As of this writing, the American Jobs Creation Act of 2004 has just passed Congress and is awaiting President Bush's expected signature. With 580 amendments to the Internal Revenue Code affecting 274 sections, including 34 brand-new sections, there is much for tax practitioners to ponder in this legislation.
In some cases, however, it may be best not to ponder too long, because some of these provisions may warrant quick action. Although the provisions are focused heavily on business and international tax issues, there are a number of significant individual tax issues addressed as well.
This column will discuss a few of the more significant issues that might warrant some early discussions with clients.
Deduction for U.S. production activities
This new deduction, Code Sec. 199, would affect a wide range of corporations and pass-through business entities that manufacture, produce, grow or extract qualifying property in whole or in part within the U.S. While this deduction originated as the primary replacement for the repealed extraterritorial income exclusion, it would affect many corporations that had never used the extraterritorial income provision.
Because the effective tax rate applicable to business income will depend on whether it falls within or without the various categories of income and expense defined in the new law - "qualified production activities income," "domestic production gross receipts" and "qualifying production property" - accountants will be hard at work getting income and expense allocated to the proper category.
Although the new provision is not effective until 2005, businesses will want to get the procedures in place to properly account for the new categories of income and expense before the end of the year, and also to develop strategies that might help maximize the allocations that will minimize tax under the new rules.
Many business groups had lobbyists in Washington to try to ensure that the new law clearly stated that their business activities would benefit from the new deduction. Others will have to sort out what the language means for their businesses. It may be that some businesses will be better off shifting to a corporate structure with an effective corporate tax rate now lower than the top individual marginal rate. Other businesses may seek to maximize employee expenses rather than having those expenses associated with independent contractor or outsourcing activities.
Deferred compensation plans
Effective for amounts deferred after Dec. 31, 2004, tighter rules will apply as to what constitutes a substantial risk of forfeiture to support deferral under many nonqualified deferred compensation plans. Problems have already been developing in determining the boundaries of these new rules.
However, the law does clearly state that offshore rabbi trusts will not be considered deferred compensation under the new standards. Existing nonqualified deferred compensation plans should be reviewed before year's end for possible restructuring in line with the new guidelines to insure that the appropriate deferral decisions are in place before the start of 2005.
The Internal Revenue Service and, more recently, Congress, have been concerned that charitable deductions are being claimed for donated automobiles that far exceed the proceeds that the charities receive for the sale of those vehicles.
The new law will require vehicles valued at over $500 to have the charitable deduction based on an acknowledgement provided by the charity that states, among other things, the gross sales price of the vehicle when sold by the charity. The gross sales price on the acknowledgement will become the deduction to which the donor is entitled.
The effective date was delayed until Jan. 1, 2005, to give charities time to gear up to provide these acknowledgements. For the remainder of 2004, donors can continue to claim a charitable deduction based on the fair market value of the vehicle.
Since it is not always clear that the high-volume vehicle donation operations of some charities always get the best possible price for cars sold at auction, donors may be better off donating vehicles before year's end, or at least investigating the sales practices of possible donee charities to determine which are likely to produce a higher sales price and therefore the better deduction.
An exception under the new guidelines is provided where the charity acknowledges that it will hold on to the vehicle for its own use or materially modifies the vehicle. Then, the donor may continue to use fair market value to determine the deduction.
Code Sec. 179 and the SUV Loophole
The higher expense limits of Code Sec. 179 have been extended for an additional two years. Since the higher limits ($102,000 for 2004) where not scheduled to drop until 2006 anyway, this did not create an immediate planning opportunity.
The new law also, however, provides that heavy SUVs, which were not caught by the luxury auto depreciation limits and therefore were eligible for full expensing under Code Sec. 179, would now be subject to a $25,000 limit under Code Sec. 179. This change was effective upon enactment. Therefore, assuming that President Bush has by now signed the legislation, full Code Sec. 179 expensing of heavy SUVs is now history.
There is still, however, a planning opportunity before year's end. Even the $25,000 limit is much more generous than would be available to vehicles that weigh less than 6,000 pounds. Plus, 50 percent or 30 percent bonus depreciation is still around for the remainder of 2004.
Bonus depreciation is scheduled, for most property acquisitions, to end at the end of this year, and is not expected to be renewed. Therefore, purchasing a heavy SUV for a small business before year's end could still, under the new law, qualify for significantly more first-year depreciation in 2004 than will be the case in 2005.
S corporation provisions
A package of S corporation provisions was included in the legislation that, in several ways, makes the S corporation requirements less restrictive. One of the key beneficiaries will be family businesses where multiple generations of family members will now count as only one shareholder, eliminating the need to use special entities as shareholders to try to stay within the limits on the number of shareholders.
Also, the changes are designed to make it easier for small community banks to operate as S corporations. These provisions are generally effective either on the date of enactment or starting in 2005. Tax practitioners will want to review these changes with their S corporation clients or those clients that are contemplating S corporation status, particularly in light of the new Code Sec. 199 deduction discussed above.
State and local tax deduction
The new act permits individual taxpayers to chose between an itemized deduction of state and local sales taxes or state and local income taxes on their returns. The law also permits an election to deduct actual sales taxes paid or to pull a figure from tables to be created by the IRS that will base the numbers on sales taxes in a particular state, income level, filing status and number of exemptions. Taxpayers can also add sales taxes for certain big-ticket purchases to the table figure.
This new provision is effective as of Jan. 1, 2004, so taxpayers who have already disposed of sales tax receipts for the first part of the year may be stuck with the tables for 2004.
Tax practitioners should alert their clients to the new record-keeping requirements implied by this law, the need to re-evaluate whether to itemize or take the standard deduction, the merits of claiming the income tax deduction or the sales tax deduction, the merits of using actual expenses or the IRS table, and the possible affect of the new provision on the taxpayer's itemized deduction phase-out and alternative minimum tax exposure.
The provision is likely to be of most benefit in states with a sales tax but with no income tax, or states with a relatively high sales tax rate as compared to the income tax rate. (For more, see "Financial Planning Tax Tactics," p. 18.)
The American Jobs Creation Act of 2004 is a sizable piece of tax legislation that will impact many businesses and individuals. These are just a few of the provisions that should receive the immediate attention of the tax practitioner.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a WoltersKluwer company.
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