by George G. Jones and Mark A. Luscombe
A new year always brings change. Nevertheless, the passage from tax year 2003 to 2004 seemed more quiet than usual. The big news in 2003 — the lowering of the marginal tax rates and tax rates on capital gains and dividends — already took place in 2003, rather than waiting until 2004 to start. Digging deeper, however, you will find that 2004 kicks off plenty of new developments that need immediate attention.
Perhaps the most obvious tax change for 2004 is the availability of the new Health Savings Accounts, discussed in this column in the last issue. The sooner these accounts can be evaluated by employers, the sooner they can be put into place in maximizing a full-year’s benefit.
Yet the most attention-grabbing development in need of action, however, might come in the form of what Congress did not yet do: pass a bill to extend a number of significant tax breaks that expired at the end of 2003. Another group of developments demanding attention at the beginning of the new year relates to the growing number of changes made by Congress several years ago that are now continuing to either be phased in over time by statute or annually adjusted for inflation.
The legislation to renew expiring tax provisions that failed to pass in 2003 addresses expiring provisions in the Tax Code. Congressional leadership has promised to push for passage early in 2004 and make the renewal retroactive to the beginning of the year.
In the past, when Congress had failed to pass renewals of expiring provisions in time, it always managed to come through with the promised retroactive extensions. Still, the current situation leaves taxpayers and their advisors in something of a quandary over whether to continue to engage in certain activities that only make economic sense with the associated tax benefits.
Three expiring provisions have the most direct impact on individual taxpayers. As part of the effort to control the growing number of taxpayers who are subject to the alternative minimum tax (expected to reach 2.9 million taxpayers in 2004), Congress allowed nonrefundable personal credits against both the regular tax and the alternative minimum tax.
With respect to some nonrefundable credits, this change has been made permanent through a statutory change to the code section addressing that particular credit. The general provision addressing the other nonrefundable credits, however, expired on Dec. 31, 2003.
These credits include the HOPE and lifetime learning credits, the dependent care credit, the District of Columbia homebuyer’s credit, the credit for the elderly and disabled, and the home mortgage interest credit. In many cases, the expense would be incurred regardless of whether the credit is available or not; but, in some cases, taxpayers may wish to postpone particular transactions until Congress acts to restore AMT protection.
The above-the-line deduction available to teachers for out-of-pocket classroom expenditures also expired on Dec. 31, 2003. The credit was largely put in place to offer some tax assistance to teachers who were often already undertaking these expenses in order to provide their students with a richer educational experience.
It is likely, therefore, that teachers will continue to incur these expenses whenever they perceive a need rather than waiting for the tax deduction to be restored.
The ability to set up new Archer Medical Savings Accounts also expired at the end of 2003. However, with the creation of Health Savings Accounts starting in 2004, there would likely have been a move toward HSAs in any event (MSAs were never all that popular), and the delay in renewing MSAs probably will not have a severe impact.
Two credits that are important to many businesses hiring welfare recipients and disadvantaged workers, the Welfare to Work Credit and the Work Opportunity Tax Credit, expired at the end of 2003. The lack of these credits could cause employers to postpone hiring decisions until Congress acts to restore these credits.
It might also be the case, as with Congress’ failure to extend the time period for unemployment benefits, that some members of Congress may view the improving economy as lessening the need for these types of tax breaks.
Although it actually expired at the end of 2002, the extenders package in Congress includes a provision permitting net operating losses incurred in 2003 to be carried back five years. This is a change that tax practitioners should be able to address when and if Congress passes the legislation without having much of an impact on taxpayer behavior.
Other provisions that expired in 2003 that were included in the extenders package before Congress include: the charitable contribution of computer technology and equipment for educational purposes; the expensing of environmental remediation costs; tax breaks for the District of Columbia and New York Liberty Zone taxpayers; special tax rules for mutual life insurance companies; qualified zone academy bonds; mental health parity requirements; and tax breaks for rum from Puerto Rico and the Virgin Islands.
The Economic Growth and Tax Relief Reconciliation Act of 2001 put in place a number of phased-in increases in various retirement plan limits under the code, some of which come into being in 2004. IRA contribution limits remain the same; however, limits on employee contributions to a 401(k) plan increase again in 2004 to $13,000, a $1,000 increase, and to $16,000, a $2,000 increase, for employees age 50 and over eligible for the catch-up contribution.
Employees who want to achieve the maximum contributions for the year should act now to adjust the amount withheld from their pay to achieve the maximum contribution by year end 2004. These increased amounts also apply to 403(b) plans, 457 plans and the employee deferral portion of SARSEPs. SIMPLE plans also had an adjustment in 2004 for the employee contribution: $9,000 (a $1,000 increase) for the regular contribution limit and $10,500 (a $1,500 increase) for those eligible for the catch-up contribution.
Also as a result of EGTRRA, the deduction for higher education expenses has a statutory increase that goes into effect in 2004. The maximum deduction increases from $3,000 to $4,000.
Another EGTRRA change in the estate tax area increases the lifetime exclusion from estate taxes to $1.5 million and decreases the top rate for estate and gift tax to 48 percent from 49 percent. 2004 represents, therefore, the first year in a long time that there is no longer one unified credit amount for estate and gift tax purposes. The gift tax lifetime exclusion remains at $1 million. This will require more careful documentation and tracking of gifts.
Other significant estate tax developments for 2004 include a further reduction in the state death tax credit to 25 percent of the prior law amount and, in a reversal of the recent pattern in the code, an end to inflation adjustments for the generation-skipping transfer tax exemption.
Another statutory adjustment for 2004 relates back to a schedule first put into motion by the Taxpayer Relief Act of 1997. The income eligibility limits for a deductible IRA contribution increase to a range of $45,000 to $55,000 for single taxpayers (an increase from $40,000 to $50,000 in 2003) and $65,000 to $75,000 for joint filers (an increase from $60,000 to $70,000 in 2003).
The ever-growing number of provisions annually adjusted for inflation in the code has resulted in a number of changes for 2004. The income cut-off for the rate brackets had their usual increases, as have the personal exemption, standard deduction, and the phase-out income for personal exemptions and itemized deductions.
The dependent standard deduction adjustment increases in 2004 for the first time since 2001, from $750 to $800. The standard mileage allowance for business has had a larger than usual increase to 37.5 cents per mile from 36 cents per mile; the mileage rate related to medical and moving expenses also increased significantly from 12 cents to 14 cents per mile.
Several inflation adjustments to retirement plan limits enacted as part of EGTRRA come into play for the first time in 2004. The defined-benefit plan annual benefit limit is increased from $160,000 to $165,000. The defined contribution plan limit increases from $40,000 to $41,000, and the annual compensation limit increases from $200,000 to $205,000.
One new inflation adjustment from EGTRRA for the income phase-out on the student loan interest deduction came into play for joint filers, increasing from $100,000 to $105,000, while failing to yet come into play for single filers, remaining at $50,000. An inflation adjustment created by the Jobs and Growth Tax Relief Reconciliation Act of 2003 also resulted in a change for the first time in 2004 — the Code Sec. 179 expense limit increases from $100,000 to $102,000.
As year-round tax planning becomes an ever more important adjunct to tax return preparation for the tax practitioner, addressing the new developments in the tax law at an early point in the year can often assist the client in achieving the best result possible when it finally comes time to prepare the tax return.
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