2004 American Jobs Creation Act: selected highlights.
Extraterritorial Income (ETI) Exclusion Repealed
The Act repeals the ETI exclusion for post-2004 transactions, subject to 2005 and 2006 transaction relief (see Box 1) and grandfather rules for binding contracts in effect on Sept. 17, 2003 and at all times thereafter.
New Deduction Regarding Domestic Production Activities
For tax years beginning after 2004, the Act provides a new 9 percent regular tax deduction, equivalent to a 3 percent tax rate reduction, relating to income attributable to domestic manufacturing and certain other production activities.
This deduction will be available for C and S corporations, partnerships, sole proprietorships, estates, trusts and cooperatives--as well as for AMT purposes.
Many domestic production activities will qualify for this new deduction, including, but not limited to, traditional manufacturing; construction; engineering; energy production; computer software; films and videotape; and processing of agricultural products.
The deduction cannot exceed 50 percent of an employer's W-2 wages for any tax year. A five-year phase-in applies, as shown in Box 1.
Extension of Increased Sec. 179 Deduction for Small Business
The new law extends the increases and other changes enacted by the 2003 tax law to the Sec. 179 small-business expense deduction, for two more years, through tax years beginning in 2006 and 2007.
Therefore, the maximum amount that may be deducted under Sec. 179 will be $100,000 for qualifying property placed in service in tax years beginning after 2002 and before 2008, and $25,000 thereafter.
The $100,000 maximum deduction is reduced by the amount by which the cost of such property exceeds $400,000 for tax years beginning after 2002 and before 2008, and $200,000 thereafter.
These $100,000 and $400,000 limitations are indexed for inflation for tax years beginning after 2003 and before 2008. For 2004, these limitations are $102,000 and $410,000, respectively.
Off-the-shelf computer software placed in service in a tax year beginning after 2002 and before 2008 will be qualifying property.
Taxpayers can make or revoke Sec. 179 expense deduction elections on amended returns without IRS consent for tax years beginning after 2002 and before 2008. However, any such revocation is irrevocable.
Reduced Sec. 179 Deduction for SUVs
The new law limits the Sec. 179 expense deduction for SUVs placed in service after Oct. 22, 2004 to not more than $25,000 (for any tax year).
An SUV is any four-wheeled vehicle designed, or which can be used, to carry passengers over public streets, roads or highways (except any vehicle operated exclusively on a rail or rails); not subject to Sec. 280F; and rated at not more than 14,000 pounds gross vehicle weight.
Sec. 280F applies only to vehicles rated at 6,000 pounds unloaded gross vehicle weight or less.
Under the new law, SUVs do not include any vehicle which:
* Is designed to have a seating capacity of more than nine persons behind the driver's seat;
* Is equipped with a cargo area of at least six feet in interior length which is in an open area or designed for use as an open area--but is enclosed by a cap and is not readily accessible directly from the passenger compartment; or
* Has an integral enclosure, fully enclosing the driver compartment and load carrying device, does not have seating rearward of the driver's seat and has no body section protruding more than 30 inches ahead of the wind-shield's leading edge.
Charitable Contributions of Motor Vehicles, Boats and Airplanes ("Vehicles")
For vehicles, except inventory, contributed after 2004, the new law generally allows a charitable deduction if the claimed value exceeds $500 and if the taxpayer substantiates this contribution with a written acknowledgement from the charitable donee and attaches such acknowledgement to the taxpayer's tax return claiming that deduction.
In addition, if the donee sells the vehicle without the donee's significant intervening use or material improvement of the vehicle, the charitable contribution deduction cannot exceed the gross sale proceeds.
This acknowledgement must contain the donor's name, taxpayer identification number and vehicle identification number.
If the donee sells the vehicle without any significant intervening use or material improvement, the acknowledgement also must contain:
* A certification that the vehicle was sold in an arm's length transaction between unrelated parties;
* The sale's gross proceeds; and
* A statement that the deductible amount may not exceed the amount of these gross proceeds.
Otherwise, the acknowledgement must contain this alternative information: a certification of the vehicle's intended use or material improvement and the intended duration of such use, and a certification that the vehicle would not be transferred in exchange for money, other property or services before completion of such use or improvement.
An acknowledgement is contemporaneous if the donee provides it within 30 days of the vehicle's sale or contribution (for acknowledgements containing the alternative certifications described above).
The donee also must provide the information in these acknowledgements to the IRS at such time and in such manner as the IRS may prescribe.
Severe penalties are imposed on a donee that knowingly furnishes a false or fraudulent acknowledgement or knowingly fails to furnish an acknowledgement in the prescribed time and manner showing the required information.
Charitable Contributions of Intellectual Property
For contributions after June 3, 2004, the new law provides that the charitable deduction for contributions of intellectual property (except certain copyrights and computer software), including applications or registrations of such property, may not exceed the taxpayer's basis in the property (or the property's fair market value, if less).
The donor is allowed an additional charitable deduction, either in the contribution year or subsequent tax years based on a specified percentage [set forth in new Sec. 170(m)(7)] of the income the donee receives or accrues that is attributable to this property.
However, this additional deduction is not available for intellectual property contributed to private foundations (with certain exceptions).
