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Numerous changes appear in the new forms as the IRS tries to handle both new
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American Jobs Creation Act of 2004
More last-minute tax law changes
Right on the heels of the Working Families Tax Relief Act of 2004 (signed into
law on October 4, and summarized in our Fall 2004 HowardNews), Congress passed another sweeping
tax bill, the American Jobs Creation Act of 2004, on October 11 (signed into law on October 22).
Even though the latest bill was publicized as the "Corporate Tax Bill," it contains a number of provisions
that directly affect individuals and non-corporate businesses. Furthermore, it is extremely complex and
more than 600 pages long as a result of a plethora of amendments added to garner support for the bill.
In fact, there are so many special provisions relating to specific industries or groups that it is
known in some circles as the "American Pork Act of 2004."
Here we detail provisions that affect Form 1040 returns for tax year 2004, then give
a brief overview of the rest of the bill.
Highlights for individuals for tax year 2004
Before getting into the myriad of provisions in the new tax bill that don't take effect until
tax year 2005, here are some items of
particular interest to individuals for tax year 2004 ...
most of which neither affect corporations nor create jobs!
- State and local sales tax deduction for itemizers. Before 1986, state and local sales tax
paid by a taxpayer was deductible as an itemized deduction on Schedule A,
as was state and local income tax paid. When the deduction for sales tax
was eliminated, the deduction for state income tax paid was retained. As a result,
there became an inequity for taxpayers in states that have no state income tax and support themselves
with other taxes instead. Without reverting to the pre-1986 law, the new law attempts to
alleviate this inequity by giving taxpayers the option of deducting either their state and local
income tax paid or their state and local sales tax paid, whichever is higher.
Furthermore, the law is retroactive to January 1, 2004. However, since no-one can expect that
taxpayers would have kept track of their sales taxes prior to the enactment of this new law,
and few would want to do so even after knowing about the law, Congress instructed the IRS to
generate tables for use by taxpayers in lieu of actual receipts, at the taxpayer's option).
The tables are to be based on the taxpayer's filing status,
number of dependents, AGI, and applicable sales tax rates. Motor vehicles, boats, and other special
high-ticket items would be excluded from the tables, and the taxpayer could deduct the amount from the table
plus the amount stemming from the cited high-ticket items.
The main beneficiaries of this new law are residents of Alaska, Florida, Nevada, South Dakota,
Texas, Washington, and Wyoming, all of which have no state income tax, as well as New Hampshire and
Tennessee, both of which tax only dividend income.
(As written in the law, the new deduction
applies only to tax years 2004 and 2005. The IRS has already issued a new draft of Schedule A to handle
this change, but the tables that the IRS must generate for those who don't save receipts could
greatly delay the instructions for Schedule A.)
- Tightening of the notorious SUV loophole. Many sport utility vehicles have
escaped the annual limitation on depreciation of passenger automobiles because of their weight.
Vehicles of more than 6,000 pounds of unloaded gross weight are exempt from the limitations, a
provision intended to exempt vehicles that could not be reasonably be considered as "luxury cars."
The new law, which affects only purchases made after October 22, 2004 (the enactment date for the bill),
still does not apply the "luxury car" limitations, but it prevents SUVs rated no more than 14,000
pounds gross weight from taking advantage of the
current $102,000 ceiling on section 179 deductions (special first-year depreciation) and instead
restricts them to the former $25,000 ceiling. However, the new rule is not nearly as restrictive
as it may seem because SUVs are still eligible for a 50% bonus depreciation and the first year
depreciation of a 5-year accelerated depreciation. As a result, a taxpayer who purchases an SUV
for $50,000 can still deduct a total depreciation of $40,000 in the first year, which contrasts
sharply with the $10,710 first-year limitation placed on other cars!
(We do not expect the IRS
to alter Form 4562 to handle this new law, but only to expand its instructions.)
- Income averaging for fishermen. Income averaging has been available to farmers for the
past few years through Schedule J (Form 1040). It lowers the regular tax for farmers who had much lower
income in the previous three years. Under the new law, fishermen are qualified to
use Schedule J for the same purpose starting tax year 2004.
(The IRS will likely change the released
draft of the new Schedule J to reflect the addition of fishermen to the form.)
- AMT relief for farmers who use Income averaging. The benefits of farm income averaging have been
offset to some extent in the past by the alternative minimum tax (AMT). Under the new law,
farmers (and now fishermen too) can compute the tax on Form 6251 (the AMT form) without regard
to income averaging, resulting in a lower AMT for most taxpayers.
(We expect the IRS to
alter the released draft of Form 6251 to reflect this change and greatly expand its instructions.)
Other highlights of the tax bill
The main provisions of the bill, which have been in the bill since its inception, have a major effect
on exporters and manufacturers -- both corporate and non-corporate entities. But there are also several
very narrow provisions that apply to specific industries and favored groups. We list below only a very
small sampling of the provisions of this omnibus bill,
choosing provisions of most interest to individuals and partnerships
and excluding provisions that apply only to corporations.
Extraterritorial income (ETI) could be excluded from gross income
to the extent that it would reduce taxable income by the greater of:
(a) 1.2% of foreign trading gross receipts,
(b) 15% of foreign trade income, or
(c) 30% of foreign sale and leasing income.
Phases out the ETI exclusion to 80% of the former allowance for tax year 2005,
60% of the former allowance for tax year 2006, and zero starting tax year 2007.
(This change is designed to eliminate European Union sanctions against the United States for what it calls
an "illegal export subsidy." The loss of this exclusion is offset for most businesses
by a new deduction for "domestic manufacturing," below.)
