New Tax Laws Real Opportunities for Tax Savings
Two New Acts • Working Families Tax Relief Act-signed by President Bush 10/4/2004 • American Jobs Creation Act of 2004-signed by President Bush 10/22/2004
Working Families Tax Relief Act of 2004 • Extensions of benefits for individuals • Extensions of benefits for corporations • Uniform definition of a child • Technical corrections
Extensions of Benefits for Individuals • Child tax credit • Marriage penalty relief • Increase AMT exemption • Use of personal credits against AMT • Extension of educator deduction
Extension of Benefits for Businesses • Research credit extension • Expensing of environmental remediation costs
American Jobs Creation Act of 2004 • General Business Considerations • Tax Shelter Changes • Individual Changes • Manufacturing and Production • International Tax Changes
General Business Considerations • S Corporation changes • Deferred Compensation • Cost Recovery Changes • Other Business Items
S Corporation Changes • Number of allowable shareholders increases to 100 (up from 75) • Family members count as a single shareholder • Other changes: • ESBT changes • Transfers of suspended losses to spouse or former spouse • Inadvertent invalid QSub election relief
Deferred Compensation • Why change? • New, rigorous standards for when compensation can be deferred from tax • What kind of plans are affected? • Key changes • Timing of deferral election • Distribution of amounts deferred • Added anti-abuse provisions • What is the affect of failing to comply?
Action Points • Every deferred comp plan needs to be reviewed • Don’t rush • Evaluate current election for 2005 deferrals • Advise participants about access to funds
Cost Recovery Changes • $102,000 immediate write-off of §179 property is extended for two years • New limit of $25,000 for SUV’s purchased after October 22, 2004 • Depreciable life for leasehold improvements and certain restaurant property reduced from 39 to 15 years
Other Business Changes • Restrictions on business airplanes and entertainment facilities • Extended amortization for business start-up or organizational costs • Increased withholding on supplemental wage payments > $1 million
Other Business Changes (cont.) • Charitable contributions of property appraisal requirements • Clarification of FICA on options and stock option plans • Capital gain on sale of stock acquired from exercise of stock options to comply with Federal conflict of interest requirements
Tax Shelter Changes • Why? • New penalties • No statute of limitations on undisclosed reportable transactions • Tightens up on enforcement of existing penalties • Tightens up on practitioners, as well as taxpayers
Individual Changes • Changes in Charitable Contributions of Property • Deduction for Sales Tax
Changes in Charitable Contributions of Property • Standards established for the contribution of intellectual property • Restrictions imposed on contributions of vehicles • Increased reporting for contributions of property
Deduction for Sales Tax • Taxpayer can elect to claim deduction for state income taxes or deduction for state sales taxes • Choose between documented expenses or table amounts • Of particular interest to taxpayers in states with no income taxes • Effective for 2004 and 2005 returns
Action Points • Accumulate records now for large purchases • Where subject to sales and income taxes, consider combining large taxable purchase into a single year • Special rule for vehicle purchases • Watch out for AMT
Political Outlook – Post Election • White House Tax Plans • Senate Finance Tax Agenda
Under Current Law Trust Fund BabyWorking Couple Wages-T $ -0- $ 65,000 Wages-S $ -0- $ 65,000 Dividends $ 65,000 $ -0- Long-Term Gains $ 65,000 $ -0- Itemized Deductions $ (30,000) $ (30,000) Exemptions $ ( 6,000)$ (6,000) Taxable Income $ 94,000$ 94,000 Federal Tax $ 8,300 $ 16,925 Payroll Taxes (ee & er) $ -0- $ 19,900 Total Taxes $ 8,300 $ 36,825 % of Total Income 6.3% 28.3%
White House Plan • President hopes to have bipartisan advisory panel on tax reform by end of 2004 • Tax proposals will be revenue neutral and promote economic growth and jobs • Looking to simplify existing system-current system is complicated • Make it more fair • Should the existing system be modified or replaced • Reduce administrative burdens on taxpayers
White House Plan • Retain the 15% rate for qualified dividends and long-term capital gains. • Make permanent the repeal of the Federal estate tax • Supports foreign tax reforms and tax breaks for manufacturers • Extend expiring middle-class tax breaks
White House Plan (cont.) • Tax credit to help the uninsured buy health insurance • Credits for energy efficient homes • Expand incentives for college education • Preservation of mortgage and charitable deductions
Senate Finance Tax Agenda • Due to a GOP victory at the Polls, Senator Grassley expects to resume the chairmanship of the Senate Finance Committee • Extend “Tax Relief Legacy in 2005” • Make permanent previously enacted tax relief measures • Extend key tax breaks • College tuition deductibility
