TOPICS COVERED IN THIS ISSUE
- Summer 2005
- 2004 Tax legislation
- The definition of a "qualifying" child
- Child tax credit increase is extended
- Tax brackets reduced
- 10% tax bracket increased and extended
- Marriage
penalty relief extended
- Lower capital gains
rates
- Dividends taxed at 15%
- Electric
vehicle credit and clean fuels
tax deduction
- State sales tax deduction
- States
with no income tax
- States With No Sales Tax
- Charitable Contributions of Cars
and Other Vehicles
- Educator's deduction
- Tuition
and fees deduction
- Amt
- Health savings accounts
- Conclusion
Summer
2005
The Summer 2005 Tax Client Newsletter brings you
up-to-date on a number of important tax law changes for 2005. As a
result of tax legislation over the past few years, there are a number
of significant tax law changes affecting you this year and right now.
You may be aware through media attention that
many of the important tax law changes are scheduled to "sunset" (go away) at various
dates - some sooner rather than later. You should think of the "sunset" issue
as a future concern and take advantage
of the opportunities available to you now.
The focus in Washington these days is on Social Security Reform.
Congress, it appears, has placed tax law legislation on the post-Labor
Day agenda. Only time will tell what, if any, tax law changes will
be enacted in 2005. If you recall, this is exactly what happened last
year and in the Fall of 2004, Congress passed and President Bush signed
into law two significant pieces of tax legislation: The Working Families
Tax Relief Act of 2004 and the American Jobs Creation Act of 2004.
If you have any questions concerning any of the information being
reported on in this issue of the Tax Client Newsletter, please contact
my office to schedule an appointment.
2004 TAX LEGISLATION
The 2004 Tax Acts (721 pages and 755 amendments
to the Internal Revenue Code) affects a significant number of taxpayers
and in a number of ways. In this issue of the Tax Client Newsletter
we will review some of the most important changes for 2005.
THE DEFINITION OF A "QUALIFYING" CHILD
Child-related tax benefits frequently
depend on the existence of a "qualifying" child.
Among the items impacted by the definition are: is the taxpayer
entitled to a dependency exemption, head-of-household filing
status, the child tax credit, the earned income tax credit,
or the dependent care credit? Prior to the 2004 tax legislation,
each of the above items came with its own definition of
a "qualifying" child. Talk about confusion.
Beginning in 2005, one set of dependency
tests applies to the taxpayer's "qualifying" children
and another test will be used for "qualifying" relatives.
To be a "qualifying" child and eligible for the
dependency exemption, the child:
1. Must be under the age of 19 at the
end of the year or a full-time student under age 24.
2. Must share a home with the taxpayer for more than half the year.
3. Must not provide more than half of his/her support.
4. Must be the taxpayer's child, grandchild, brother, sister, niece or nephew.
Under a new, uniform definition of a child,
a taxpayer's children include the taxpayer's natural children,
stepchildren, adopted children and eligible foster children.
This new, uniform definition will be used for other child-related
tax benefits.
Alert: If a child satisfies the test for
more than one taxpayer there are rules in place that favor
parents first. This issue can become tricky and we are available
to work you through this.
Planning for the
future is a lot like planting a tree. You've
got to do it today if you want your family
to enjoy it tomorrow.
CHILD TAX CREDIT INCREASE IS EXTENDED
The child tax credit which was scheduled
to decrease to $700 in 2005 will stay at $1,000 per child
through 2010. Keep in mind that the available child tax
credit is reduced (and in some cases eliminated altogether)
if the taxpayer's modified adjusted gross income is greater
than certain amounts. Note that the new, uniform definition
of a child (see above) did not increase the age at which
the child tax credit is available. The child tax credit
is only available for children under the age of 17 at the
end of the tax year.
TAX BRACKETS REDUCED
One of the most significant features of
the recent tax law changes was the lowering of income tax
brackets. The 2001 Economic Growth and Tax Relief Reconciliation
Act provided that individual marginal tax rates gradually
decline over several years. The Jobs and Growth Tax Reconciliation
Act of 2003 accelerated the reductions. The new tax rates/brackets
are:
Now Was
35% 38.6%
33% 35%
28% 30%
25% 27%
15% 15% (no change)
10% 10% (no change)
Note: Rates were retroactive to January
1, 2003.
