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Tax Newsletter
December 2004

The year 2004 saw the enactment of two more tax acts the Working Families Tax Relief Act of 2004 in September and the American Jobs Creation Act in October (the "Tax Acts"). The Tax Acts resulted in a number of changes for both corporations and individuals.

Bonus Depreciation. Business taxpayers may wish to accelerate new equipment acquisitions into 2004. The "bonus" depreciation provisions allow for an immediate write off of 50% of the cost of assets. This provision will expire on December 31, 2004.

Charitable contribution of vehicles. Under the new law, an individual who wishes to claim a charitable deduction for a vehicle in an amount in excess of $500 must obtain a contemporaneous written acknowledgment from the charity. The acknowledgment must reflect the gross proceeds from the sale of the vehicle; the maximum deduction available to the taxpayer will be the gross proceeds from such sale. This provision is effective for donations in 2005. Thus, individuals who donate vehicles prior to December 31, 2004 will be subject to less stringent documentation requirements.

Expenses of elementary and secondary school teachers. The deduction for eligible educator expenses has been extended for expenses incurred in calendar years 2004 and 2005.

Exclusion of gain on sale of personal residence. For homes purchased outright, an individual may exclude up to $250,000 of gain ($500,000 for joint filers) realized on the sale or exchange of a principal residence owned and used for a period aggregating two years or more out of the preceding five year period. Under the new law, an individual who acquires a principal residence in a like-kind exchange must own the property for at least five years (rather than two) prior to its sale or exchange in order for the exclusion of gain to be applicable.

SUV limit. The new law limits to $25,000 the expense deduction for the cost of a sports utility vehicle (SUV) that is used in a trade or business. This limitation is effective immediately and applies to an SUV that has a gross vehicle weight rating that exceeds 6,000 pounds.

Deducting sales taxes or state taxes. For tax years beginning in 2004 and 2005, individuals who itemize deductions on their returns may elect to deduct either state and local income taxes or state and local general sales taxes as an itemized deduction. The amount to be deducted is either (1) total of actual general sales taxes paid as substantiated by receipts or (2) an amount from IRS-generated tables plus, if any, the amount of general sales taxes paid in the purchase of a motor vehicle, boat, or other specified items. This provision will have its greatest impact on individuals residing in states that do not have a state income tax.

Following are additional items that should be considered in year-end planning:

Lower capital gains rates. The federal capital gain rate remains a historically low 15%. The combined federal and California tax rate for long term capital gains is approximately 25%.

Prepayment of Expenses. As the year-end approaches, consider prepaying tax deductible expenses, such as state taxes, real estate taxes and home mortgage interest. This strategy will not be beneficial if you are subject to AMT, however, so we recommend running a year-end projection prior to pre-paying expenses.

Charitable Contributions. Charitable contributions continue to be one of the most flexible of deductible expenses, because their timing is discretionary. As a general rule, gifts of appreciated property (e.g., stocks) have a very significant tax advantage. You receive a charitable contribution deduction for the full appreciated value of the property, and avoid paying tax on the capital gain that would have been realized if you had sold the property and contributed the proceeds. Even with the reduced tax on capital gains, there is a benefit to avoiding the 25% combined federal and California tax cost associated with the sale of appreciated assets. Charitable remainder trusts and private foundations are additional planning tools that may help you achieve your charitable goals.

Section 179 Deduction. The 179 election allows a current deduction for items that would normally be capitalized and depreciated. The amount eligible for the election is $100,000.

Retirement Plan Contributions. Contributions to tax deferred retirement plans remain a valuable financial planning tool. Increased contribution limitations and catch-up provisions have been added with the hope of encouraging older workers to increase their retirement savings. Parents with children with earned income may want to consider making a gift to a child, which the child can contribute to an IRA up to the amount of his or her earned income.

Self Employed Health Insurance Deduction. For the year 2004, self-employed persons may deduct 100% of the cost of health insurance from gross income.

Gifting. For estate and gift tax purposes, the current top marginal rate is 49%. For larger estates, a gift-giving program may be an effective way to reduce transfer taxes and provide for beneficiaries:

  • The first $11,000 (per donee) of gifts made by a donor is not subject to gift tax.
  • The first $1,000,000 (excluding annual $11,000 gifts) of lifetime gifts is not subject to gift tax

California. The two-year net operating loss suspension has been lifted. Taxpayers may use NOLs suspended or incurred in 2002 and 2003 in the 2004 taxable year. Also, all losses incurred in 2004 may be carried forward at 100%. In addition, beginning in 2005, California will charge a 1% surcharge on taxable income over $1 million dollars, therefore, if you have an opportunity to accelerate income into 2004, the costs and benefits of the acceleration in relation to the surcharge should be assessed.

Running the numbers. Before implementing year-end tax strategies, we recommend that you review the impact of the strategies by running a projection for 2004, and possibly, for 2005. If you would like our assistance in preparing a projection, please let us know.

The information contained in this newsletter is general in nature and does not constitute tax advice or opinion. Applicability to specific situations should be determined through consultation with your tax advisor.

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