TAXES AND ACCOUNTING

Working Families Tax Relief Act: General Information

Dear Clients and Friends:

For the fourth time in four years, Congress has enacted some big tax cuts. How much you'll save in taxes depends on your filing status, family circumstances and business situation, and how you maximize benefits through careful planning. This letter will help you identify which parts of the new $146 billion tax cut package can benefit you. It also explains how timely tax planning can enhance these benefits. Especially now, as we enter the year-end tax planning season, the new tax law comes at an ideal time to cut your tax bill.

Overview

The new law extends two sets of expiring provisions: one for individuals and one for businesses. Without these extensions, individual taxpayers would be paying a lot more in taxes in 2005, and subsequent years, than in 2004. Business taxpayers receive even more immediate tax relief. The business tax breaks, which have been extended into 2005 by the new law, had already expired for the most part at the end of 2003.

Tax relief for individuals: Here are the big changes for most individual taxpayers:

• Parents of children under 17 can continue to claim a $1,000 child tax credit - for every child - through 2010. Without the new law, the child credit would have plummeted to $700 per child in 2005.
  
• Married taxpayers filing jointly will continue to benefit from full marriage penalty relief. Through 2010, joint filers pay tax at double the single rate for the 15 percent rate and for the standard deduction. For 2005, this means having the high end of the 15 percent tax bracket pegged at $59,400 (rather than at $53,450) if Congress hadn't passed the new law. The change in the new law in the standard deduction for married couples filing jointly is equally as dramatic -- $10,000 in 2005 instead of $8,700.
  
• The 10 percent tax bracket's upper limit for married taxpayers filing jointly stays at $14,000 ($14,600 inflation indexed) for 2005 rather than dropping to $12,000. For single taxpayers, it stays at $7,000 rather than dropping to $6,000.
  
• The alternative minimum tax (AMT) exemption amount remains at $42,250 for single individuals and $58,000 for married couples for one more year. Taxpayers can also use the personal nonrefundable credits against AMT liability for one more year.

Tax relief for businesses: The new law extends over 20 tax breaks for business taxpayers back to January 1, 2004 and forward to December 31, 2005. These tax breaks benefit almost every business.

The new law extends more than 30 business tax incentives. Here are some of the major extensions:

• The research and development tax credit is extended for amounts paid or incurred after June 30, 2004 and before 2006. Over $4.3 billion in research and development credits are claimed each year by some of America's biggest companies. They had lobbied for an expansion of the research tax credit, but came away with only an extension.
  
• The welfare-to-work and work opportunity tax credits are extended for wages paid or incurred for qualified individuals starting work after 2003 and before 2006. Many businesses have been lobbying for extensions of these two credits, which reward employers for hiring economically disadvantaged individuals. The WOTC can reach as high as $2,400 for each employee. The maximum welfare-to-work credit is $8,500 per employee.
  
• The enhanced deduction for charitable contributions of qualified computers is extended for contributions made in tax years beginning after 2003 and before 2006. Donations generally must be made to libraries and schools.
  
• The teacher's classroom expense deduction is extended for 2004 and 2005. This incentive allows professional educators to deduct, above-the-line, up to $250 of out-of-pocket classroom expenses. The deduction is available to K-12 teachers, instructors, counselors, principals, and aides. The deduction had expired at the beginning of this year. The new law extends it for 2004 and 2005. The "average teacher reportedly spends about $450 of his or her own money each year on books and supplies. Eighty percent report spending $1,000 or more.
  
• Contributions to Archer Medical Savings Accounts (MSAs) are extended through 2004 and 2005. Archer MSAs have not fulfilled the initial vision of many lawmakers. Participation has lagged and now they have a new competitor: Health Savings Accounts (HSAs). MSA balances may be rolled over into HSAs.
  
• Suspension of the marginal-well net-income limitation is extended for tax years beginning after 2003 and before 2006.

Other Issues

Some important tax cuts are not in the new law. That doesn't mean they should be forgotten. Because they are expiring soon, time is running out to take advantage of them. Among the biggest in this category are section 179 expensing and bonus depreciation.

• After 2005, the $100,000 limit on section 179 expensing is scheduled to revert to the pre-2003 $25,000 level. This is a significant benefit that should not be overlooked while it is still on the books.
  
• Even more pressing, however, is making certain your business maximizes allowable bonus depreciation. That tax break expires at the end of this year. Most experts anticipate that it will not be extended.

Also, the standard mileage rates for employees, self-employed individuals and other taxpayers to use in 2005 to compute their deductions for the costs of operating an automobile just have released.

• 40.5 cents per mile (37.5 cents in 2004).

Businesses should be aware of a change regarding the deduction for certain SUVs placed in service after October 22, 2004. Under the American Jobs Creation Act of 2004, businesses cannot take a first year depreciation of more than $25,000 for an SUV. (The limit for vehicle placed in service before Oct 23 was $100,000.)

Starting in 2005, your deduction for a vehicle contributed to charity for which you are claiming more than a $500 deduction will be limited to the price the charity gets for selling it. If you're thinking of donating a used car, do it by the end of this year if possible, when you still can deduct its full fair market value.

Consequences

The tax planning implications of the new law for individuals are as broad as the scope of the law itself. For example, individuals going through a divorce know that the right to claim the child tax credit is very valuable. For married couples who both work, and whose incomes are about equal, marriage penalty relief in the new law comes as a welcome perk for 2005. However, year-end strategies for accelerating or deferring income and doing the opposite for deductions remain critical for many couples since the marriage penalty is not eliminated in any of the tax bracket above the 15 percent bracket.

Finally, on the individual tax planning side, the tax breaks in the new law require most people to take a very close look at the AMT. This is especially critical before the end of the year so that steps can be taken to reduce your AMT liability. You may be liable for AMT because the new law could reduce your regular tax liability and at the same tome increases your liability for AMT.

Businesses have an easier time reacting to the new law. For each of the extended credits or deductions, businesses should evaluate if they qualify for any of the extended credits or deductions, such as the work opportunity credit, and then take steps to make sure they qualify in 2004, 2005 or in both years. These steps include not only evaluation of income and expenses, but also whether proper substantiation procedures are in place.

Whatever your circumstances, you'll likely benefit from taking time to do some tax planning as the result of the new law. You should start planning now before the year ends and you can no longer change your taxable income, deductions and credits for 2004. Please don't hesitate to call our office for more details about the new law.

Sincerely yours,

Bob Kim, CPA
Gatto McFerson, CPA's

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