LOISELLE, GOODWIN & HINDS
CERTIFIED PUBLIC ACCOUNTANTS

Fourth Quarter 2004/January 2005 Tax Developments

The American Jobs Creation Act of 2004 (Jobs Act) dominated the tax news in the fourth quarter of 2004 and in January of 2005. However, there were also other important tax developments that may affect you, your family, your investments, and your livelihood. We've summarized the most important new developments below (including additional IRS guidance on some Jobs Act changes). Please contact us for more information about any of these developments and what steps you should implement to take advantage of favorable developments and to minimize the impact of those that are unfavorable.

Tsunami relief donations made in Jan. 2005 can be deducted on 2004 returns. A new law permits taxpayers to claim a charitable deduction in tax year 2004 for qualifying donations made through Jan. 31, 2005, for the relief of victims affected by the Dec. 26, 2004 Indian Ocean Tsunami. Thus, provided certain conditions are met, if you are an individual who itemizes deductions and you made Tsunami relief donations during January of 2005, you have the option to deduct them on your 2004 tax return rather than waiting to deduct them on your 2005 tax return. In order to be able to do this, the donations must have been made in cash, by check or money order, or by credit card to a qualified charity (e.g., one listed on the IRS website). In addition you must have adequate records to show that the contributions were made for Tsunami relief.

IRS certifies 2005 Ford Escape SUV and more Toyota Prius models for clean fuel deduction. The IRS says that if you purchased a Ford Escape SUV, model year 2005, or a Toyota Prius model year 2005, you can claim an above-the-line tax deduction of $2,000. The 2005 Ford Escape is the first SUV model to be certified for the deduction. The IRS previously certified the Toyota Prius for model years 2001-2004. You must be the original owner to qualify for the deduction. The deduction is claimed for the year of purchase.

IRS optional sales tax tables available to compute new sales tax deduction. For the 2004 and 2005 tax years, the Jobs Act permits taxpayers who itemize deductions to choose between deducting state and local income taxes or sales taxes. The IRS has made available an optional sales tax table which you may use for your 2004 return if you choose to itemize your deductions. Specifically, the table gives taxpayers a sales tax deduction amount as an alternative to tabulating the amount actually paid based on sales receipts. In general, taxpayers use their level of total available income (which includes nontaxable items) and number of exemptions to find the sales tax amount for their state.

If you use the table to calculate your deduction, you may be able to add the following to the deduction amount shown in the table: local sales taxes (where appropriate); sales taxes paid on a purchased or leased motor vehicle (including cars, motorcycles, motor homes, SUVs, trucks, and vans) but only up to the amount of tax paid at the general sales tax rate; and sales tax paid on an aircraft, boat, home or home building materials, if the tax rate is the same as the general sales tax rate.

IRS says most payments for signing or canceling employment contracts aren't exempt from payroll taxes. In an about face, two IRS rulings treat most payments by employers to employees in connection with employment contracts as wages for purposes of FICA, FUTA, and federal income tax withholding. Specifically, one ruling held that employment taxes must be paid—and income taxes withheld—on bonuses paid for signing an employment contract. Another ruling held that if an employment contract is cancelled before its agreed-upon end, a payment made in lieu of the remaining period of employment is treated as wages for purposes of employment taxes and income tax withholding.

Standard mileage rates increase for 2005. The IRS announced that the optional mileage allowance for owned or leased autos (as well as vans and pickups or panel trucks) is 40.5¢ for 2005 business travel, up from 37.5¢ in 2004. This largest-ever year-to-year mileage-rate increase is due to higher prices for vehicles and fuel.

Key dollar limits for plans have been increased by COLAs or by legislative changes. The following dollar limits have been increased for 2005, thanks to cost of living adjustments or legislative changes that go into effect this year:

• The limitation on the annual benefit under a defined benefit (pension-type) plan increased from $165,000 to $170,000.
• The maximum annual addition to each participant's account in a defined contribution (e.g. profit sharing) plan increased from $41,000 to $42,000.
• The maximum amount of annual compensation that can be taken into account for various qualified retirement plan purposes increased from $205,000 to $210,000.
• The maximum exclusion for elective deferrals (which applies to 401(k) plans, 403(b) annuities, and salary reduction SEPs) increased from $13,000 to $14,000. This increase also applies to the limit on deferred compensation plans of state and local governments.
• The maximum elective deferral under a SIMPLE plan increased from $9,000 to $10,000.
• Generally, catch-up contributions to an employer plan by individuals aged 50 or over increased from $3,000 to $4,000. However, for SIMPLE plans, the catch-up amount for individuals age 50 or over increased from $1,500 to $2,000.

IRS offers guidance on new rules for nonqualified deferred comp. The Jobs Act added new statutory rules governing the tax treatment of nonqualified deferred compensation (NQDC). Under the new rules, if certain conditions aren't met, all amounts deferred under a NQDC plan for all tax years may be currently includible in gross income by the plan participant. The IRS has issued guidance on key aspects of these rules that you may need to know about right now including: the types of compensation arrangements that are within and beyond the reach of the rules, when the new rules are effective (generally for amounts deferred in tax years beginning after Dec. 31, 2004), and the payroll tax implications of the rules.

Guidance on new deduction for domestic production activities. The IRS has issued guidance explaining the new deduction for domestic production activities under the Jobs Act. For tax years beginning after 2004, C corporations, S corporations, partnerships, sole proprietorships, cooperatives, and estates and trusts can deduct a percentage of income earned from production activities undertaken in the U.S. (including manufacturing, food production, software development, film and music production, production of electricity, natural gas or water, construction and engineering and architectural services). The deduction is a percentage of the smaller of (1) the qualified production activities income of the taxpayer for the tax year, or (2) taxable income (modified adjusted gross income, for individual taxpayers) without regard to the manufacturing deduction, for the tax year. The percentage is 3% for tax years beginning in 2005 and 2006, and increases for later tax years. An employer's deduction for domestic production activities can't exceed 50% of all employees' W-2 wages reported for the tax year.

The IRS guidance on the new manufacturing deduction includes: who is the taxpayer eligible for the deduction, how wages are defined for these purposes, the types of software income eligible for the deduction, how costs of goods sold or other deductions are allocated to production activities, and eligible and ineligible food and beverage preparation.

(02/03/05)

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Last modified: May 04, 2005