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In spite of the lack of publicity about tax law changes, there are numerous changes for the upcoming tax season, which we highlight in this newsletter. HowardSoft is ready with its complete automation of the changes, so you don't have to worry about them. But you do have to get prepared by ordering now because we ship on a first-in/first-out basis. Order securely over the internet, or by phone, fax, or mail (all major credit cards accepted). Get ready NOW!

by HowardSoft®
Professional software at personal prices.
Fall 2005

The September Tax Surprise

Everything was going fine... Because no major tax bills were expected in 2005, the IRS had been releasing advance drafts of tax forms in an unusually timely manner this year, and refrained from any but the most essential changes. In fact, in spite of a big rise in average prices at the gas pump (from $1.82 at the beginning of the year to $2.65 just before Katrina hit), the IRS stubbornly stuck to a 40.5 cents per mile standard rate for business mileage deductions throughout the year.

... then Katrina changed everything! With gas prices spiking above $3 per gallon after Katrina hit, the IRS could no longer hold fast to a 40.5-cent rate. As a result, the IRS announced on September 9th a 2-tier mileage rate for business, medical, and moving mileage deductions. Shortly thereafter the House and Senate each drafted Katrina-related tax bills and the joint Congress passed on September 21st the Katrina Emergency Tax Relief Act of 2005 (H.R. 3768) with breaks that reach far beyond Katrina. (For a good detailed explanation of the entire act, prepared by the Joint Committee on Taxation, click the following link: HR3768.pdf (220 KB). You must have Adobe's Acrobat Reader installed on your computer in order to read this 39-page report.)

New 2-tier mileage rates. The IRS defined higher rates for the last third of 2005, and Congress tied Katrina-related charity mileage to those rates. The new rates for 2005 are:

  • for business mileage: 40.5 cents per mile through August 31, 2005, and 48.5 cents thereafter.
  • for medical or moving mileage: 15 cents per mile through August 31, 2005, and 22 cents thereafter.
  • for Katrina-related charity: For the period August 25, 2005 through December 31, 2006, the rate for Katrina-related volunteers is 70% of the business mileage rate. This means that the rates for 2005 will be 28.35 cents per mile for August 25 through August 31, 2005, and 33.95 cents per mile thereafter.

Form 2106 and the instructions for many other forms will be greatly complicated by this change. (The rate for regular charity-related mileage remains at 14 cents per mile. Unlike the other rates, the IRS does not have the authority to raise this rate, and Congress chose not to raise the rate for non-Katrina activities.)

Breaks for donors. The Katrina tax bill surprisingly includes some breaks for charitable contributions irrespective of whether they are Katrina-related:

  • Suspension of limitations on contributions. For the period August 28, 2005 through December 31, 2005, the rules that limit your deductions based on your income are suspended. Both the limitation to 50% of AGI and the phase-out with taxable income are rescinded.
  • Liberalized deduction for contributions of food. The liberal valuation of food inventories that applies to C corporations is applied to all business forms, including sole proprietors, for food contributed from August 29, 2005 through December 31, 2005. (The food must be suitable for human consumption.)
  • Liberalized deduction for contributions of books to public schools. The liberal valuation of book inventories that applies to C corporations is applied to all business forms for books contributed from August 29, 2005 through December 31, 2005. (The books must be donated to a K-through-12 public school that will certify the use and appropriateness of the books.)

Breaks for employers. Three credits are patterned after the Work Opportunity Credit, which provides a credit of 40% of wages up to $6,000 per qualified employee via Form 5884:

  • For employers hiring inside the Katrina area. Credit applies for Katrina employees hired August 29, 2005 through August 28, 2007.
  • For employers hiring outside the Katrina area. Credit applies for Katrina employees hired August 29, 2005 through December 31, 2005. Applies to employers throughout the country who hire displaced victims.
  • For Katrina-area employers paying wages while business closed. Employers who continue to pay wages while their business is closed qualify for the credit for wages paid from August 29, 2005 through December 31, 2005. Restricted to Katrina-area employers with no more than 200 employees (average) in 2005.

For all of these credits the employee must have had his or her main home in the core disaster area.

Breaks for volunteers. Congress provided additional breaks to Katrina-related volunteers:

  • Exemptions for those who house victims rent-free. $500 per person ($2,000 maximum) is provided for 2005 or 2006 (not both). Applies to Samaritans throughout the country who board victims for free.
  • Special mileage rate for volunteers. Volunteers are allowed to deduct unreimbursed mileage through the end of 2006 at a rate that is 70% of the standard rate for business mileage, but only for Katrina-related mileage.
  • Mileage reimbursement not taxable. Reimbursements for Katrina-related charity work are not taxable as long as they do not exceed the standard business mileage rates in effect at the time (August 25, 2005 through December 31, 2006).

