Tax Law Changes Continue ... But Earlier Releases Expected

It’s a mixed bag this time around. While the complex Jobs and Growth Tax Relief Reconciliation Act of 2003 included several changes for 2004, the only major tax legislation after that was in the Medicare bill – creating a new kind of tax-favored savings account. As a result, the changes pale by comparison to the sweeping changes made last year, and some forms are even simpler because only one set of rules for capital gains now apply.

The Good News

Inflationary increases abound, as usual, but there are bigger increases in some areas and even some simpler forms:

• No more post-May 5 complexities. Several forms and computations were complicated by a transition in the rules for capital gains on May 5, 2003. Now that the new law is in full force, many additions to the 2003 forms will disappear:
  • Form 1040 line 13b eliminated. All capital gain distributions will be post-May 5 distributions for tax year 2004, so line 13b will be unnecessary.
  • Schedule D column (g) eliminated. Similarly, all sales for 2004 occur after May 5, 2003, so there will be no need for a column (g) on Schedule D.
  • Form 4797 column (h) eliminated. Likewise, there will be no need for a column (h) on Form 4797.
  • Capital gain tax computations simplified. Along with the elimination of the transition for post-May 5 transactions, the qualified 5-year gains of the past are gone. All long-term gains are now treated the same, so the tax computations on Schedule D, the Schedule D tax worksheet, and Form 6251 are all simpler, albeit still very complex.
• A jump in standard mileage rates. After surprising decreases last year, the standard mileage rates will jump for 2004. The standard deduction for business mileage will be 37½ cents per mile, up from 36 cents per mile. The standard deduction for medical or moving expenses will be 14 cents per mile, up from 12 cents per mile.
• More tax-free QTP distributions. Under prior law, a distribution from a Qualified Tuition Program (QTP) could be excluded from income if used for qualified higher education expenses as long as the QTP was established and maintained by a state agency. For 2004, that same benefit is extended to QTPs established and maintained by eligible private colleges or universities.
• New Form 1040 line: Deduction for clean-fuel vehicles. A deduction was allowed for 2003, but was hidden in the instructions as a "write-in" adjustment to line 33 of Form 1040. For 2004, however, the clean-fuel deduction is the first line item in the adjustments to income on Form 1040 (line 23 on the 2004 Form 1040).
• New Form 1040 line: Deduction for expenses of certain targeted employees, including reservists. Employee expenses have long been allowed as an adjustment to income for performing artists and fee-basis government officials, rather than an itemized deduction on Schedule A subject to a 2% of AGI floor. However, this deduction too was hidden in the instructions as a "write-in" adjustment to line 33 of Form 1040. For 2004, the deduction is the second line item in the adjustments to income on Form 1040 (line 24 on the 2004 Form 1040). Furthermore, reservists are now given the benefit of this favorable treatment of expenses.
• IRA phaseout thresholds rise. The levels at which the phaseout of IRA deductions start will take another jump far beyond inflation. The phaseout level for taxpayers covered at work will start at $65,000 for married filing jointly and qualifying widow(er), up from $60,000, and $45,000 for single or head of household, up from $40,000. (The deduction will be taken at line 25 of the 2004 Form 1040.)
• Expanded tuition and fees deduction. The former law provided up to $3,000 of deduction of higher education expenses at line 25 of the 2003 Form 1040, but no deduction if modified AGI exceeded $65,000 ($130,000 if married filing jointly). For tax year 2004 the maximum deduction is $4,000, and a slight phaseout is added by allowing a $2,000 deduction for modified AGI over $65,000 ($130,000 if married filing jointly) but no more than $80,000 ($160,000 if married filing jointly). (The deduction will be taken at line 27 of the 2004 Form 1040.)
• New Form 1040 line: Deduction for health savings accounts. A new kind of account to which contributions are tax-deductible comes into force in 2004. Called a Health Savings Account (HSA), it is similar in many ways to Archer Medical Savings Accounts (MSAs) but with its own set of rules. The deduction will be taken at line 28 of the 2004 Form 1040, and can amount to as much as $5,650. This new type of account is described in detail in IRS Publication 553, Highlights of 2003 Tax Changes (pages 7 through 10).
• Standard deductions rise. The standard deduction will rise as a result of the usual indexing with inflation. The new standard deductions are $4,850 for single and married filing separately, $9,700 for married filing jointly, and $7,150 for head of household.
• Exemptions rise. The exemptions for you, spouse, and dependents will rise to $3,100 per person for tax year 2004, up from $3,050, as a result of the usual indexing with inflation. The phaseout thresholds will rise as well, to $142,700 for single, $214,050 for married filing jointly, $107,025 for married filing separately, and $178,350 for head of household.
• Tax rate schedule and tables indexed with inflation. For the first time in years, there are no structural changes to the tax rate schedule. All brackets will increase with inflation and all tax rates will remain unchanged. This simplification is a result of the acceleration of previously-scheduled tax breaks to 2003.
• Extension of bonus depreciation to year-end. The first-year bonus depreciation was originally set to expire on September 11, 2004. However, in a rare recognition of the tax complexities that mid-year changes impose, Congress extended the date to December 31, 2004 when it introduced a 50% bonus depreciation last year. The potential complexity has therefore been eliminated so there will be no need for changes in the calculations or forms for tax year 2004.
• Increase in Sec. 179 depreciation. The first-year expensing will be limited to $102,000 for tax year 2004, up from $100,000 for tax year 2003. The full limit will be available for property costs up to $410,000, up from $400,000.

... and the Bad News

It’s not all rosy because several past benefits are set to expire with little chance of timely renewal by Congress. (With the shortfall created by recent tax cuts, its no wonder that Congress is letting the less well-known benefits slide.) Significant changes include:

• No deduction for educator expenses. For qualifying teachers of grades K through 12, there was a deduction against income at line 23 of Form 1040 for 2003. That line does not appear on the 2004 Form 1040 because the law applied only to 2002 and 2003.

• Fewer credits allowed against the AMT. A number of credits will be limited to no more than the regular tax, whereas they formally could be as high as the regular plus minimum tax. As a result, the IRS has rearranged the credits on Form 1040 so that those that are not allowed against the AMT are first: child and dependent care credit, credit for the elderly or disabled, education credits, mortgage interest credit, and D.C. first-time homebuyer credit. If history repeats itself, the credit forms will remain unchanged and the change in the law will be written only into the instructions. Tax Preparer will enforce the change automatically, as it did before these credits were allowed against the AMT.

• Work Opportunity Credit and Welfare-to-Work Credit expired. These credits for hiring targeted workers expired at the end of 2003. Legislation to extend them has been pending for months, but has not yet passed. If the credits are not renewed, you will not be able to use Forms 5884 and 8861 for tax year 2004.

• R&D Credit set to expire June 30, 2004. Under current law, only R&D expenses incurred in the first half of 2004 will qualify for the credit, but pending legislation could change that. If the credit is not renewed, tax year 2004 will be the last year that Form 6765 will exist.

• Social security base rises. The social security tax and related self-employment tax will apply to the first $87,900 of earned income for tax year 2004, up from $87,000 for 2003. The tax rates are unchanged.

• SUV loophole may be closed. Under current law, SUVs are not subject to the limitations on depreciation or expensing like other passenger vehicles if weighing more than 6,000 pounds. But pending legislation could trim first-year depreciation to $25,000. That’s still much higher than the limit for other cars, but a far cry from the $102,000 expensing allowed for other property.

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