The American Jobs Creation Act of 2004, at least in terms of the tonnage it adds to the Internal Revenue Code, is one of the biggest tax laws to come along since the 1986 Tax Reform Act. Some contend that it has no rival in terms of complexity.Its main focus is on business and, within that focus, many provisions require quick decisions to be made. Add to these deadlines the fact that another tax year is about to close for most taxpayers and the immediacy of this new law becomes even more urgent.
Last month we presented a column on year-end tax planning for 2004, fairly confident that Congress would not reach agreement on the Jobs bill at least before breaking for the November elections. This column updates year-end planning in light of the AJCA. We do so again with the advice that subsequent events - this time in particular the outcome of the presidential and congressional elections - will continue to remain important variables that should be considered in any tax planning.
Tackling year-end planning considerations under the AJCA may be done in two stages: (1) Look at those provisions that have taken effect immediately that apply to the tax year about to end, and (2) examine those provisions that start Jan. 1, 2005, for which advance planning may be fruitful.
Provisions immediately effective
* The "SUV" deduction. Starting for vehicles placed in service after Oct. 22, 2004, the $100,000 cap on Section 179 first-year expensing deductions on passenger vehicles weighing between 6,000 and 14,000 pounds has been rolled back to $25,000.
While the Jobs Act was still waiting to be signed by President George W. Bush, the advice had been to hurry up and buy that SUV. That advice remains unchanged, since those vehicles are entitled to bonus first-year depreciation of 50 percent, which Congress left to expire on Dec. 31, 2004, for all small business property. That deduction is taken after taking the $25,000 Internal Revenue Code Section 179 write-off and before regular depreciation.
With all but the most expensive of SUVs, depreciation for 2004 will turn out sufficiently generous that, if other Section 179 property may be purchased before year's end, the overall $100,000 limit should be used instead of wasting $25,000 of it on the SUV. Also, remember that both the purchase and placed-in-service date controls; a contract of sale doesn't count, nor does having it sit in a garage without being used in the business until January.
* State sales taxes. Up until 1987, taxpayers could take itemized deductions for both their state and local income taxes and their state and local sales taxes. The 1986 Tax Reform Act did away with the deduction for sales taxes. The new law brings it back, but only as an option to be taken instead of state and local income taxes.
Primarily taxpayers in states with low or no income taxes will benefit, although the option is open to taxpayers throughout the nation. Since this option is effective retroactively to the start of 2004, many taxpayers are now scrambling to find sales receipts.
Predicting the extent of Internal Revenue Service guidance at this point seems hopeless, with the IRS itself admitting that it was unprepared for the change. Right now, the consensus is that taxpayers should follow the regulations in effect for the pre-1987 sales tax deduction. Receipts should be collected, especially on big-ticket items. Tables issued for 1986, multiplied by the general inflation rate since then, might be a good start for estimating expenses, but until new tables are issued, actual receipts are the only acceptable proof.
If the IRS decides not to issue tables for 2004, questions will remain as to whether amended returns might be filed based on 2005 tables or whether 2005 tables will eventually be acceptable for 2004 tax year examinations.
* Teachers' classroom expense deduction. Congress has reinstated the $250-per-year, above-the-line "teachers'" deduction for out-of-pocket classroom expenses, retroactively back to Jan. 1, 2004. K-12 teachers, principals, counselors and aides should collect receipts for prior purchases this year (credit card statements might help) and try to ask their principal or school administrator to certify a list. While expenses of more than $250 are also deductible, they must be taken as an itemized miscellaneous deduction subject to the 2 percent adjusted gross income floor.
Preparing for January 1
* Vehicle donations. One year-end planning technique receiving a considerable amount of press is the strategy of donating a used vehicle to charity before stricter rules kick in for 2005. Starting in 2005, the deduction for a vehicle contributed to charity for which more than a $500 deduction is claimed will be limited to the price that the charity gets for selling it - which is typically a deeply-discounted wholesale price. There is no SUV loophole here - all vehicles are included and corporations are included.