Breaks for victims. The remaining provisions of the new tax bill apply directly to individuals who are victims of Hurricane Katrina. Anyone whose main home was in the core disaster area on August 25th qualifies as well as anyone who suffered economic loss from the hurricane and lived outside the core area but in the Hurricane Katrina disaster area.

  • Exclusion of cancelled debt. Income realized because of discharged nonbusiness debt discharged after August 25, 2005 but before January 1, 2006 is not taxable.
  • Suspension of limitations on casualty loss. The $100 and 10% of AGI floors on personal casualty or theft losses are suspended for Katrina-related losses.
  • Extension of replacement period for like-kind exchange of condemned property. For involuntarily converted property in the hurricane area, gain can be deferred by replacing the property with like-kind property in the same area within 5 years (rather than the usual 2).
  • Option to use prior-year income in EIC and refundable child tax credit computations. If their 2004 income was higher than their 2005 income, victims may use their 2004 income when advantageous to them in computing these credits.
  • Tax-favored withdrawals, loans, and recontributions for pension plans. Penalties for qualifying early withdrawals are forgiven, certain amounts can be borrowed, and certain recontributions are treated as nontaxable rollovers. IRAs and most other plans qualify.

Other provisions in this category include special rules for mortgage revenue bonds and authority given to the IRS to relieve various penalties and taxes.

What about Rita? At the time we issued this newsletter, there was no special tax bill in the works for victims of Rita. However, the IRS has placed on their web site a complete review of relief available from prior laws for those in designated Rita disaster areas. For more information, go to the IRS home page and click on Help for Hurricane Victims.

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What's Changing in the 2005 Forms

Even without the tragic events of Katrina and Rita, there was plenty scheduled to change from prior legislation. It all started with the Economic Growth and Tax Relief Reconciliation Act of 2001, which scheduled sweeping tax cuts phased in gradually over a 10-year period. The Job Creation and Worker Assistance Act of 2002 added high limits for section 179 depreciation and a new 30% bonus depreciation. Then the Jobs and Growth Tax Relief Reconciliation Act of 2003 accelerated the scheduled changes, but slated many of them to revert to the old schedule in 2005. The Working Families Tax Relief Act of 2004 then prevented many of the breaks in the 2003 act from expiring, extended some of them through 2010, and added its own liberalized provisions for 2005. Finally, the American Jobs Creation Act of 2004 extended high section 179 limits through 2007 and introduced a new deduction for domestic manufacturing for 2005, but allowed the bonus depreciation provisions to expire at the end of 2004. The combination of all these bills and the September surprises affects a long list of forms and their instructions for 2005:

  • Form 1040. A jump in allowed IRA deductions to $4,000 ($4,500 if 50 or older), a new line for domestic production activities deduction (a new Form 8903), and a new Form 8901 for the child tax credit.
  • Schedule A. A two-tier standard mileage deduction applies to medical expenses - 15 cents per mile for the first 8 months of 2005 and 22 cents thereafter.
  • Form 2106. A two-tier standard deduction for business mileage: 401/2 cents per mile for the first 8 months and 481/2 cents a mile thereafter.
  • Form 2688. Dropped because of the increased time for the regular extension. (See Form 4868.)
  • Form 3903. A two-tier standard mileage deduction - 15 cents per mile for the first 8 months of 2005 and 22 cents thereafter.
  • Form 4562. No more special depreciation allowance, but a new allowance for special cases.
  • Form 4868. Now provides a six-month extension (to October 15) instead of four.
  • Form 5329. New lines for Health Savings Accounts (introduced last year).
  • Form 6478. Numerous previously scheduled phase-outs and new provisions in the last 2004 tax bill.
  • Form 8283. New requirements for donated cars and new categories on page 2.
  • Form 8801. Major redesign of page 2 to reflect prior-year changes in Form 6251.
  • Form 8903. NEW FORM to handle the new domestic production activities deduction on Form 1040 (allows up to 3% of the qualifying income in the U.S.).

Many other forms are affected by indexing with inflation and will have major changes in their instructions, but Tax Preparer automates the changes so completely that you'll hardly notice any difference in how you prepare returns!

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