An overview of federal taxation enacted in 2002. (New York Liberty Zone).

Although many tax bills were approved by the House of Representatives in 2002, the Senate managed to avoid action on most of them. Only two bills of interest to taxpayers made the trip down Pennsylvania Avenue to the White House to be signed into law. When the House and Senate adjourned in late October for the November 5 election, last-minute efforts to pass tax bills relating to energy conservation and production, charitable giving, pension reform and relief for the military had languished. Prospects for their enactment after Congress returns in a lame-duck session are questionable at best.

The big news this year was the Job Creation and Worker Assistance Act of 2002. This bill, signed into law in March 2002, made several retroactive changes to the 2001 tax year: allowing a 30 percent bonus depreciation on assets placed in service after September 10, 2001 and temporarily increasing the carry-back period for net operating losses from two to five years for losses arising in tax years ending in 2001 and 2002. Other significant changes to the Code are summarized below. Practitioners are urged to refer to the statutory language, guidance from the IRS and other technical sources to determine how these provisions will affect their clients.

To help damaged areas of New York City to recover following the terrorist attack of September 11, 2001 the Job Creation and Worker Assistance Act:

* Created a new, targeted group for the Work Opportunity Tax Credit.

* Increased the Section 179 deduction to the lesser of $35,000 or the cost of qualified property used in the "New York Liberty Zone" for property placed in service from September 10, 2001 to January 1, 2007. This is in addition to the amount otherwise deductible under Section 179.

* Provided 30% additional first year depreciation on the adjusted basis of qualified "New York Liberty Zone" property.

* Extended the replacement period for certain property involuntary converted in the "New York Liberty Zone" to five years.

* Provided that five-year property for purposes of the depreciation rules under Section 168 includes qualified "New York Liberty Zone" leasehold improvement property. The straight-line depreciation method is required for this property and a nine-year period is the class life for purposes of the alternative depreciation system.

If you have clients who are schoolteachers, they may qualify under a provision in the bill for an above the line deduction for up to $250 of expenses paid for books, supplies, computer equipment and software and other materials used in the classroom. Eligible expenses must otherwise be deductible under Section 162 as a trade or business expense. Eligible individuals are teachers, instructors, principals, and counselors from kindergarten to grade twelve who work in a school for at least 900 hours during a school year. This deduction is in effect for tax years beginning after December 31, 2001 and before January 1, 2004.

In a provision affecting the tax treatment of S corporations, the bill provides that income from discharge of indebtedness of a S corporation that is excluded from the income of the S corporation is not taken into account as income to the shareholder and does not increase the basis of the shareholders stock. This provision overturns the effect of Gitliz v. Commissioner (531 U.S. 206 (2001)).

The Worker Assistance and Job Creation Act also expands the exclusion from income for qualified foster care payments. The definition of foster care payments was modified to include payments by any placement agency licensed or certified to make payments to providers of foster care. The definition of an individual in foster care is expanded to include foster care individuals placed by a qualified foster care placement agency, regardless of the individual's age at the time of placement.

A limitation on the use of the non-accrual experience method was included

in the legislation. Affecting tax years ending after date of enactment, the non-accrual experience method is only available for amounts to be received from the performance of qualified services and services provided by certain small businesses. Qualified services are: health, law, accounting, engineering, architecture, performing arts, actuarial science, and consulting. For small business, the method is available for the performance of non-qualified services if average annual gross receipts do not exceed $5 million.

The bill extended a variety of so-called expiring provisions:

* Alternative Minimum Tax-Individuals may offset their entire regular tax liability and alternative minimum tax liability by personal non-refundable credits in 2002 and 2003.

* Tax credit for purchase of electric vehicles-taxpayers may claim the full amount of the credit for qualified purchases made in 2002 and 2003.

* Section 45 credit for production of electricity from wind, biomass and other sources--placed in service date extended to January 1, 2004.

* Work opportunity tax credit--extended through December 31, 2003.

* Welfare to work credit--extended through December 31, 2003.

* 100% net income limitation for percentage depletion from marginal wells was suspended for an additional two years to include taxable years beginning in 2002 and 2003.

* Deduction for qualified clean-fuel vehicle property and qualified clean-fuel refueling property--taxpayers may claim full deduction for qualified property placed in service in 2002 and 2003. Phase-out will begin in 2004 and will be unavailable for purchases made after December 31, 2006.

* Archer Medical Savings Accounts--extended through December 31, 2003.

* Indian (Native American) employment credit and provision for accelerated depreciation of certain property used predominately in an active trade or business within an Indian reservation was extended through December 31, 2004.

The second tax bill, signed into law in May 2002, was narrowly focused on some members of the clergy. Public law 107-81, the Clergy Housing Allowance Act of 2002, clarifies that the Section 107 rental allowance exclusion may not exceed the fair rental value of the home including furnishings, appurtenances and cost of utilities. The bill is generally effective for tax years beginning after December 31, 2001. An exception applies for tax years beginning before January 1, 2002, if the taxpayer filed a return before April 17, 2002, and indicated that the Section107 exclusion was limited to the fair rental value of the home (including furnishings, appurtenances and cost of utilities) or filed a return after April 16, 2002.

What is in store for tax legislation in 2003? The new Congress that convenes in January 2003 may pick up many of the bills that stalled in the fall of 2002. The balance of power in the House and Senate will drive congressional action. Prime candidates for an early tax bill could be tax relief for members of the armed services and incentives to encourage charitable giving. If the economy remains sluggish, some sort of economic stimulus bill may take shape, perhaps tied into an increase in the minimum wage.

Michael Chakarun, CPA, is NSA's Director of Federal and Legislative Affairs.