Of course, having the taxpayer sell the vehicle first and donate the cash would avoid any problem in the future, except for the hassle of selling and the worry that certain state liability disclosure laws may apply.
After 2004, finding a charity that will actually use the vehicle will be worthwhile if it appears to be in good condition, since fair market value then will be the test. Unfortunately, again, this represents too much of a hassle for most taxpayers to bother. For taxpayers donating old "junkers" or those satisfied with a smaller deduction, taking a $499 deduction starting next year will represent an alternative, although it will be up to the IRS as to how aggressively it will enforce its right to have fair market value substantiated on an audit of that deduction.
Those rushing to donate vehicles before year-end 2004 should also remember that the rules proving fair market value are not liberalized by the new law - the substantiation rules remain applicable and a taxpayer, if audited, must prove such value or face a deficiency and penalties.
* Manufacturers' deduction. Effective Jan. 1, 2005, a significant new deduction begins to be phased in for many businesses. Called the "manufacturers' deduction," it would benefit a considerable number of businesses not traditionally thought of as manufacturers.
The new deduction isn't just for the traditional manufacturer of widgets. Congress chose to define "manufacturer" very broadly. In addition to traditional manufacturers, businesses that qualify for the new deduction include construction firms, engineering and architectural firms, film and video production companies, computer software makers, agricultural processors, and even a few operations that would otherwise be considered service-intensive. The deduction starts at 3 percent and grows to 9 percent by 2010.
Planning to be ready to maximize this new tax break starting Jan. 1 should start now. Many questions remain to be answered by the IRS. For example, numerous issues are expected to arise in connection with allocating gross receipts, income, deductions, expenses and losses in determining "qualified production activities income." A serious look into how the issues will impact clients should start soon.
* Nonqualified deferred compensation. The AJCA makes important changes to the tax law as it is applied to deferred compensation. Most of these changes start immediately on Jan. 1, 2005. If certain operational or design failures occur in a nonqualified deferred compensation plan, the deferred amounts will be included in the affected plan participant's gross income immediately, unless it is still subject to a substantial risk of forfeiture.
Failures that a nonqualified plan must avoid include those having to do with distributions, the acceleration of benefits, and the timing and nature of the election to defer compensation and other elections allowed under the plan.
Preparation for the rules should begin immediately. However, care should be taken to avoid amending existing plans until IRS guidance is forthcoming. Amending a plan could cause it to lose grandfathered status under the new guidelines.
* S corporation reform. S corporations are sure to be even more popular under the new tax law. Instead of 75 shareholders, S corporations can have 100 shareholders. One family can also elect to be treated as a single shareholder. All told, 10 major changes have been made in the S corp area, and they apply to tax years beginning after Dec. 31, 2004.
* Recovery period for leasehold and restaurant purchases. The AJCA provides that "qualified leasehold improvement property" and "qualified restaurant property" placed in service after Oct. 22, 2004, and before Jan. 1, 2006, is 15-year MACRS property with 15-year recovery periods.
The improvements must be made to the interior portion of nonresidential real property. The applicable depreciation method is the MACRS straight-line method. If the MACRS alternative depreciation system is elected or otherwise applies, the recovery period is 39 years and the recovery method is the straight-line method. Whether or not ADS is elected, the applicable convention is the half-year convention, unless the mid-quarter convention applies. Purchasing qualifying property before the end of the year, instead of early next year, therefore, can accelerate deductions proportionately.
These are highlights of only some of the hundreds of provisions effective either immediately or on Jan. 1, 2005, that should go into tax planning as we approach the end of the year. Those with international operations especially should pore over the many provisions affecting foreign operations.
For all of us, the full implications of the AJCA will take months to digest, along with the rules and regulations that will be issued by the Treasury Department and the IRS. Nevertheless, the clock is ticking on 2004, and qualifying for tax benefits or avoiding trouble in this immediate tax year should take center stage for the moment within the broader reaches of the AJCA.
George G. Jones, JD, LL.M, is managing editor, Federal and State Tax, and Mark A. Luscombe, JD, LL.M., CPA, is principal analyst, Tax & Accounting, at CCH Inc.
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