2004 Working Families Tax Relief Act: selected highlights.

The following are selected highlights of the 2004 Working Families Tax Relief Act signed into law Oct. 4:

CHANGES AFFECTING INDIVIDUALS

Child Tax Credit

Under the existing law, for 2004, an individual may claim a $1,000 tax credit for each qualifying child under the age of 17. In general, a qualifying child is an individual for whom the taxpayers can claim a dependency exemption and who is the taxpayer's son or daughter (or descendent of either); stepson or step-daughter (or descendent of either); or eligible foster child.

Table 1 (above) shows the amount of the child tax credit that was scheduled under the old law for post-2004 years and the credit under the new law.

Refundability

Under the old law, for 2004, the child credit was refundable to the extent of 10 percent of the taxpayer's taxable earned income (which is taken into account in determining taxable income) in excess of $10,750 (indexed for inflation). This percentage is increased to 15 percent for tax years 2005 and thereafter.

The new law accelerates to 2004 the increase in refundability of the child credit to 15 percent of the taxpayer's earned income exceeding $10,750 (with indexing).

Combat Pay Treated as Earned Income

The new law provides that combat pay, otherwise excluded from gross income under IRC Sec. 112, is treated as earned income, which is taken into account in computing taxable income for purposes of calculating the refundable portion of the child credit. This new provision is effective for tax years beginning after 2003.

The new law also provides that any taxpayer may elect to treat combat pay, otherwise excluded from gross income under Sec. 112, as earned income for purposes of the earned income credit. This election is available for any tax year ending after Oct. 4, 2004 and before 2006.

Marriage Penalty Relief

Increased Basic Standard Deduction

Individuals who do not itemize deductions may choose the basic standard deduction, plus additional standard deductions if they are 65 years old or over or blind. The size of the basic standard deduction varies according to filing status and is adjusted annually for inflation.

For 2004, the basic standard deduction amounts are:

* $9,700 for married individuals filing joint returns;

* $4,850 for unmarried individuals;

* $4,850 for married individuals filing separate returns; and

* $7,150 for heads of households.

The following table shows the basic standard deduction for married couples filing joint returns, as a percentage of the standard deduction for unmarried individuals, that was scheduled under the old law for post-2004 years:

2005  174%
2006  184%
2007  187%
2008  190%
2009  200%
2010  200%

The new law increases the basic standard deduction for joint returns to twice the basic standard deduction for single returns, effective for 2005-08. Therefore, the basic standard deduction for joint returns will be twice the basic standard deduction for single returns for tax years 2004 through 2010.

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Caution: For tax years beginning after 2010, absent further legislation, the lower pre-2001 Tax Act statutory basic standard deduction dollar amount, adjusted annually for inflation, will apply to married couples filing joint returns.

Expanded 15-Percent Bracket For Married Couples Filing Joint Returns

Under the 2001 Tax Act, the 15 percent regular income tax rate bracket was increased for a married couple filing a joint return to twice the size of the corresponding bracket for an unmarried individual filing a single return. Before the 2001 Tax Act's effective date for this provision, the difference was 167 percent. This increased bracket was effective for tax years beginning after 2004, but was phased in over four years as follows:

Tax Year   Phase-in %

  2005        180%
  2006        187%
  2007        193%
2008-2010     200%

The 2003 Tax Act increased the size of the 15 percent regular income tax rate bracket for joint returns to twice the width of the 15 percent bracket for single returns for tax years beginning in 2003 and 2004.

The 2004 Tax Act increases the size of the 15 percent tax rate bracket for joint returns to twice the size of the corresponding tax rate bracket for single returns effective for 2005-2007. Therefore, the size of the 15 percent tax rate bracket for joint returns is twice the size of the corresponding tax rate bracket for single returns for tax years 2003 through 2010.

Caution: This increase in the 15 percent bracket for married couples filing joint returns will be repealed for tax years beginning after 2010, unless new legislation is enacted.

10 Percent Regular Income Tax Rate Bracket

For tax years beginning after 2000, the 2001 Tax Act created a new 10 percent bracket that applied to the following portions of taxable income:

* Single: first $6,000

* Heads of households: first $10,000

* Married filing jointly: first $12,000

For tax years beginning after 2008, the taxable income levels for the 10 percent bracket will be adjusted annually for inflation. This bracket will be rounded down to the nearest $50 for joint returns and head of household returns. The bracket for single individuals and married individuals filing separately will be one-half of the bracket for joint returns (after any inflation adjustment).

