral ministry. In 2002 he retires, and he revokes his exemption from self-employment taxes by filing Form 2031 with the IRS. His only income is the monthly pension distribution he receives from his church pension board. All of these distributions are designated as a housing allowance. Under current law, these distributions are not subject to self-employment tax, but they do count in earning “insured status” under the Social Security program and in computing Social Security benefits. If the Social Security Program Protection Act of 2002 is enacted, the amount of Pastor Bob’s pension distributions that are designated as a housing allowance will not count in earning insured status or in computing Social Security benefits.

50. Child and dependent care expenses. For the purpose of figuring the child and dependent care credit, your spouse is treated as having at least a minimum amount of earned income for any month that he or she is a full-time student or not able to care for himself or herself. Beginning in 2003, this amount is increased to $250 a month if there is one qualifying person and to $500 a month if there are two or more qualifying persons. Before 2003, the amounts were $200 and $400. The same rule applies for the exclusion of employer-provided dependent care benefits.

51. Ways and Means Committee approves deduction for private school expenses. On September 6, 2002, the House Ways and Means Committee approved the "Back to School Tax Relief Act of 2002". The Act now goes to the full House of Representatives for consideration. If enacted, it would allow an "above the line" tax deduction of up to $3,000 for education expenses incurred by parents whose children attend private schools (including church schools), or who homeschool their children. Education expenses are defined to include tuition, books, tutoring, supplies, transportation, computers, and software. The deduction is not available to married couples with AGI of more than $40,000 ($20,000 for single taxpayers). The deduction would be available whether or not a taxpayer is able to itemize deductions on Schedule A (Form 1040). The deduction would take effect in 2003. If enacted, this legislation would provide tax relief to parents who choose to send their children to church-operated private schools as well as those who homeschool their children.

52. Counting years of service with different churches as years of service with the same employer. In enacting EGTRRA in 2001, Congress inadvertently eliminated a rule that allowed ministers and lay church employees to count their years of service with different churches or denominational agencies as years of service with the same employer. This important provision was reinstated in 2002 by the Job Creation and Worker Assistance Act.

53. Congress addresses loans to officers and directors, and rabbi trusts. The recent corporate and accounting scandals involving Enron, WorldCom, and other companies have resulted in several bills being introduced in Congress. Consider the following:

(1) The Sarbanes-Oxley Act of 2002 was signed into law by President Bush in July of 2002. This legislation imposes strict new requirements on issuers of publicly-traded securities. One provision makes it a crime to authorize personal loans to officers or directors. This provision only applies to companies that issue securities that are registered under the Securities Exchange Act of 1934 (publicly traded companies). This legislation will not apply to most churches.

(2) The American Competitiveness and Corporate Accountability Act of 2002 (H.R. 4095) was introduced in Congress in 2002, and had not been enacted at the time of publication of this text. It contains several provisions that address “executive compensation.” If enacted, this legislation would prohibit officers and directors from avoiding tax on funds set aside by their employer in a rabbi trust.

(3) The National Employee Savings and Trust Equity Guarantee Act (S. 1971) was introduced in Congress in 2002, and had not been enacted at the time of publication of this text. If enacted, it would treat any loan made by an employer to an officer or director as taxable compensation in the year the loan is made, unless the loan is evidenced by a promissory note or other written evidence of indebtedness, there is adequate collateral or security for the loan, and there is a fixed schedule of not greater than 10 years over which the loan is to be repaid in substantially equal installments.