Did you know we do more than just prepare,
compile, and crunch numbers? We are not just
bean-counters. We
can also advise you on estate and business
planning and offer financial strategies to
meet your goals. As your CPA, we know your
needs better than many other professionals.
10% TAX BRACKET INCREASED AND EXTENDED
Both single taxpayers and joint filers will benefit
from an extension of the 10% tax bracket. For tax years through 2010,
the 10% tax bracket applies to the first $7,000 of taxable income
(single filers) and the first $14,000 (married joint filers). The
10% tax bracket amounts are adjusted for inflation (started in 2003).
Under the old law, the amounts would have been adjusted for inflation
only in 2004, 2009 and 2010.
For 2005, the 10% tax bracket applies to the first
$7,300 of taxable income for single taxpayers (also for married taxpayers
filing separate) and $14,600 for married taxpayers filing jointly.
MARRIAGE PENALTY RELIEF
EXTENDED
The 2003 Act changed the so-called "marriage
penalty" rules of the tax code. The marriage
penalty is a feature of the tax code that, in some
cases, leaves two working spouses worse off taxwise
than they would be as singles. The marriage penalty
comes about because some features of the tax laws
don't always double for married couples.
The 2004 Act extends the 2003 marriage penalty
relief by continuing to increase the standard deduction available
to married couples to twice the standard deduction available to single
taxpayers. The 2004 Act extends this relief through 2010.
The 2003 Act expanded the 15% tax bracket for married
couples filing jointly to double that of single taxpayers. The 2004
Act extends this relief through 2010.
LOWER CAPITAL GAINS RATES
Investors came out a very big winner under
the 2003 Act. The top capital gains rate was lowered from 20%
to 15%. The lowest capital gains rate decreased to 5% from 10%.
Note that the lower rates were effective for transactions after
May 5, 2003. The lower rates are scheduled to expire after 2008.
Taxpayers in the lowest two brackets (10%
and 15%) will get a one-year bonus in 2008 when they will pay
no federal taxes on capital gains. The tax is reinstated after
2008.
DIVIDENDS TAXED AT 15%
Historically, dividend income was taxed as
ordinary income. Under the 2003 Act, the top dividend rate was
lowered to 15%. Taxpayers in the lowest two tax brackets pay
5%. This is a very significant change when you consider the
fact that the top rate for dividends was 38.6%. The new lower
rates are effective for qualified dividends received after December
31, 2002. The reduced rates are the same rates that apply to
capital gains.
With up to a 20 percentage point difference
between the highest income tax rate (35%) and the highest
dividend rate (15%), determining what a "qualifying" dividend
is can make a big difference. To be a "qualified" dividend,
the stock must be held for more than 60 days during a 120
day period starting 60 days before the ex-dividend date.
If this sounds complicated - it is. Many companies have experienced
difficulty in properly reporting this information to their
shareholders. The lower rates are scheduled to expire after
2008.
Out of favor for years, dividends on stock
have surged back. The 2003 dividend-tax cut has prompted
companies to pay out an increasing share of their profits
rather than stash the cash or reinvest it. Some companies,
notably Microsoft, have started paying dividends for the
first time. In 2004, U.S. companies paid out a record $181
billion in dividends.
Taxpayers in the lowest two brackets will
get a one-year bonus in 2008 when they will pay no tax on
dividend income. The tax is reinstated after 2008.
ELECTRIC VEHICLE CREDIT AND CLEAN
FUELS TAX DEDUCTION
Taxpayers, who purchase a "qualified
electric vehicle" in 2004 or 2005, are allowed a nonrefundable
tax credit for 10% of the costs. The maximum tax credit
is $4,000. Note that for vehicles placed in service in 2006,
the amount of the allowed credit is reduced by 75% and then
eliminated for vehicles placed in service after 2006.