The 2003 Tax Act temporarily accelerated the increase in the taxable income levels for the 10 percent bracket for 2003 and 2004. It also provided that these taxable income levels will be adjusted annually for inflation for tax years beginning after 2003.

For the taxable income levels for the 10 percent bracket for 2003 through 2011, before enactment of the 2004 Tax Act, see Table 2.

The 2004 Tax Act extends the size of the 10 percent tax rate bracket through 2010. Specifically, the size of the 10 percent tax rate bracket for 2005 through 2010 is set at the 2003 level--with annual indexing after 2003.

Alternative Minimum Tax

Nonrefundable Personal Credits

Existing law provides for certain nonrefundable personal tax credits, such as dependent care credit; credit for the elderly and disabled; adoption credit; child tax credit (a portion of which may be refundable); credit for interest on certain home mortgages; HOPE Scholarship and Lifetime Learning credits; and credit for savers.

Under the old law, for tax years beginning in 2003, all the nonrefundable personal tax credits were allowed to the extent of the full amount of the individual's regular tax and AMT.

For tax years beginning after 2003, under the old law, the credits (except the adoption credit, child credit and credit for savers) were allowed only to the extent that the individual's regular income tax exceeded the individual's tentative minimum tax (determined without regard to the minimum tax foreign tax credit).

The adoption credit, child credit and savers' credit were allowed to the full extent of the individual's regular tax and AMT.

The new law extends the allowance of the nonrefundable personal credits to the full extent of the regular tax and AMT for tax years beginning in 2004 and 2005.

Uniform Definition Of A Qualifying Child

The existing law contains the following five commonly used provisions that provide benefits to taxpayers with children: dependency exemption; child credit; earned income credit; dependent care credit; and head of household filing status.

Each provision has separate criteria for determining whether the taxpayer qualifies for the applicable tax benefit with respect to a particular child, such as: the relationship (if any) the child must bear to the taxpayer; the child's age; and whether the child must live with the taxpayer.

Thus, with respect to the same individual, a taxpayer must determine eligibility for each benefit separately. Consequently, an individual who qualified a taxpayer for one provision did not automatically qualify the taxpayer for another provision.

For tax years beginning after 2004, the new law establishes a uniform definition of qualifying child for purposes of these five benefits. A taxpayer generally may claim an individual who does not meet the uniform definition of a qualifying child (with respect to any taxpayer) as a dependent if the existing-law dependency requirements are satisfied.

The new law generally does not modify the other parameters of each tax benefit (e.g., the earned income requirements of the earned income credit) or the rules for determining whether individuals other than the taxpayer's children qualify for each tax benefit.

Generally, under this new uniform definition, a child is the taxpayer's qualifying child if the child satisfies each of these tests: the child has the same principal place of abode as the taxpayer for more than one-half of the tax year; the child has a specified relationship to the taxpayer; and the child has not yet attained a specified age.

A tie-breaking rule applies if more than one taxpayer claims a child as a qualifying child.

Under the new law, the old law's support and gross income tests for determining whether an individual is a dependent generally do not apply to a child who meets the uniform definition's requirements for a qualifying child.

Extensions of Archer Medical Savings Accounts

Within limits, contributions to an Archer MSA are deductible in determining adjusted gross income if made by an eligible individual and are excludable from gross income and wages for employment tax purposes if made by an eligible individual's employer. Earnings on amounts in an Archer MSA are not currently taxable. Distributions from an Archer MSA for medical expenses are not includible in gross income. Distributions not used for medical expenses are includible in gross income. In addition, distributions not used for medical expenses are subject to an additional 15 percent tax unless the distribution is made after age 65, death or disability.

Under the old law, after 2003, no new contributions may be made to Archer MSAs except by--or on behalf of--individuals who previously had Archer MSA contributions and employees who are employed by a participating employer.

The new law extends Archer MSAs through Dec. 31, 2005.

CHANGES AFFECTING BUSINESSES

Research Credit

The research credit expired and generally did not apply to amounts paid or incurred after June 30, 2004.

The new law extends this credit for qualified amounts paid or incurred after June 30, 2004 and before Jan. 1, 2006.

Work Opportunity Credit

This credit expired for wages paid or incurred to an individual who

began work for the employer after 2003.

The new law extends the credit for two years, through Dec. 31, 2005.

Welfare-to-Work Credit

Under the old law, this credit did not apply to individuals who began work for the employer after 2003.

The new law extends the credit for two years, through Dec. 31, 2005.

Enhanced Charitable Contribution Deduction

Under the existing law, a corporate deduction for charitable contributions of computer technology and equipment generally is limited to the corporation's basis in the property. However, certain corporations may claim a deduction exceeding basis for qualified computer contributions. This enhanced deduction expired for contributions made during any tax year beginning after 2003.

