The Ernst and Young Tax Guide 2002

The Ernst and Young Tax Guide 2002

2.0 2
by Ernst & Young LLP

". . . The best tax guide of the bunch . . ." –USA Today

". . . Hard to Beat . . ." –Money magazine

Here is the only guide that provides complete coverage of the new tax law provisions and includes essential forms for the upcoming tax season, plus the IRS’s official filing instructions for these forms. Make the most of the new

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". . . The best tax guide of the bunch . . ." –USA Today

". . . Hard to Beat . . ." –Money magazine

Here is the only guide that provides complete coverage of the new tax law provisions and includes essential forms for the upcoming tax season, plus the IRS’s official filing instructions for these forms. Make the most of the new tax law by saving more money on your taxes with America’s leading tax and accounting firm, Ernst & Young LLP.


• The Economic Growth and Tax Relief Reconciliation Act of 2001 and how it will affect your taxes–now and in the years to come • IRS Publication 17, "Your Federal Income Tax" • Estate Tax phase-in of lower rates, increased estate and tax exemption levels, and reduction in state death tax credit • How to take advantage of new rules on retirement plan rollover and distribution • Using Education IRAs and Qualified Tuition (Section 529) programs • 50 Most Commonly Overlooked Deductions

PLUS the always popular features

TaxSavers–tips to slash your taxes this year and next
TaxPlanners–strategies to help you prepare for the upcoming year
TaxAlerts–pointers on the new tax law changes that may affect you
TaxOrganizers–reminders that help you keep track of your important tax records

Over 450 of them at your fingertips!

Tax help online! for downloadable forms for Ernst & Young’s full range of online services

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Chapter One

Filing Information

Do I Have to File a Return? 
Individuals—In General 
Child Under Age 14 
Self-Employed Persons 
Which Form Should I Use? 
Form 1040EZ 
Form 1040A 
Form 1040 
Does My Return Have to Be on Paper? 
When Do I Have to File? 
Extensions of Time to File 
How Do I Prepare My Return? 
When Do I Report My Income and Expenses? 
Accounting Periods 
Accounting Methods 
Social Security Number 
Presidential Election Campaign Fund 
Gift to Reduce the Public Debt 
Peel-Off Address Label 
Where Do I File? 
What Happens After I File? 
What Records Should I Keep? 
Interest on Refunds 
What If I Made a Mistake? 
Amended Returns and Claims for Refund 



Unlike the other certainty in life, paying taxes is the one for which you may obtain an extension. Besides explaining when you must file your tax return and what to do if you are unable to get it prepared on time, this chapter provides an introduction to the basic framework within which you file your federal income tax return. It answers a lot of the elementary questions about the procedures and calculations involved in determining your income tax.

    This chapter discusses such items as who is required to file and who should file even though he or she is not required to do so. It tells you which forms to use, how to go about preparing your tax return once you have obtained the correct forms, and where to mail your tax return once it has been completed. In addition, the chapter informs you about the penalties that may be imposed if you do not pay your taxes on time and instructs you. on what to do if you discover that a previous tax return is in error. The chapter also explains what the different accounting methods are and which method may be used in preparing your return.

    Remember, one of the most important features of this book is Chapter 48, 2001 Federal Tax Forms and Schedules You Can Use.

Important Changes

Who must file. Generally, the amount of income you can receive before you must file a return has been increased. See Table 1-1, Table 1-2, and Table 1-3 for the specific amounts.

Third party designee. You can now allow the IRS to discuss your 2001 tax return with a friend, family member, or any other person you choose by checking the "Yes" box in the "third party designee" area of your return. See Third Party Designee.

Mailing your return. You may be mailing your return to a different address this year because the IRS has changed the filing location for several areas. If you received an envelope with your tax package, please use it. Otherwise, see your form instructions for where to file.

Sign your return electronically. Create your own personal identification number (PIN) and file a completely paperless tax return with IRS e-file. See Does My Return Have To Be On Paper.

Important Reminders

Alternative filing methods. Rather than filing a return on paper, you may be able to file electronically using IRS e-file. For more information, see Does My Return Have To Be On Paper, later.

Change of address. If you change your address, you should notify the IRS. See Change of Address, later, under What Happens After I File.