Taxpayers who purchase a "qualified
clean-fuel vehicle" in 2004 or 2005 are eligible
for a deduction of up to $2,000. For clean-fuel vehicles
placed in service in 2006, the deduction will be reduced
by 75% and then eliminated for vehicles placed in service
after 2006.
The IRS is, on an ongoing basis, "certifying" vehicles.
The most recent vehicle "certified" is the
2006 Toyota Highlander hybrid. Please be sure that the
vehicle "qualifies" before making the purchase.
The
Massachusetts Society of CPAs represents
over 8,800 certified public accountants
working in public accounting, industry & business,
government and education.
STATE SALES TAX DEDUCTION
One of the most exciting developments
(maybe not for all taxpayers) in the 2004 Jobs
Act was a provision to allow taxpayers to deduct
state and local sales taxes in place of (not in
addition to) state and local income taxes. This
election is available for tax years 2004 and 2005.
This new deduction is most popular among taxpayers
from states (there are nine) that do not have a
state income tax.
Taxpayers who elect to deduct
state and local sales taxes have two options for
determining the deductible amount. Taxpayers may
deduct the actual amount of taxes paid (keep those
receipts) or they may deduct the appropriate amount
from tables provided by the IRS.
If you pay state income tax,
the chances are you'll come out ahead with the
state income tax deduction. But there are exceptions.
Big spenders should run the numbers. So should
residents of states, including Illinois and Michigan,
where income tax rates are lower than the state
sales tax rate.
Alert: The Alternative Minimum
Tax (AMT) may eliminate any benefit provided by
the new sales tax deduction.
DON'T FORGET:
"IT'S NOT WHAT YOU MAKE THAT COUNTS; IT'S WHAT YOU KEEP!"
If you are pleased with our service,
please tell your friends. If you are not
pleased with our service, please tell me;
that way we can please you.
STATES WITH NO INCOME TAX
Alaska
Florida
Nevada
*New Hampshire
South Dakota
*Tennessee
Texas
Washington
Wyoming
*New Hampshire and Tennessee
have a state income tax limited to interest and
dividends.
STATES WITH NO SALES TAX
*Alaska
Delaware
Montana
New Hampshire
Oregon
*There are some local jurisdictions
in Alaska that impose a local sales tax.
CHARITABLE CONTRIBUTIONS
OF CARS AND OTHER VEHICLES
Concerned that too many taxpayers
were taking much larger tax deductions for donated
automobiles than the amount the charities were
receiving when the cars were sold at auction, the
American Jobs Creation Act of 2004 enacted some
major changes to the rules effective January 1,
2005.
Under the 2004 Act, the general
rule is that the amount of the deduction for the
contribution of an automobile, boat or aircraft
valued at more than $500 is limited to the gross
sales proceeds obtain by the charity when the vehicle
is sold.
The 2004 Act provides for two
circumstances in which the old (you get to deduct
the fair market value) rules would apply: (1) the
charity keeps the vehicle or (2) the charity makes
significant improvements to the vehicle before
selling it.
On June 3, 2005, the IRS issued
some guidance (Notice 2005-44) on how the new law
will be applied. The Notice says that the new gross
proceeds limits on fair market value hold that
if the fair market value is less than the amount
obtained by the charity, the donor is still to
use the fair market value. The Notice also says
that if a charity donates the vehicle or sells
it at a nominal price in furtherance of its charitable
purposes, the taxpayer can rely on the fair market
value.
Here's the bottom line. If you
are thinking of donating a vehicle - do not believe
everything that is being advertised. Call my office
to make sure that you understand any limits you
are facing and whether there are any alternatives
available to you.
The IRS expects to bring in $2.4
billion in extra tax revenue over the next ten
years as a result of the new limits placed on vehicle
donations.
Remember: “A failure to
plan is a plan to fail.” (Anonymous.)
EDUCATOR'S DEDUCTION
Educators can deduct (above-the-line) up to $250
of qualified out-of-pocket expenses paid in 2005. If both spouses
are eligible educators and a joint tax return is filed, each may
deduct up to $250. Eligible "educators" include teachers
of K-12, counselors, principals, and aides in a school who work at
least 900 hours during the school year.
