September 2004 Monthly News Update

New tax law revises year-end tax strategies

Just as year-end tax planning season for 2004 approaches, Washington has added an unexpected variable -- the Working Families Tax Relief Act of 2004. Although this piece of major tax legislation was expected to pass earlier in the year, it did not. Within the last few weeks of the Congressional session before Election Day, however, the logjam unexpectedly broke. Now, certain year-end tax strategies need to be abandoned and others retooled. Most traditional year-end tax strategies will work, but some will not.

The new law
The Working Families Tax Relief Act of 2004 impacts on year-end planning in several different ways. First, most tax laws for 2004 and 2005 will remain the same. Without the new tax law, you would have been in a higher tax bracket in 2005, especially if you are married,file joint returns, and take the standard deduction. Someone with gross income of about $150,000 would have paid on average over $1,000 more in taxes in 2005.

Second, it raises the level at which income continues to be taxed at the 10 percent level by several thousand dollars for most taxpayers. Upper bracket taxpayers also benefit from this increase. If you are managing a portfolio of investments for your child, the new ten percent bracket becomes doubly important because it, and the 15 percent bracket,defines the levels at which the child's long-term capital gains are taxed a 5 percent rate, instead of the usual 15 percent capital gains rate.

Third, if you have children under 17, your child tax credit remains at $1,000 per child for 2005, rather than dropping to $700 as had been scheduled. Making certain a child qualifies as your dependent becomes a more important tax issue because of the higher credit amount.

Fourth, the alternative minimum tax (AMT) exemption has been continued at its higher 2004 level. Without it, some experts estimate that over one million more taxpayers would pay AMT in 2005. Even with this gift in the new law, planning to avoid the AMT and, if within its grasp, to minimize it, may yield significant benefits.

Ironically, some taxpayers will be thrown into the AMT because of the new law. The reason is that whenever regular income tax liability (which is reduced by the new law) is less than the tax under the AMT, the AMT becomes the tax you must pay. Balancing between 2004 and 2005 income and deductions that trigger AMT is frequently a solution; but sometimes, loading AMT income into just one year is the better strategy.

Teachers benefit from the new law, with a retroactive extension of 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 end of the year.

Traditional year-end planning
With the worry of higher tax rates for next year behind us, traditional tax planning concepts may serve you well. Generally, this means deferring income into 2005 whenever possible and accelerating deductions into 2004. Of course, doing the math is important because over-utilizing that strategy may put you in a higher bracket for one of the years.

Accelerating deductions and deferring income, itself, becomes a strategy. It's not as easy as it first looks because of a rule called "claim of right." If someone owes you money or you owe payment on a bill, simply ignoring collection or payment until next year won't necessarily defer tax treatment. Special rules also apply in certain circumstances.

Timing is especially useful in planning to have your portfolio of investments taxed at the lowest rate. Before the next year rolls in, taking a look at capital gains and losses for the year, as well as dividends, can help you "net out" gains against losses and maximize their tax benefits.

Business planning
Businesses have two special concerns this year: taking bonus depreciation before it permanently ends in 2004; and qualifying for any one of a handful of tax credits that have been renewed under the new law, retroactively to January 1, 2004.

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 December 31, 2004, and almost certainly will not be renewed. If your business is planning a purchase, doing it in 2004 rather than in early 2005 can save you thousands of tax dollars.

The new law has been generous is extending many business tax credits and deductions that had already expired during 2004. Among those your business might review before the year ends are the work opportunity tax credit; welfare-to-work tax credit; the research credit; charitable contributions of computer technology and equipment used for educational purposes; expensing of environmental remediation costs; credit for electricity produced from certain renewable resources; suspension of the 100-percent-of-net-income limitation of percentage depletion; credit for qualified electric vehicles; deduction for qualified clean-fuel vehicle property; and Archer medical savings accounts.