Write in your social security number. You must write your social security number (SSN) in the spaces provided on your tax return. If you file a joint return, please write the SSNs in the same order as the names.

Direct Deposit of refund. Instead of getting a paper check, you may be able to have your refund deposited directly into your account at a bank or other financial institution. See Direct Deposit under Refunds, later.

Alternative payment methods. If you owe additional tax, you may be able to pay electronically. See How To Pay, later.

Installment agreement. If you cannot pay the full amount due with your return, you may ask to make monthly installment payments. See Installment Agreement, later, under Amount You Owe.

Service in combat zone. You are allowed extra time to take care of your tax matters if you are a member of the Armed Forces who served in a combat zone, or if you served in the combat zone in support of the Armed Forces. See Individuals Serving in Combat Zone, later, under When Do I Have To File.

Adoption taxpayer identification number. If a child has been placed in your home for purposes of legal adoption and you will not be able to get a social security number for the child in time to file your return, you may be able to get an adoption taxpayer identification number (ATIN). For more information, see Social Security Number, later.

Taxpayer identification number for aliens. If you or your dependent is a nonresident or resident alien who does not have and is not eligible to get a social security number, file Form W-7 with the IRS to apply for an Individual Taxpayer Identification Number (ITIN). For more information, see Social Security Number, later.

1040PC format no longer accepted. The 1040PC format was a computer-generated paper tax return. The availability of electronic filing for home computer users has reduced the need for this format. The IRS no longer accepts tax returns in the 1040PC format. The IRS encourages all former 1040PC filers to use IRS e-file.

    This chapter discusses:

• Whether you have to file a return,

• Which form to use,

• How to file electronically,

• When, how, and where to file your return,

• What happens if you pay too little or too much tax,

• What records you should keep and how long you should keep them, and

• How you can change a return you have already filed.

Do I Have To File a Return?

You must file a federal income tax return if you are a citizen or resident of the United States or a resident of Puerto Rico and you meet the filing requirements for any of the following categories that apply to you.

1) Individuals in general. (There are special rules for surviving spouses, executors, administrators, legal representatives, U.S. citizens living outside the United States, residents of Puerto Rico, and individuals with income from U.S. possessions.)

2) Dependents.

3) Child under age 14.

4) Self-employed persons.

5) Aliens.

The filing requirements for each category are explained in this chapter.

The filing requirements apply even if you do not owe tax.

Tip. Even if you do not have to file a return, it may be to your advantage to do so. See Who Should File, later.

One return. File only one federal income tax return for the year regardless of how many jobs you had, how many Forms W-2 you received, or how many states you lived in during the year.

Individuals—In General

If you are a U.S. citizen or resident, whether you must file a return depends on three factors:

1) Your gross income,

2) Your filing status, and

3) Your age.

    To find out whether you must file, see Table 1-1, Table 1-2, and Table 1-3. Even if no table shows that you must file, you may need to file to get money back (See Who Should File, later.)

Gross income. This includes all income you receive in the form of money, goods, property, and services that is not exempt from tax. It also includes income from sources outside the United States (even if you may exclude all or part of it). Common types of income are discussed in the chapters in Part Two of this publication.

    Community property. If you are married and your permanent home is in a community property state, half of any income described by state law as community income may be considered yours. This affects your federal taxes, including whether you must file if you do not file a joint return with your spouse. See Publication 555, Community Property, for more information.

    Self-employed individuals. If you are self-employed, your gross income includes the amount on line 7 of Schedule C (Form 1040), Profit or Loss From Business, or line 1 of Schedule C-EZ (Form 1040), Net Profit From Business. See Self-Employed Persons, later, for more information about your filing requirements.

Caution. If you do not report all of your self-employment income, you could cause your social security benefits to be lower when you retire.

Filing status. Your filing status depends on whether you are single or married and on your family situation. Your filing status is determined on the last day of your tax year, which is December 31 for most taxpayers. See chapter 2 for an explanation of each filing status.

Age. If you are 65 or older at the end of the year, you generally can have a higher amount of gross income than other taxpayers before you must file. See Table 1-1. You are considered 65 on the day before your 65th birthday. For example, if your 65th birthday was on January 1, 2002, you are considered 65 for 2001.

Surviving Spouses, Executors, Administrators, and Legal Representatives

You must file a final return for a decedent (a person who died) if both of the following are true.

