On Oct. 22, 2004, the President signed into law
the American Jobs Creation Act of 2004. This massive tax law replaces the U.S. export tax regime with
broad-based tax relief for domestic manufacturing, U.S. multinationals, and a
wide variety of other businesses and industries. It also includes a number of important changes for individuals. Here is what you need to know right now about
the more widely applicable tax changes for individuals in this important new
law:
New itemized deduction for state and local
general sales taxes. Individuals who itemize will be able to deduct either state
and local income taxes or state sales taxes on their 2004 and 2005 federal tax
returns. Previously, only state and
local income taxes were deductible. Individuals
who take the sales tax option may deduct their actual sales taxes or use
IRS-published tables. This change will
primarily benefit individuals in states with sales taxes but with no or limited
individual income taxes (i.e., Alaska, Florida, Nevada, New Hampshire, South
Dakota, Tennessee, Texas, Washington and Wyoming). But even individuals who live in states that impose both income
taxes and sales taxes may be affected. For example, residents of states with an income tax and sales
taxes should determine whether their sales taxes for a particular year will
exceed their income taxes for that year. In some cases, they may want to bunch major purchases into the
same year so that sales and use taxes for that year will exceed the income
taxes paid for that year. By doing
this, they can deduct their sales and use taxes in one year, and their income
taxes in another year.
Tougher rules for charitable donations of
autos. Tougher rules will apply to the charitable deduction for autos
(as well as boats and planes) donated to charity after 2004 if the vehicle has
a claimed value of more than $500. If
the charitable organization immediately sells the auto (for example, to a
wholesaler) without making material improvements to it, your charitable
deduction generally cannot exceed the charity's gross proceeds from the sale. By contrast, under the pre-2005 rules, the
charitable contribution deduction for a non-cash contribution (including an
auto) generally equals the fair market value of the contributed property. Thus, if you are thinking of donating an auto
(or boat or plane), you will probably wind up with a bigger deduction if you
make the gift this year rather than next year. Beginning next year, tougher substantiation rules also will apply
to donated vehicles that have claimed value of more than $500 (e.g., the
charity must provide a contemporaneous written acknowledgment of the gift
bearing a number of specific facts, such as the sales price if it immediately
sells the vehicle).
Statutory stock options are officially
free of FICA and FUTA. The Jobs Act provides that FICA and FUTA taxes do not apply
and income tax withholding is not required when a statutory stock option is
exercised. This term refers to an
incentive stock option or an option to purchase stock under an employee stock
purchase plan. The exercise of a
statutory stock option also is not taken into account to determine Social
Security benefits. Although these
changes are effective for options exercised after Oct. 22, 2004, the IRS had
said back in 2002 that pending detailed guidance it would not assess FICA or
FUTA taxes, or require withholding, on statutory stock options.
New rules for nonqualified deferred
compensation plans. Under current rules, compensation deferred under a
nonqualified deferred compensation plan (one that is not subject to the usual tax rules that apply to pension plans)
generally is taxed to the recipient when it is no longer subject to a
substantial risk of forfeiture.
Effective generally for amounts deferred in tax years beginning after
2004, a sweeping new set of rules will apply.
Amounts deferred under a nonqualified deferred compensation plan will
not be subject to a substantial risk of forfeiture (and thus will not produce
income tax deferral) if distributions from the plan can be made for any reason
other than passage of a certain period of time, termination of employment,
death, disability or unforeseeable emergency (e.g., financial hardship
resulting from illness), or change of control in the employer. There also will not be a substantial risk of
forfeiture if funds are held in certain specialized vehicles called offshore
rabbi trusts. Additionally, the plan
will have to require that compensation for services performed during a tax year
may be deferred only if the participant so elects no later than the close of
the preceding tax year or at the time provided by IRS regulations.
New deduction for U.S. production
activities. The Jobs Act creates a new tax deduction for domestic
production activities. The deduction is
a percentage of the net income from these activities - 3% in 2005-2006, 6% for
2007-2009, 9% after 2009, but it is subject to several limitations.
The new deduction is allowed for qualified
production activities income, which is the domestic production gross receipts
of a business net of related expenses. “Domestic production gross receipts” includes receipts from any
lease, rental, license, sale, exchange, etc., of qualifying production property
(i.e., tangible personal property, any computer software, and certain sound
recordings) that was manufactured, produced, grown, or extracted in whole or in
significant part by the business within the U.S. Also included are receipts
from construction in the U.S., engineering and architectural services performed
in the U.S. for construction projects in the U.S., and the domestic production
of certain films.
“Domestic production gross receipts” do not
include gross receipts from selling food or beverages at a retail
establishment.
Complex allocation rules will apply if only part
of a business's gross receipts are domestic production gross receipts. The deduction is available to regular (C)
corporations, pass-through entities such as S corporations and partnerships,
and to sole proprietorships, estates, and trusts.
