Year-end tax planning generally never turns out to be the same routine each year. Either the client's circumstances change, or the tax law changes. For 2004, one of the major unexpected developments is the eleventh-hour passage of the Working Families Tax Relief Act of 2004.
Although expected earlier this year, by early September many practitioners had given up on its passage. Suddenly, Congress approved it on September 23 and added business extender provisions to boot. This new law, together with some remaining twists left over from the 2001 and 2003 tax acts, requires the revision of several year-end tax strategies.
Recent legislation - individuals
The primary impact of the Working Families Tax Relief Act of 2004 has been to give more continuity to the transition between 2004 and 2005. Without the new tax law, virtually all taxpayers would be paying more tax in 2005. In many cases, that change would have required more acceleration of income into 2004 and deferral of deductions in 2005 as a year-end technique.
The new tax law changes that planning equation by raising the child credit, keeping the 10 percent bracket for all filers at its expanded size, and retaining marriage penalty relief for joint filers in the form of a 15 percent rate bracket and standard deduction at double that of single filers. For example, the "average" family with 1.5 children that is earning $150,000 in 2005 will save over $2,000 in taxes in 2005 because of the new tax law.
In managing capital gains and losses to maximize overall 2004-2005 taxes, the role of the 10 percent and 15 percent income tax bracket should not be overlooked. Not only can that higher bracket shelter more earned income but, since it also defines that level at which an individual's capital gains are taxed at a 5 percent rate, acceleration of capital gains to reach that level should be considered.
If a child is under 17, the taxpayer who claims the child as a dependent is allowed the child tax credit at a $1,000-per-child level for both 2004 and 2005. Without the new law, that amount would have dropped to $700. Making certain that a child qualifies as the taxpayer's dependent becomes a more important tax issue because of the higher credit amount. It also makes that right more valuable in divorce situations.
Ironically, the new law provides both good news and bad news regarding the alternative minimum tax. The new law continues the exemption at its higher 2004 levels ($58,000 in the case of a joint return filer or a surviving spouse, $40,250 for an individual who is not married and who is not a surviving spouse, and $29,000 for an individual who is married but files a separate return).
At the same time, however, all of the other tax breaks extended under the new law serve as an unexpected decrease in regular tax liability for 2005. Since the AMT applies when AMT liability exceeds liability under the regular tax, more taxpayers will continue to fall into the AMT.
Year-end tax planning requires a run-through of the numbers for both 2004 and 2005 to anticipate any AMT liability. If possible AMT is forecast, balancing between 2004 and 2005 income and deductions that trigger the AMT is frequently a solution.
However, loading AMT tax preferences into one year to qualify for the regular tax for the other can yield greater overall tax savings. "Number crunching" is essential.
Finally, teachers have been singled out for relief under the new law. The new law retroactively extends an above-the-line deduction of up to $250 for out-of-pocket classroom expenses. This deduction had expired at the end of 2003, but now runs through 2005. Since the $250 deduction starts fresh each year, teachers should organize receipts and spending plans to maximize their 2004 deduction before the year ends.
Recent legislation - businesses
Out of fear that the Families Tax Relief Act would be the last tax train out of the legislative station this year, Congress moved over most of the business "extender" provisions that had been in the FSC/ETI bill. The new law has been generous in extending many business tax credits and deductions that had already expired during 2004. Business clients should review the list to make certain not to overlook any.
Year-end plans to maximize these benefits in both 2004 and 2005 should include a look at the work opportunity tax credit; the welfare-to-work tax credit; the research credit; the deduction for charitable contributions of computer technology and equipment used for educational purposes; the expensing of environmental remediation costs; the credit for electricity produced from certain renewable resources; the suspension of the 100-percent-of-net-income limitation of percentage depletion; the credit for qualified electric vehicles; the deduction for qualified clean-fuel vehicle property; and the contribution level for Archer medical savings accounts.
Other legislative ripples
Because of the budget-saving legislative technique of providing temporary tax benefits rather than permanent rules, taxpayers should pay particular attention to two additional tax benefits during this year-end planning season.
First, businesses should not miss taking advantage of bonus depreciation. Bonus depreciation can be of tremendous value to a business. A full additional 50 percent of the cost of business equipment and other property - in addition to regular depreciation - may be written off in the year of purchase.
Bonus depreciation ends, however, on Dec. 31, 2004. It is almost certain not to be renewed, even retroactively, since the "bonus" was intended only as a short-term stimulus to jump-start the economy after the recent slowdown and 9-11. Especially if a business is planning a purchase of qualifying property soon, doing it in 2004 rather than in early 2005 can accelerate a considerable amount of depreciation into 2004.
Second, investors should keep one eye on the elections and another on the calendar. Timing capital gains and losses always has been a classic year-end technique to net out the lowest overall tax. The 2003 tax act reduced the maximum rates from 20 percent to 15 percent, and allowed dividends the same rate.
Those same provisions, however, sunset after 2008. Since taking away something temporary is usually easier politically than removing a permanent provision, some speculate that the maximum capital gains rate may rise to 20 or even 25 percent as early as Jan. 1, 2005, especially if Senator Kerry is elected president. Taking more capital gains in 2004 as a precautionary measure has been one suggested reaction to this uncertainty.
Conclusions
While year-end tax planning does share certain common threads year after year, the current technique of Congress to provide temporary tax breaks threatens to make each year-end unique because of at least one or two expiring provisions. Add to that the uncertainty of last-minute temporary extensions to those temporary measures, and the matrix for year-end tax planning will continue to change regularly and, at times, unexpectedly.
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.
