New Tax Acts Provide Planning Opportunities for Individuals and Businesses
Universal Advisor, 2004 Issue No. 3

Congress recently passed two significant pieces of tax legislation. The Working Families Tax Relief Act of 2004 was signed into law on October 4, and President Bush quietly signed the American Jobs Creation Act of 2004 on October 22. The much publicized Jobs Creation Act represents the largest restructuring of business taxes in nearly two decades. This section is intended to give you a broad overview of both pieces of legislation.

The Working Families Tax Relief Act provides $146 billion of tax relief to families and businesses. This act principally extends previously enacted rate reductions and credits that were set to expire this year. Included are extensions of the $1,000 per child tax credit, the expanded 10% individual tax bracket, and “marriage penalty” relief through an expanded 15% bracket and an increased standard deduction. The act also provides a slightly higher alternative minimum tax exemption for individual taxpayers and extends the $250 expense deduction for teachers and the Archer Medical Savings Account provisions through 2005. The research development credit, work opportunity credit, and welfare-to-work credit are also extended through 2005.

More comprehensive tax legislation is contained in the Jobs Creation Act. This act provides $137 billion of tax relief, largely aiding domestic manufacturing companies who have seen more than 2.5 million jobs lost over the past few years. The revenue offset is in part intended to end the trade war with Europe and includes a phase-out of the extraterritorial income exclusion (ETI) for export sales, along with several other revenue raisers addressing perceived tax loopholes and abusive transactions. The centerpiece of the legislation is a new deduction for a percentage of domestic manufacturing income. This new deduction is described as a domestic manufacturing incentive, but it will also apply to construction activities, engineering and architectural services, the production of computer software, and a number of other “qualified production activities.” The deduction applies to activities conducted within the United States and, unlike the ETI, is not tied to export sales. It is available to individuals as well as corporations and to the owners of flow-through entities. The deduction equals 3% of qualified production activities income for years beginning in 2005. The percentage increases to 6% for 2006 through 2009 and to 9% thereafter. When fully phased in, the deduction will reduce the effective federal tax rate for qualifying activities by approximately three percentage points for taxpayers in the highest tax bracket.

The Jobs Creation Act also contains numerous provisions that are more narrowly targeted but which will be extremely important to taxpayers engaged in certain types of activities or transactions. Among the more common transactions affected are certain transfers of property to partnerships and corporations, and sales or redemptions of partnership interests involving an inherent loss. The Act also:

• Liberalizes the foreign tax credit rules.

• Permits corporate owners of controlled foreign corporations to repatriate certain foreign earnings at a special 5.25% tax rate.

• Increases the maximum permissible number of S Corporation shareholders from 75 to 100 and provides for an election to treat members of a family as a single shareholder.

• Extends the $100,000 annual deduction limit for the purchase of business equipment through 2007. The maximum deduction for taxable years beginning in 2008 is $25,000.

• Extends bonus depreciation for certain noncommercial aircraft.

• Limits the deduction for charitable contributions of automobiles and intellectual property.

• Changes the rules for deducting business organization and start-up expenses.

• Creates a new, 15-year recovery period for restaurant equipment and certain leasehold improvements.

• Permits individuals to elect to deduct sales taxes instead of state and local income taxes.

• Limits the maximum first-year depreciation deduction for SUVs to $25,000.

• Expands the definition of related corporations that must share the lower corporate rate brackets and the minimum tax and accumulated earnings exemptions.

• Contains widely applicable rules that\ restrict the deferral of compensation under “nonqualified” plans.

• Restricts tax shelters through expanded disclosure and penalty provisions.

It’s noteworthy that the 50% first-year bonus depreciation deduction was not extended to most property placed in service after December 31, 2004. As a result, many taxpayers may want to accelerate equipment acquisitions to qualify for the special depreciation rules that still apply this year.