• You are the surviving spouse, executor, administrator, or legal representative.

• The decedent met the filing requirements at the date of death.

   For more information on rules for filing a decedent's final return, see chapter 4.

U.S. Citizens Living Outside the United States

If you are a U.S. citizen living outside the United States, you must file a return if you meet the filing requirements. For information on special tax rules that may apply to you, get Publication 54, Tax Guide for U.S. Citizens and Resident Aliens Abroad. It is available at most U.S. embassies and consulates. Also see How To Get Tax Help in the back of this publication.

Residents of Puerto Rico

Generally, if you are a U.S. citizen and a resident of Puerto Rico, you must file a U.S. income tax return if you meet the filing requirements. This is in addition to any legal requirement you may have to file an income tax return for Puerto Rico.

    If you are a resident of Puerto Rico for the entire year, gross income does not include income from sources within Puerto Rico, except for amounts received as an employee of the United States or a U.S. agency. If you receive income from Puerto Rican sources that is not subject to U.S. tax, you must reduce your standard deduction. As a result, the amount of income you must have before you are required to file a U.S. income tax return is lower than the applicable amount in Table 1-1 or Table 1-2. See U.S. taxation and its discussion, Standard deduction, under The Commonwealth of Puerto Rico in Publication 570, Tax Guide for Individuals With Income From U.S. Possessions, for further information.

Individuals With Income From U.S. Possessions

If you had income from Guam, the Commonwealth of the Northern Mariana Islands, American Samoa, or the Virgin Islands, special rules may apply when determining whether you must file a U.S. federal income tax return. In addition, you may have to file a return with the individual island government. See Publication 570 for more information.


If you are a dependent one who meets the dependency tests in chapter 3), see Table 1-2 to find whether you must file a return. You also must file if your situation is described in Table 1-3.

Responsibility of parent. Generally, a child is responsible for filing his or her own tax return and for paying any tax on the return. But if a dependent child who must file an income tax return cannot file it for any reason, such as age, a parent, guardian, or other legally responsible person must file it for the child. If the child cannot sign the return, the parent or guardian must sign the child's name followed by the words "By (signature), parent (or guardian) for minor child."

    Child's earnings. Amounts a child earns by performing services are his or her gross income. This is true even if under local law the child's parents have the right to the earnings and may actually have received them. If the child does not pay the tax due on this income, the parent is liable for the tax.

Child Under Age 14

If a child's only income is interest and dividends (including Alaska Permanent Fund dividends) and certain other conditions are met, a parent can elect to include the child's income on the parent's return. If this election is made, the child does not have to file a return. See Parent's Election To Report Child's Interest and Dividends in chapter 32.

Self-Employed Persons

You are self-employed if you:

• Carry on a trade or business as a sole proprietor,

• Are an independent contractor,

• Are a member of a partnership, or

• Are in business for yourself in any other way.

    Self-employment can include work in addition to your regular full-time business activities. It also includes certain part-time work that you do at home or in addition to your regular job.

    You must file a return if your gross income is at least as much as the filing requirement amount for your filing status and age (shown in Table 1-1). Also, you must file Form 1040 and Schedule SE (Form 1040), Self-Employment Tax, if:

1) Your net earnings from self-employment (excluding church employee income) were $400 or more, or

2) You had church employee income of $108.28 or more. (See Table 13.)

    Use Schedule SE (Form 1040) to figure your self-employment tax. Self-employment tax is comparable to the social security and Medicare tax withheld from an employee's wages. For more information about this tax, get Publication 533, Self-Employment Tax.

    Foreign governments or international organizations. If you are a U.S. citizen who works in the United States for an international organization, a foreign government, or a wholly owned instrumentality of a foreign government, and your employer does not deduct social security and Medicare taxes from your income, you must include your earnings from services performed in the United States when figuring your net earnings from self-employment.

    Ministers. You must include income from services you performed as a minister when figuring your net earnings from self-employment, unless you have an exemption from self-employment tax. This also applies to Christian Science practitioners and members of a religious order who have not taken a vow of poverty. For more information, get Publication 517, Social Security and Other Information for Members of the Clergy and Religious Workers.


Your status as an alien—resident, nonresident, or dual—status—determines whether and how you must file an income tax return.

    The rules used to determine your alien status are discussed in Publication 519, U.S. Tax Guide for Aliens.