Senate Finance Tax Agenda (cont.) • Close loopholes • Adopt permanent interest rate for calculating pension liabilities • Enact Enron-inspired participant protections. • Make flexible spending accounts work efficiently
Trivia Question What is the estimated percentage of U.S. corporations that paid no federal taxes between 1996 and 2000? • 26% • 48% • 61% • 82%
Highlights of the American Jobs Creation Act of 2004 Repeal of Exclusion for Extraterritorial Income Phase-Out of the Extraterritorial Income Exclusion Phase-In of the Deduction for Manufacturing/Production Activities Tax Reform & Simplification for U.S. Businesses Incentive to Reinvest Foreign Earnings in U.S. Foreign Tax Credit Reforms Other Significant International Reforms
Phase-Out of Extraterritoral Income Exclusion (ETI) Two year phase-out ‹ 2005 – 80% ‹ 2006 – 60% ‹ 2007 – no ETI benefit Grandfather for transactions entered into it ‹ In the ordinary course of business ‹ Pursuant to a binding contract before 9/17/03 ‹ Applies to leases, licenses and options
Action Points Can export transactions be accelerated into 2004? Should associated expenses be deferred, if possible? Is the IC-DISC (Interest Charge Domestic International Sales Corporation) an alternative?
Manufacturing and Production Activities New deduction for domestic production activity (IRC Section 199)
Domestic Production Activity Deduction Lesser of a percentage of: - Taxable income, or - Qualified domestic production activities income (QDPAI) Not to exceed 50% of wages paid
What is Qualified Production Activity Income? Income from certain domestic production activities Less: - Costs attributable to producing the income
What is Qualified Production Activity Income? (cont.) • Any sale, exchanges or other disposition, • or any lease, rental or license, of qualifying • production property that was • manufactured, produced, grown or • extracted by the taxpayer in whole or in • significant part with the U.S.; Taxpayer’s gross receipts derived from:
What is Qualified Production Activity Income? (cont.) 2. Any sale, exchange or other disposition, or any lease, rental or license, of qualified films produced by the taxpayer; 3. Any sale, exchange or other disposition of electricity, natural gas, or potable water produced by the taxpayer in the U.S.;
What is Qualified Production Activity Income? (cont.) 4. Construction activities performed in the U.S.; or 5. Engineering or architecturalservices performed in the U.S. for construction projects located in the U.S.
What is Qualified Production Activity Income? (cont.) Exclusions: 1. Food and beverages prepared at a retail establishment 2. Transmission or distribution of electricity, natural gas or potable water 3. Property leased, licensed or rented by the taxpayer for use by any related person
Deduction Offers Complexity Related Persons • Control group, affiliated service group or entities under common control • Similar to rules under the ETI regime
Deduction Offers Complexity (cont.) Affiliated Groups • Members of an affiliated group (i.e., 50% ownership) are treated as a single corporation
Deduction Offers Complexity (cont.) Pass-Through Entities • Deduction is available • Limitation determined at the shareholder or partner level • A shareholder or partner allocated W-2 wages equal to lesser of: 1. Person’s allocable share of the wages, 2. 2x QPAI allocated to that person
Deduction Offers Complexity (cont.) Deduction Limited to Wages Paid • Wages determined on a calendar year basis • Creates incentive to obtain services through employees rather than independent contractors.
Deduction Offers Complexity (cont.) DPGR’s • “In whole or in significant part” within the U.S. • Does not include receipts from leasing, licensing or renting property for use by a related person. But, does include receipts from selling property to a related party.
Deduction Offers Complexity (cont.) Individuals • Not limited by the 2% AGI on miscellaneous itemized deductions • Subject to Section 469, passive activity loss limitation
Allowable Deduction Lesser of % of T. Inc. or QDPAI Not to exceed 50 % of wages paid Calculated on a controlled group basis Passed through to sole proprietors and owners of partnerships and S corporations Deduction allowed against AMT
Action Points Do you conduct a Domestic Manufacturing Activity? Do your accounting systems provide sufficient information to measure direct and allocable indirect costs? Can and should the business be restructured to maximize this deduction?
Incentives to Reinvest Foreign Earnings in U.S. General rule: a USC may elect to claim an 85% DRD on repatriated earnings received from a CFC during the election period - Base: dividends qualify for DRD to extent > avg. actual and deemed dividends in 3 of last 5 years (highest and lowest years disregarded)