On
October 22, 2004, President Bush signed the American Jobs Creation Act of
2004" (Jobs Act). This legislation is far too large and complex to cover in depth in
this letter. Instead, the following summary highlights selected provisions we
feel will have the greatest impact on 2004 planning for individuals.
New
Deduction for State and Local Sales Tax.
Prior
to 1987, you could deduct both your state and local income taxes and sales
taxes as an itemized deduction. After
1986, however, Congress removed the deductibility of state and local sales
taxes. Generally for 2004 and
2005, the Jobs Act allows you to elect to deduct either state and
local income taxes or state and local sales taxes, as itemized deductions. If
you elect to deduct sales taxes, your deduction is either 1) your
actual sales taxes substantiated by receipts, or 2) an amount provided
in IRS tables (based on your filing status, income, etc.), plus any sales tax
you pay on the purchase of a motor vehicle, boat, or other items prescribed by
the IRS. Tax Tip.
This new election will be particularly beneficial to the residents of states
with little or no state income taxes or states where the state income tax rate
is generally lower than the sales tax rate. However, this option may also help
individuals in any state where the state income tax liability has been
significantly reduced because of state credits, etc.
Also, taking the sales tax deduction rather than the state income tax
deduction may avoid including a state income tax refund in federal taxable
income in a subsequent year.
Excluding
Gain on Sale of Principal Residence. For
the past several years, Congress has been concerned that taxpayers were
inappropriately combining the 1031 like-kind exchange rules with the 121
home-sale exclusion rules. For
example, assume you own a highly-appreciated commercial building worth
$500,000. You swap that building
in a tax-free, like-kind exchange for a $500,000 beach resort home that you
rent to an outsider for a reasonable period of time. Later, you move into the
beach home and establish it as your principal residence for 2 years. Under
prior law, you could then sell the beach home and exclude up to $250,000 of
gain ($500,000 on a joint return) under the home-sale exclusion rules. To curb
this perceived abuse, the Jobs Act provides a new rule. Effective for home
sales after October 22, 2004, if you sell your residence and it was
acquired in a tax-free, like-kind exchange within the five year period
ending on the date of the sale, any gain on the sale is taxable. Tax Tip.
The new rule doesn”t change the requirement that you must use the
residence as your principal residence for 2 years out of the 5-year period
ending on the date of the sale, it merely adds a new 5-year waiting period
where the residence was acquired in a like-kind exchange.
Donations
of Motor Vehicles, Boats, and Aircraft. Generally,
if you contribute non-cash property to a charity, you are entitled to a
charitable contribution equal to the fair market value of the contributed
property. Items valued at more
than $5,000 (except marketable securities) generally require a qualified
appraisal. In recent years, the IRS has been concerned that some taxpayers
were contributing automobiles, boats, etc. and deducting an inflated value as
a charitable contribution. To curb these perceived abuses, the Jobs Act adds
stringent reporting and documentation requirements, for the donor and the
charity, that must be satisfied in order to claim a charitable deduction in
excess of $500 for a qualified vehicle. A
qualified vehicle generally includes motor vehicles designed for highway use,
boats, or airplanes. The new rules are effective for contributions made
after December 31, 2004. Generally, under the new rules, you will be required to
receive a detailed, written receipt from the charity.
If the charity sells the vehicle without any material improvement or
significant use of the vehicle by the charity, your charitable deduction
cannot exceed the gross sales price of the vehicle which must be listed on the
receipt. The charity will be required to send a copy of the receipt to the
IRS, and you will be required to attach a copy of the receipt to your tax
return. Furthermore, significant penalties are imposed if the charity fails to
provide a timely, accurate and complete receipt.
Tax Tip. You
will not be subject to these new stringent reporting requirements if you
contribute your qualified vehicle by December 31, 2004. However, if the
vehicle has a value of more than $5,000, an appraisal is required.
179
Deduction for SUVs Reduced. The maximum annual depreciation deduction for business, passenger
automobiles is capped at certain dollar amounts. However, trucks, vans and SUVs are exempt from these
passenger auto depreciation limitations if the gross vehicle weight exceeds
6,000 lbs. (e.g., a full-size pick-up; a full-size van; or a sport utility
vehicle, including: Expedition, Range Rover, Tahoe, Durango, Suburban, BMW
X-5, etc.). Consequently,
under current law, if more than 50% of the use of one of these vehicles was
for business purposes, you could have taken the 179 deduction (up to $102,000
in 2004) with respect to the business portion cost of the vehicle.
For example, if this vehicle had 100% business use, you could have
immediately deducted up to $102,000 of its cost in 2004 (if it otherwise
qualified under 179). Under the
Jobs Act, SUVs, vans and certain other vehicles that have a gross vehicle
weight of 14,000 lbs. or less are limited to a 179 deduction of up to $25,000
(reduced from $102,000). This new rule is effective for vehicles placed in
service after October 22, 2004. Example.
Assume that on December 1, 2004, your business purchases an SUV
(weighing 6,005 lbs.) for $70,000, which you use 100% for business.