The new law extends the enhanced deduction to contributions made during any tax year beginning before 2006.

Certain Expenses of Elementary and Secondary School Teachers

Generally, for tax years beginning in 2002 and 2003, an "above-the-line" deduction was allowed for up to $250 annually of expenses paid or incurred by an eligible educator for books, supplies (other than nonathletic supplies for courses of instruction in health or physical education), computer equipment (including related software and services) and other equipment and supplementary materials used by the eligible educator in the classroom.

The new law extends this deduction for two years (i.e., for tax years beginning in 2004 and 2005).

Expensing of Environmental Remediation Costs

Under existing law, taxpayers can elect to treat certain eligible environmental remediation expenditures, that would otherwise be capitalized, as deductible in the year paid or incurred. However, eligible expenditures were those paid or incurred before 2004.

The new law extends the existing law's expensing provision for two years, through Dec. 31, 2005.

Suspension of 100%-of-Net Income Limitation on Percentage Depletion for Oil and Gas from Marginal Wells

The percentage depletion method for oil and gas properties applies to independent producers and royalty owners. Generally, under this method, 15 percent of the taxpayer's gross income from an oil or gas producing property is deductible each tax year.

However, the amount deducted generally may not exceed 100 percent of the property's net income in any year--the net income limitation. This limitation, for marginal wells, was suspended for tax years beginning after 1997 and before 2004.

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The new law extends the suspension of this net income limitation for marginal wells for tax years beginning before 2006.

table 1

CHILD TAX CREDIT

OLD LAW

Tax Year      Credit Amount Per Child

2005-08       $700

2009          $800

2010          $1,000

2011 & later  $500

NEW LAW

Tax Year      Credit Amount Per Child

2004-2010     $1,000

2011 & later  $500

table 2

Pre-2004 Act

TAXABLE INCOME LEVELS FOR 10% BRACKET

Tax Year  Single or Married   Heads of       Married
          Filing Separately  Households  Filing  Jointly

2003           $7,000         $10,000       $14,000

2004           $7,150         $10,200       $14,300

2005           $6,000         $10,000       $12,000

2006           $6,000         $10,000       $12,000

2007           $6,000         $10,000       $12,000

2008           $7,000         $10,000       $14,000

2009           $7,000         $10,000       $14,000

2010           $7,000         $10,000       $14,000

2011           Expires        Expires       Expires

table 3

ALTERNATIVE MINIMUM TAX

AMT EXEMPTIONS

Before the 2003 Tax Act, the following AMT exemptions applied:

Tax Year Beginning in  Joint Return  Single
2003                   $49,000       $35,750
2004                   49,000        35,750
2005 & later           45,00         33,750

The 2003 Tax Act increased the AMT exemption for individuals, as
follows:

Tax Year Beginning in  Joint Return  Single
2003                   $58,000       $40,250
2004                   58,000        40,250
2005 & later           45,000        33,750

The 2004 Tax Act extends the increased AMT exemptions to tax years
beginning in 2005. Therefore, the following exemptions will be
available:

Tax Year Beginning in  Joint Return  Single
2003                   $58,000       $40,250
2004                   58,000        40,250
2005                   58,000        40,250
2006 & later           45,000        33,750

Before the 2003 Tax Act, the following AMT exemptions applied:

Tax Year Beginning in  Married Filing Separately  Estate or Trust
2003                   $24,500                    $22,500
2004                   24,500                     22,500
2005 & later           22,500                     22,500

The 2003 Tax Act increased the AMT exemption for individuals, as
follows:

Tax Year Beginning in  Married Filing Separately  Estate or Trust
2003                   $29,000                    $22,500
2004                   29,000                     22,500
2005 & later           22,500                     22,500

The 2004 Tax Act extends the increased AMT exemptions to tax years
beginning in 2005. Therefore, the following exemptions will be
available:

Tax Year Beginning in  Married Filing Separately  Estate or Trust
2003                   $29,000                    $22,500
2004                   29,000                     22,500
2005                   29,000                     22,500
2006 & later           22,500                     22,500

Note: These AMT exemptions are not indexed for inflation.

By Stuart R. Josephs, CPA

Stuart R. Josephs, CPA, has a San Diego-based Tax Assistance Practice (TAP) that specializes in assisting practitioners in resolving their clients' tax questions and problems. Josephs, chair of the Federal Subcommittee of CalCPA's Committee on Taxation, can be reached at [phone] or [e-mail].