Domestic manufacturing deduction
Provides a deduction of up to 3% of qualified income for tax year 2005 and 2006,
6% for 2007 through 2009, and 9% starting 2010, but limited no more than the lesser of taxable income
or 50% of wages paid. The income must be derived from an activity in the U.S., but the definition of "manufacturing"
includes film, computer software, and sound recordings in addition to tangible property.
Charitable donations of cars
Donor could deduct the fair market value of the donated vehicle
as determined from an establihed pricing guide like the Kelly Blue Book
Starting tax year 2005, if the donee sells the contributed vehicle, the donor can generally deduct no more than the
gross proceeds of the sale, subject to increase by cost of improvements made by the donee.
If the donee uses the vehicle instead of selling it, the use must be considered significant by IRS guidelines.
Maximum Sec. 179 deduction
For tax years 2003 through 2005, up to $100,000 could be deducted, subject to
reduction by total costs in excess of $400,000 (with both figures indexed for inflation).
For tax years after 2005,
only $25,000 could be deducted, subject to reduction by total costs in excess of $200,000 (with neither
figure indexed with inflation.)
The new law extends the $100,000 maximum (and the $400,000 start of the phase-out)
to tax years 2006 and 2007 (indexed for inflation).
Accordingly, the return to the $25,000 level (and $200,000 phase-out start) does not apply until tax year 2008.
Expatriation of individuals
Generally taxed on U.S. source income for the 10 years after expatriation if the tax liability
for the preceding 5 years exceeded $100,000 or net worth on date of expatriation was $500,000 or more. (Both amounts
are adjusted for inflation so that they would be $124,000 and $644,000, respectively, for tax year 2004.)
However, certain individuals could submit a ruling request to not have these rules apply and the IRS would make
a subjective judgement.
Generally taxed on U.S. source income for the 10 years after expatriation
unless the taxpayer (a) can establish that tax liability for the preceding 5 years did not exceed $124,000 (adjusted
for inflation after 2004), and (b) net worth on date of expatriation did not exceed $2 million,
and (c) certifies under penalty of perjury compliance with the U.S. tax laws for the preceding 5 years
(with proof if so requested), and (d) gives proper notice of expatriation.
Furthermore, if the taxpayer returns to the U.S. for more than 30 days in a calendar year, that taxpayer is taxed
like resident U.S. citizens on worldwide income for the taxable year in which the calendar year ends.
Tax treatment of expatriated entities and their foreign parents
Owners of a domestic company could become owners of a foreign
holding company that holds the property of the former domestic company and avoid taxation on income
derived outside the U.S., even if the foreign company has no substantial business in the foreign country
in which it is established.
If the foreign company does not have substantial business in the foreign country
in which it is established, the following restrictions apply:
(A) If the former owners of the domestic company own 80% or more of the foreign company,
the foreign company is treated as a domestic company and its entire worldwide income subject to U.S. tax
(but with credit for taxes paid to a foreign country).
(B) If the former owners of the domestic company own at least 60%
but no more than 80% of the foreign company, the new company is treated as foreign but these owners are not allowed
to shelter gains from the transaction for at least 10 years.
Tax shelter disclosure
A taxpayer is required to disclose with the taxpayer's tax return certain information
on "reportable transactions" (popularly called "tax shelter activities") for the year. There was no specific penalty for failure to provide the required information,
but there could be a penalty on any tax underpayment resulting from a disallowance of the transactions.
Specific penalties now apply for failure to disclose required information on returns due
after October 22, 2004 (the date the tax bill was enacted). The penalty is $10,000 for individuals participating in a tax shelter, and $50,000
for all other entities. The penalties are raised to $100,000 and $200,000, respectively, for certain "listed transactions."
Furthermore the penalty for listed transactions cannot be waived by the IRS, and the penalty for other reportable
transactions can be waived only under special circumstances determined by the IRS. The precise definitions of "reportable
transactions" and "listed transactions" are left to the Treasury Secretary to define.
Nonqualified deferred compensation
Whether or not deferred compensation must be included in taxable income depends on "the
facts and circumstances of the arrangement." If the arrangement is unfunded, the compensation is generally deferred until
it is actually or constructively received. But if the arrangement is funded, it is deferred only when it is not subject to
substantial risk of forfeiture or when the individual's rights are transferable.
Under the new law, all compensation that is not subject to substantial risk of forfeiture
is taxable, whether funded or unfunded. Failure to report such income when required is subject to the normal
underpayment penalties plus 1%, and also subject to a 20% additional tax. The new law applies not only to deferrals made in
tax years 2005 and later but also to certain deferrals before 2005 if the plan was modified after Oct. 3, 2004.
Depreciation of certain leasehold and restaurant improvements
Depreciation of improvements made on nonresidential property must be depreciated over
a 39-year period, even when the property is leased for a much shorter period.
Qualified leasehold property and qualified restaurant property are now eligible for
15-year recovery periods if placed in
service after October 22, 2004 (the tax bill enactment date) and before January 1, 2006. The straight-line method of depreciation
must be used.
Numerous other provisions exist in the bill, but they are generally affect either corporations
or very specific individuals, not the general public. Examples of the narrow character of some of
the provisions include
- an allowance of up to $10,000 per year of expense deduction for certain whaling captains
- an increased allowance for expenses of film and TV production
- a "buy-out" of tobacco farmers from the price support system
- the allowance of a new accounting method for naval shipbuilders
There are also numerous new details concerning fuel tax credits, some liberalizing the current law
and others restricting it. There are even changes in Subchapter S rules, including a big increase in
the number of shareholders allowed. If you want a look at the details, you can download the complete
Legislative Text (1.34 MB) of the American Jobs Creation Act of 2004
or the more helpful
Conference Report (1.75 MB) which explains the prior law and the specific
changes to it.