Assume further that this SUV qualifies for the maximum 179 deduction,
the 50% additional first-year depreciation, and the normal accelerated
depreciation deductions (using the mid-quarter convention).
The total deductions in 2004 on this SUV would be $48,625, computed as
follows: (i) a 179 deduction of $25,000, plus (ii) additional
50% first-year depreciation of $22,500 on the remaining basis ([$70,000 -
$25,000] x 50%), plus (iii) $1,125 of MACRS depreciation ([$45,000 -
$22,500] x 5% [using mid-quarter convention and 200% declining balance]). The remaining $21,375 of cost would be recovered in 2005 and
later under the general depreciation rules.
Planning
Alert! If the SUV is
instead placed in service on January 2, 2005 (when the 50% depreciation is no
longer available), the total depreciation deductions for 2005 would be only
$34,000 (using the mid-year convention). Therefore, if you want maximum
up-front depreciation deductions, you must place the SUV in service before
2005.
Tax Tip. As
you evaluate the impact of this new rule, please keep the following points in
mind:
$ Any truck, van, or SUV weighing over 6,000
lbs is still fully exempt from the passenger auto depreciation limitations. It
is only the 179 deduction amount that has been changed.
Planning
Alert! Subject to limited
exceptions, the 50% additional first-year depreciation deduction sunsets for
all depreciable property (not just SUVs) if placed in service after
December 31, 2004.
$ The Jobs Act provides that some vehicles
weighing over 6,000 lbs. (even though not over 14,000 lbs.) are still entitled
to the maximum 179 deduction ($102,000 for 2004).
For example, a pick-up truck with
a cargo area of at least 6 feet of interior length and a van with a seating
capacity of more than 9 persons behind the driver are not limited to a $25,000
179 deduction.
New
Restrictions on Non-Qualified Deferred Compensation Plans.
Non-qualified deferred compensation plans are frequently used as part of a
compensation package providing financial incentives to executive and middle
management employees. Congress
believes that many companies are too aggressive with their non-qualified
deferred compensation plans and are deferring compensation income without
sufficient restrictions on the funds. Consequently,
generally effective for compensation amounts deferred after 2004, the
Jobs Act for the first time establishes comprehensive statutory criteria that
must be satisfied to defer compensation income under non-qualified plans.
Generally, amounts deferred under these plans before January 1, 2005,
will not be subject to these new rules. However,
if the plan is materially modified after October 3, 2004, amounts
deferred prior to 2005 could be subject to taxation, an interest charge, and a
20% penalty. Caution! Materially modifying a deferred compensation plan
after October 3, 2004 could result in serious tax consequences unless the plan
already complies with the Jobs Act requirements! Planning Alert! If
your company sponsors, or you are a beneficiary of, a non-qualified deferred
compensation plan, it is imperative that this plan be reviewed by us and an
attorney responsible for the plan. At least a preliminary review should take
place before December 31, 2004 and before any additional deferrals are elected
for 2005. Please call our office if you want us to assist you in this review.
Attorney
Fees.
After years of controversy, Congress has resolved the issue of how to
deduct attorney fees relating to taxable damage awards. Unless you are
recovering for a physical personal injury, most lawsuit recoveries are fully
taxable. However, courts in some circuits (5th, 6th, 9th,
and 11th Circuits) believe that an individual is taxed only on the
damage award net of any attorney’s fees paid with regard to the lawsuit. In
other circuits (2nd, 4th, 7th, 10th,
and Federal Circuits), courts have held that an individual is taxed on 100% of
the damage award, and is entitled to a miscellaneous itemized deduction for
the resulting attorney’s fees. Unfortunately,
a miscellaneous itemized deduction cannot be deducted for regular tax
purposes, except to the extent all miscellaneous itemized deductions exceed 2%
of adjusted gross income. Furthermore,
these deductions are not allowed at all for alternative minimum tax (AMT)
purposes. Consequently,
individuals receiving payments in circuits that treat attorney’s fees as
miscellaneous itemized deductions pay significantly more taxes than plaintiffs
recovering in circuits that only tax the award net of attorney’s fees.
Effective for fees and costs paid after October 22, 2004, with
regard to any judgment or settlement taking place after October 22, 2004,
the Jobs Act allows an above-the-line deduction for claims of unlawful
discrimination, certain claims against the Federal Government, and certain
claims under the Medicare Secondary Payer Statute.
Good News! Because
this deduction is now above-the-line, the attorney’s fees and court costs
will no longer be subject to any percentage reduction applied to
itemized deductions, and can be claimed fully for AMT purposes. Tax
Tip. The United States Supreme Court is poised to settle this
issue for judgments, settlements, and related fees before October 23, 2004.
If you have settled a lawsuit in the past and treated the attorney’s
fee as a miscellaneous itemized deduction, you should consider filing a
protective claim for refund before the statue of limitation runs for that tax
year. This could enable you to
recover your taxes if the Supreme Court rules that taxable damage awards are
included in income net of attorney fees. We will gladly help you prepare a
protective claim for refund.