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Tax Newsletter
November 2005

Several tax acts have been enacted during 2005, resulting in a number of changes and incentives for both corporations and individuals.

Katrina Emergency Tax Relief Act of 2005

The Congress and the President all acted quickly to help out the victims of the devastating hurricanes in the South. While the majority of this legislation provides relief to the individuals and businesses directly affected, there were some provisions which affect all taxpayers:

Charitable Contributions - Individuals. Generally, charitable contributions are limited to 50% of the individual taxpayer’s adjusted gross income for the tax year. The new law replaces the 50% limitation with a 100% limitation for all cash donations to qualified charitable organizations (not just Katrina relief organizations) for the period beginning August 28, 2005 and ending on December 31, 2005. The provision also exempts those donations from the application of the phase out of itemized deductions for high-AGI taxpayers.

Charitable Contributions - Corporations. Generally, the charitable contribution deduction for a corporation is limited to 10% of its taxable income for the year in which the contribution is made. The new law waives the 10% limitation for cash donations made by corporate donors to qualified charitable organizations during the period beginning August 28, 2005 and ending on December 31, 2005. Note, this incentive also covers employer matching donations made to relief organizations. However, unlike the provision for individuals, the corporate benefit is available only for contributions to Katrina relief organizations.

Energy Tax Incentives Act of 2005; SAFE Transportation Equity Act of 2005

The focus of this legislation was on tax cuts to promote domestic energy production. Several incentives are included for individual taxpayers.

Residential energy property credit. A credit of up to $500 for property placed in service in 2006 and 2007 tax years is available for homeowners who install residential energy property such as exterior doors and windows, insulation, heat pumps, central A/C and water heaters.

Residential alternative energy expenditures credit. This provision makes available a credit of up to 30 percent of the cost of eligible solar water heaters, photovoltaic equipment and fuel cell plants. The maximum credit is $2,000 per each year for solar water heating equipment or photovoltaic property, and $500 for each .5 kw of capacity for fuel cell property that is placed in service in 2006 or 2007.

Alternative Motor Vehicle Credit. A number of credits are available for hybrid and other fuel efficient vehicles, including—

  • Qualified hybrid motor vehicle credit, consisting of—
    • A fuel economy credit ranging from $400 to $2,400 on the purchase of vehicles that are more fuel efficient than prior models
    • A conservation credit of $250 to $1,000 for certain hybrid vehicles.
  • A base credit as high as $8,000 for certain fuel cell vehicles.
  • A credit of up to $4,000 for certain alternative fuel vehicles
  • Credit for residential clean-fuel refining equipment

Bankruptcy Abuse Prevention and Consumer Protection Act of 2005

Although the provisions of this act are found in the bankruptcy code, a number of changes were made that affect taxpayers, including increased protection for tax-favored accounts such as IRAs.

Other year-end planning considerations for individuals:

Deducting sales taxes or state taxes. For the tax year 2005, individuals 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.

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 contribution of vehicles. 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.

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 significant tax advantage over cash contributions. You receive a charitable contribution deduction for the full appreciated value of the property, while avoiding 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.

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.

Other year-end planning considerations for businesses:

SUV limit. The 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 applies to an SUV that has a gross vehicle weight rating that exceeds 6,000 pounds.

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 $105,000 (reduced to $25,000 in 2008). Additionally, California does not conform to the Federal maximum, but limits the deduction to $25,000 for the calendar year 2005.

Business Mileage Rate. For the period January 1, 2005 to August 31, 2005, the standard business mileage rate is 40.5 cents/per/mile. From September 1, 2005 and through December 31, 2005, the standard business mileage rate is 48.5 cents/per/mile.

Self Employed Health Insurance Deduction. For the year 2005, self-employed persons may deduct 100% of the cost of health insurance from gross income.

Gift and estate tax considerations:

California. Beginning in 2005, California will charge a 1% surcharge on taxable income over $1 million dollars.

Gifting. For estate and gift tax purposes, the current top marginal rate is 47%. 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.

Estate Tax

Although the lifetime gift tax exclusion (described above) continues to be limited to $1,000,000, the estate tax exclusion will increase from $1,500,000 in 2005 to $2,000,000 in 2006.

Proposed Legislation

Estate Tax – Tax legislation enacted in 2001 (EGTRRA) repealed the federal estate tax, but only for one year, 2010. After 2010, the marginal rates and applicable exclusion amounts will return to their pre-EGTRRA levels. The Death Tax Repeal Permanency Act of 2005 would permanently repeal the estate tax. This bill has passed the House, and could be ready for a Senate vote during the Fall session. If enacted, the stepped-up basis at death rules would be permanently replaced with a modified carryover basis regime.

Mortgage Interest Deduction – The President’s tax-reform panel may propose reducing the deduction for mortgage interest. Currently, the interest on mortgages up to $1 million may be deducted. One of the options being proposed is to reduce the size of a mortgage on which interest may be deducted, with the threshold of $300,000 to $350,000 being mentioned.

AMT Repeal – Earlier this year, the Individual Alternative Minimum Tax Repeal Act of 2005 was introduced, which would repeal the personal alternative minimum tax (AMT). The AMT was enacted to target a small group of high-income taxpayers who were avoiding paying income taxes. Changes to the AMT and the effect of inflation have transformed the AMT into a trap for a growing number of unsuspecting middle-income taxpayers.

Running the numbers. Before implementing year-end tax strategies, we recommend that you review the impact of the strategies by running a projection for 2005, and possibly, for 2006. If you would like our assistance in preparing a projection, please let us know.

Reviewing the overall plan. It is becoming common to see multiple pieces of tax legislation enacted each year. Often the legislation focuses on short-term tax savings. For example, the charitable contribution provisions of the Katrina tax act apply to donations between August 28, 2005 and December 31, 2005. The energy legislation provides for certain benefits in 2006 and 2007.

We often remind our clients that tax considerations should generally not drive financial decisions. However, once financial objectives are understood, it becomes easier to determine what tax planning strategies may be consistent with one’s overall objectives. Unfortunately, frequent changes in the income tax rules, coupled with the changes and uncertainty in the estate tax area, make both short- and long-term planning more complex. With the year-end approaching, it may be a good time for a review of one’s financial objectives with a view toward assessing whether any of the recent tax incentives can be incorporated into the financial plan.

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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