"Qualified" expenses include ordinary
and necessary expenses paid in connection with books, supplies, equipment
(this includes computer equipment, software and services), and other
materials used in the classroom.
Expenses for home schooling are not eligible for
the deduction.
This deduction is scheduled to expire after 2005.
TUITION AND FEES DEDUCTION
An above-the-line deduction is available to
taxpayers for "qualified" tuition and related expenses
paid for the taxpayer, the taxpayer's spouse, or the taxpayer's
dependent. The amount that can be deducted is limited depending
on adjusted gross income. While the maximum deduction for 2005
is $4,000, there are some taxpayers (not eligible for the $4,000
based on their income) who may qualify for a $2,000 deduction.
This very popular deduction is scheduled to
expire after 2005.
Alert: If Congress doesn't extend this tax deduction
beyond 2005, it might make sense for some taxpayers to consider
paying for the first term of 2006 by December 31, 2005. In some
cases this action would result in a tax deduction for 2005. As
always, check with my office before you make any "advance" payments.
AMT
Here's one topic that we would all love to forget
about. The Alternative Minimum Tax (AMT) is designed to prevent
high-income taxpayers from avoiding significant tax liability.
A taxpayer's AMT for a tax year is the excess of the tentative
minimum tax over the regular tax. All taxpayers subject to the
regular income tax system are also subject to the AMT system.
The number of taxpayers exposed to the AMT is rapidly increasing.
The AMT is projected to affect about 3.8 million taxpayers in
2005 and more than 20 million by 2006. It appears that the government's
definition of a "high-income taxpayer" is expanding
like a balloon.
Taxpayers subject to the AMT will be happy to
know that the 2004 Act extends the higher AMT exemptions through
2005. The exemptions are:
$58,000 for married taxpayers filing jointly
and for surviving spouses
$40,250 for single taxpayers
$29,000 for married taxpayers filing jointly
Unless Congress acts to extend the higher AMT
exemptions, the amounts will revert to those that applied in the
2000 tax year ($45,000, $33,750 and $2,250 respectively).
HEALTH SAVINGS ACCOUNTS
One of the most significant tax law changes
for 2004 was the introduction of Health Savings Accounts (HSAs).
The HSAs were created in the Medicare Prescription Drug Improvement
and Modernization Act of 2003. Effective January 1, 2004, HSAs
allow deductible contributions to be set aside to cover medical
expenses that are not covered by a high-deductible medical plan
in which the taxpayer-employee participates.
HSAs allow taxpayers to save and pay part of
their medical expenses with tax-advantaged money. The funds that
taxpayers put into the accounts may grow and be used tax-free
for qualified medical expenses. The accounts can be opened only
in tandem with an HSA-qualified insurance policy that has a high
deductible - in 2005, at least $1,000 for single coverage or $2,000
for family coverage.
The contributor to the HSA - either the employee
of the employer - gets a tax deduction for the contributions going
into the HSA, and then the employee is allowed to withdraw the
funds tax-free in the same year or in a future year to cover their
unreimbursed medical expenses. Contributions that are not used
in any tax year may be rolled over for future use. Upon reaching
the age of 65, accumulated funds in an HSA can be withdrawn tax-free
to cover medical expenses or they can be withdrawn penalty-free
(but not tax-free) for any purpose.
If you have any question regarding whether a
Health Savings Account is right for you and or your family - please
contact my office to schedule an appointment.
CONCLUSION
The American Jobs Creation Act of 2004 represents
the biggest single piece of tax legislation since the Taxpayer
Relief Act of 1997. When combined with the Working Families Tax
Relief Act of 2004, taxpayers are left with a significant number
of tax law changes. In the Summer 2005 Tax Client Newsletter we
have review many of the most significant tax law changes affecting
you now.
As always your individual focus should be on
how the tax law changes affect you and how the tax law changes
benefit you.
Thank you for reviewing the Summer 2005 Tax
Client Newsletter and for the opportunity to serve as your tax
professional.