Robust expensing tax breaks extended for
two more years. A business or practice that buys machinery and equipment
generally deducts its cost over a number of years via depreciation. The expensing election permits a business or
practice to expense (that is, deduct immediately rather than depreciate over
several years) a certain amount of the cost of tangible depreciable personal
property purchased and placed in service during the year. The maximum annual expensing amount is
$100,000 (adjusted for inflation), and the maximum annual expensing amount
begins to phase out dollar-for-dollar when the business or practice places in
service during the tax year expensing-eligible property in excess of $400,000
(adjusted for inflation). Before the
2004 Jobs Act, these rules only applied for tax years beginning in 2003 through
2005. After 2005, the maximum expensing
amount was scheduled to drop to $25,000, and the expensing phase-out figure was
set to drop from $400,000 to $200,000. Under the 2004 Jobs Act, the
$100,000/$400,000 amounts (adjusted for inflation) will stay in place through
tax years beginning before 2008. The
2004 Jobs Act also extends through 2007 several other expensing breaks (allowing
most software to be expensed, and allowing taxpayers to revoke expensing
elections on amended returns without the IRS's consent).
New 15-year write-off for qualifying
leasehold improvements and qualifying restaurant property. Effective
for property placed in service after Oct. 22, 2004, and before Jan. 1, 2006,
the Jobs Act OKs 15-year straight line depreciation for qualifying leasehold
improvements and qualified restaurant property. In general terms, qualifying
leasehold improvements are interior improvements made under a lease to
commercial property (such as an office building or warehouse), and placed in
service more than three years after the building was first placed in service. Certain structural improvements don't
qualify, nor do expansions. Also, improvements made by a building owner usually
won't produce a fast write-off for a subsequent owner. Qualified restaurant
property is any improvement to a building if the improvement is placed in
service more than three years after the date the building was first placed in
service and more than 50% of the building's square footage is devoted to the
preparation of, and seating for, on-premises consumption of prepared meals. In general, qualifying leasehold improvements
and qualifying restaurant property were written off over 39 years under prior
law.
Liberalized S corporation rules. Effective
for tax years beginning after 2004, the Jobs Act makes it easier for businesses
to qualify for S corporation status. Among
the more important liberalizations are an increase in the maximum number of
shareholders from 75 to 100 and allowing family members to be counted as one
shareholder for purposes of determining the maximum number of shareholders.
Limited expensing write-off for heavy
SUVs. Heavy SUVs (those with a gross vehicle weight rating (GVWR)
of more than 6,000 pounds) are not subject to the “luxury auto” depreciation
dollar caps and lease income inclusion amount rules. Under the rules that applied before the 2004 Jobs Act, this meant
that the entire cost of a heavy SUV used 100% for business could be written off
under the expensing rules. Effective for vehicles placed in service after Oct.
22, 2004, only $25,000 of the cost of a heavy SUV may be expensed.
Revised rules for start-up and
organizational expenses. For amounts paid or incurred after Oct. 22, 2004, a
taxpayer can elect a current deduction for up to $5,000 of start-up expenses in
the tax year in which the active trade or business begins. However, this $5,000
amount is reduced (but not below zero) by the amount by which the cumulative
cost of start-up expenses exceeds $50,000. The remainder of the start-up expenses can be claimed as a
deduction ratably over a 180-month period. Before the 2004 Jobs Act, no current deductions were allowed for
start-up expenses. However, a taxpayer
could have elected to treat start-up expenses as deferred expenses and deducted
the expenses equally over a period of not less than 60 months (beginning with
the month in the active trade or business began).
Similar provisions apply to corporate
organizational expenses and partnership organizational expenses. For amounts paid or incurred after Oct. 22,
2004, a corporation or partnership can elect a current deduction for a limited
amount ($5,000) of organizational expenses in the tax year in which the active
trade or business begins. However, this $5,000 amount is reduced (but not below
zero) by the amount by which the cumulative cost of organizational expenses
exceeds $50,000. The remainder of the
organizational expenses can be claimed as a deduction ratably over a 180-month
period.
New limit on company deductions for
entertainment, etc. provided to officers and directors. For
expenses incurred after Oct. 22, 2004, the Jobs Act limits a company's trade or
business deduction for costs of entertainment-, amusement-, or
recreation-related goods, service or facilities it provides to officers,
directors, and 10%-or-more owners. The
costs are deductible only to the extent that they do not exceed the amount of
expenses treated by the company as compensation income to the recipient as a
result of receiving those goods, services, or facilities. The Act overturns a court decision holding
that a company could deduct the entire cost of providing entertainment,
amusement, or recreation-related goods, services or facilities, regardless of
whether that cost was greater or less than the amount that the recipient had to
treat as income.
Please keep in mind that the above discussion describes only the highlights of the most important changes in the new law. Give someone at Cohen & Caproni a call at your earliest convenience for more details on how you may be affected by this important tax legislation.