Resident alien. If you are a resident alien for the entire year, you must file a tax return following the same rules that apply to U.S. citizens. Use the forms discussed in this publication.

Nonresident alien. If you are a nonresident alien, the rules and tax forms that apply to you are different from those that apply to U.S. citizens and resident aliens. See Publication 519 to find out if U.S. income tax laws apply to you and which forms you should file.

Dual-status taxpayer. If you were a resident alien for part of the tax year and a nonresident alien for the rest of the year, you are a dual-status taxpayer. Different rules apply for each part of the year. For information on dual-status taxpayers, see Publication 519.

Who Should File

Even if you do not have to file, you should file a federal income tax return to get money back if any of the following conditions apply.

1) You had income tax withheld from your pay.

2) You qualify for the earned income credit. See chapter 37 for more information. 3) You qualify for the additional child tax credit. See chapter 35 for more information.

Which Form Should I Use?

You must use one of three forms to file your return: Form 1040EZ, Form 1040A, or Form 1040. (But also see Does My Return Have To Be On Paper, later.)

Form 1040EZ

Form 1040EZ is the simplest form to use.

You can use Form 1040EZ if all of the following apply.

1) your filing status is single or married filing jointly. If you were a nonresident alien at any time in 2001, your filing status must be married filing jointly. 2) You (and your spouse if married filing a joint return) were under age 65 on January 1, 2002, and not blind at the end of 2001.

3) You do not claim any dependents.

4) Your taxable income is less than $50,000. 5) Your income is only from wages, salaries, tips, unemployment compensation, Alaska Permanent Fund dividends, taxable scholarship and fellowship grants, qualified state tuition program earnings, and taxable interest of $400 or less.

6) You did not receive any advance earned income credit (EIC) payments. 7) You do not claim any adjustments to income, such as a deduction for IRA contributions or student loan interest. 8) You do not claim any credits other than the earned income credit or the rate reduction credit.

    You must meet all of these requirements to use Form 1040EZ. If you do not, you must use Form 1040A or Form 1040.

Figuring tax. On Form 1040EZ, you can only use the tax table to figure your tax. You cannot use. Form 1040EZ to report any other tax.

Form 1040A

If you do not qualify, to use Form 1040EZ, you may be able to use Form 1040A.

You can use Form 1040A if all of the following apply.

1) Your income is only from wages, salaries, tips, IRA distributions, pensions and annuities, taxable social security and railroad retirement benefits, taxable scholarship and fellowship grants, interest, ordinary dividends (including Alaska Permanent Fund dividends), capital gain distributions, qualified state tuition program earnings, and unemployment compensation.

2) Your taxable income is less than $50,000.

3) Your adjustments to income are for only the following items.

     a) The deduction for contributions to an IRA.

    b) The student loan interest deduction,

4) You do not itemize your deductions.

5) Your taxes are from only the following items.

    a) Tax Table.

    b) Alternative minimum tax. (See chapter 31.) c) Advance earned income credit (EIC) payments, if you received any. (See chapter 37.) d) Recapture of an education credit. e) Form 8615, Tax for Children Under Age 14 Who Have Investment Income of More Than $1,500. f) Capital Gain Tax Worksheet.

6) You claim only the following credits. a) The credit for child and dependent care expenses. (See chapter 33.)

    b) The credit for the elderly or the disabled. (See chapter 34.)

    c) The child tax credit. (See chapter 35.)

    d) The additional child tax credit. (See chapter 35.)

    e) The education credits. (See chapter 36.)

    f) The earned income credit (See chapter 37.)

    g) The adoption credit. (See chapter 37.)

    h) The rate reduction credit. (See chapter 37.)

    You must meet all of the above requirements to use Form 1040A. If you do not, you must use Form 1040.

    If you meet the above requirements, you can use Form 1040A even if you received employer-provided adoption benefits or dependent care benefits.

Caution. If you receive a capital gain distribution that includes 28% rate gain, qualified 5-year gain, unrecaptured section 1250 gain, or section 1202 gain, you cannot use Form 1040A. You must use Form 1040.


Excerpted from The Ernst & Young Tax Guide 2002 by . Copyright © 2002 by Ernst & Young LLP and Peter W. Bernstein Corporation. Excerpted by permission. All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.

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