This year's tax changes are mostly due to the Working Families Tax Relief Act of 2004 and the American Jobs Creation Act of 2004, and were provisions that are just now scheduled to take effect in 2005. While everyone is responsible for paying taxes, nobody has to pay more than he or she legally owes. Here are just a few of the important tax items of which you should be aware:
Increase in Standard Deduction to $5,000 for Single and Married Filing Separately taxpayers; $10,000 for Married taxpayers filing jointly; $7,500 for Head of Household taxpayers.
Uniform definition of a Qualifying Child for all of the following tax benefits: Dependency exemption;
Head of Household filing status; Earned Income Credit; Child tax credit; Credit for child and dependent care expenses.
All four tests must be met to claim someone as a qualifying child: relationship, residence (same principal residence as taxpayer for over ½ of the year; age (under 19 at year-end or under 24 if full-time student for at least five months of year); and support (child didn't provide more than ½ of his/her own support for year.
Head of Household filing status has changed; taxpayer's home must be the home of a qualifying child as defined above; taxpayer cannot claim Head of Household filing status for a dependent only because he/she lived with taxpayer for entire year or taxpayer is entitled to claim him/her as a dependent under a multiple support agreement.
Earned Income Credit thresholds increase to $35,263 for single taxpayers with more than one qualifying child ($37,263 for married filing jointly; $31,030 for single taxpayers with one qualifying child ($33,030 for married filing jointly); $11,750 for single taxpayers with no qualifying child ($13,750 for married filing jointly).
IRA deduction increased -- each taxpayer qualified to deduct an IRA contribution will be able to claim $4,000, with an extra $500 if you are age 50 or older by the end of 2005.
Mileage Rates -- Business mileage 40.5 cents/mile from January 1 through August 31, 48.5 cents/mile from September 1 through December 31; 14 cents/mile for charitable service; 15 cents/mile for medical and moving mileage from January 1 through August 31, 22 cents/mile for medical and moving from September 1 through December 31.
Charitable Contributions of Autos -- if you donated a car to a qualified organization in 2005, your deduction is limited to the gross proceeds from its sale by the organization if the claimed value of the donated vehicle is more than $500. However, if the organization makes significant use of the auto, you are allowed to deduct its fair market value. You must have a written receipt for your donation if it is valued at more than $500.
Personal Exemptions increase to $3,200 for 2005.
Qualified Clean-Fuel Vehicle -- $2,000 adjustment to income remains same as in 2004, for Toyota Prius, Honda Insight, Honda Civic Hybrid, Accord Hybrid, and Ford Escape Hybrid; $5,000 if vehicle weighs over 10,000 pounds; $50,000 if vehicle weighs over 26,000 pounds.
Health Savings Accounts (HSA's) -- monthly contribution limit for self-only coverage 1/12 of lesser of annual deductible or $2,650 (+ $600 if over 55 by 12/31/05); family coverage 1/12 of lesser of annual deductible or $5,250 (+600 if over 55 by 12/31/05).
Health Savings Accounts (HSA's) -- high deductible health plan for self-only coverage at least $1,000 but not over $5,100; for family coverage at least $2,000 but not over $10,200.
401(k) Contributions increased -- $14,000 with an additional $4,000 if age 50 or over by 12/31/05.
NEW in 2005 -- Special deduction for Domestic Production Activities, including Manufacturers and Contractors -- Section 199 --Businesses with qualified productions activities are allowed a new deduction equal to a portion of their qualified production activities income, calculated on a new form 8903. Both corporations and individuals can qualify for this deduction, and is taken as an adjustment to income on line 35 of the Form 1040. For 2005 the deduction is equal to 3% of the lesser of the qualified production activities income or the taxable income for the taxable year without regard to this deduction. The types of businesses which may qualify would be construction, wholesale food businesses, software development and sales, clothing manufacturers, water processing plants, production of newspapers and magazines, just to name a few. Only the production activities income are included for this deduction, so if a business both manufactures and services equipment, they will need to split apart the income and expenses to calculate this deduction.
Taxpayers will be able to request an automatic 6-month tax filing extension for most individual and business returns, with no reason and no signature, using Form 4868 (individuals) or Form 7004 (businesses).
Tsunami contributions that were made in January, 2005 can either be deducted in 2004 or in 2005; however if they were already deducted in 2004 they cannot be deducted again in 2005.
Sales tax can be deducted on Schedule A (for those taxpayers not taking the Standard Deduction) if that amount is higher than state and local income tax paid for the year; again this year there will be tables to determine the amount of sales tax to deduct, unless the taxpayer has kept track of actual sales tax paid throughout the year. If the taxpayer has bought or leased a vehicle in 2005, that sales tax amount can be added to the amount derived from the tables.
Self-employed health insurance deduction can only be taken up to the amount of earned income -- œderived by the taxpayer from the trade or business with respect to which the plan providing the medical care coverage is established.
Tax Preparers are now required to put in writing the terms of their engagement in the preparation of taxpayer returns; tax advisors are further required to adhere to specific best practices in providing advice and in preparing or assisting in the preparation of a submission to the IRS. Signed engagement letters are strongly encouraged, to make sure the client clearly understands the terms of the engagement. The IRS expects tax professionals to observe best practices to preserve public confidence in the tax system.
Sale of Residence and Like Kind Exchange: To qualify for exclusion of gain under IRC Sec. 121 and also qualify for the deferral of gain under IRC Sec. 1031, the taxpayer might live in the home for at least 2 years during the 5-year period prior to the sale, but rent it out for a couple of years before the sale takes place; or the taxpayer might have 2 separate buildings on his property, one of which is his residence and the other of which is his office; or the taxpayer might have an office in his home and exchange the home for another home that also has a home office area.
Holiday Gift Coupons tax treatment has been clarified by the IRS: any cash and cash equivalent like gift certificates are taxable to the recipient.
S Corporation Audits -- The IRS National Research Program has begun a series of audits of 5,000 randomly selected S Corporation returns for tax years 2003 and 2004. This will set the stage for future compliance issues to target for audit purposes.