Certain Personal Costs No Longer Deductible
The federal tax column in the March/April 2004 issue of California CPA discussed a 2003 IRS Chief Counsel Advice which allowed an S corporation to deduct expenses of providing aircraft for personal use by shareholders or employees, even though those expenses exceeded the value of the flights included in these individuals' incomes under the methodology prescribed by the regulations.
This advice was based on comparable treatment given to a C corporation in Sutherland Lumber-Southwest Inc. vs. Commissioner, 114 T.C. 197 (2000), aff'd 255 F.3d 495 (8 Cir. 2001).
The new law overrules the Sutherland result by limiting an employer's or other service recipient's deduction for goods, services and facilities, including corporate aircraft, treated as entertainment, amusement or recreation to the amount of compensation included in the employee's or service provider's income.
However, this limitation only applies to individuals subject to Section 16(a) of the 1934 Securities Exchange Act or who would be subject to that Act if the taxpayer (e.g., the corporate employer) were an issuer of equity securities referred to in Section 16(a) of the 1934 Act, Generally, such individuals are officers, directors and 10 percent owners.
This change applies to expenses incurred after Oct. 22, 2004.
Under the old law, "qualified" leasehold improvements were depreciated, using the straight-line method, over the same 39-year recovery period as nonresidential realty. Generally, these improvements are made by either the lessor or lessee to a building's interior more than three years after the building is placed in service.
For qualified leasehold improvements placed in service after Oct. 22, 2004 and before 2006, the new law substitutes a 15-year recovery period. Also, for lessor-made improvements, this shorter recovery period generally cannot be used by subsequent owners.
Startup and Organizational Expenditures
Under the old law, at the taxpayer's election, these expenditures could be deducted ratably over a minimum 60-month period, generally beginning with the month in which business began.
Under the new law, for amounts paid or incurred after Oct. 22, 2004, the following elective treatment is substituted for these expenditures. Generally, for the year in which business begins, the taxpayer can deduct the lesser of the particular expenditures or $5,000, reduced (but not below zero) by the expenditures exceeding $50,000.
The remaining expenditures are deductible ratably over the 180-month period (consistent with the 15-year amortization for Sec. 197 intangibles), generally beginning with the month in which business begins.
This new treatment applies separately to startup expenditures, corporate organizational expenditures and partnership organizational expenses.
Nonqualified Deferred Compensation Plans
Under the new law, generally for amounts deferred after 2004, all amounts deferred under such plans will be taxable to the extent not subject to a substantial risk of forfeiture and not previously included in gross income--unless certain requirements (generally described below) are satisfied. Interest [prescribed in new Sec. 409A(a)(1)(B)(ii)] and an additional 20 percent tax also will be imposed.
These taxes and interest apply only to the participants for whom these requirements are not met.
The primary requirement will be that distributions from such plans may be allowed only upon separation from service, disability, death, a specified time (or pursuant to a fixed schedule), change in control (to the extent provided by the IRS) or occurrence of any unforeseeable emergency,
Assets set aside in a trust (or other arrangement determined by the IRS) to pay nonqualified deferred compensation generally will be treated as property transferred in connection with performing services (under Sec. 83) when set aside or transferred outside the U.S.
These plans must provide that compensation for services performed during a tax year may be deferred only if the participant so elects not later than the close of the preceding tax year (or at such other time as provided in regulations).
In the first year in which a participant becomes eligible, this election can be made within 30 days after initial eligibility for services performed after the election.
A transfer of property in connection with the performance of services (under Sec. 83) also will occur if a nonqualified deferred compensation plan provides that assets will be restricted to paying such compensation upon a change in the employer's financial health.
Exclusion from Wages for Statutory Stock Option Gains
Under the new law, gains resulting from the exercise of an incentive stock option or an employee stock purchase plan (ESPP) option, or a disqualifying disposition of such stock, will not be treated as employment tax wages. Therefore, there will be no FICA and FUTA withholding on these gains. This compensation also will be excluded in determining social security benefits.
In addition, there will be no income tax withholding on such disqualifying dispositions or on gains from exercising ESPP options with an exercise price between 85 percent and 100 percent of fair market value.
These rules apply to stock acquired pursuant to options exercised after Oct. 22, 2004.
Withholding on Supplemental Wages Exceeding $1 Million
For wages paid after 2004, cumulative supplemental wages, such as bonuses or commissions, exceeding $1 million during a calendar year will be subject to income tax withholding at the highest ordinary income tax rate--35 percent. For this purpose, wages paid by certain other employers controlled by, or under common control with, the employer are aggregated with the employer's wages.
Civil Rights Tax Relief
The new law allows a deduction from gross income, instead of an itemized deduction, for attorney fees and court costs arising from unlawful discrimination claims or certain claims against the government--effective for fees and costs paid after Oct. 22, 2004 regarding judgments or settlements after this date.
Optional Sales Tax Deduction
For tax years beginning after 2003 and before 2006, the new law allows taxpayers to elect an itemized deduction for state and local general sales taxes instead of state and local income taxes.
Taxpayers also can elect to determine their sales tax deductions from IRS-prescribed tables. Sales taxes paid on motor vehicles, boats and other items specified by the IRS are added to the tables' amounts.
The new law increases the number of eligible shareholders from 75 to 100 and treats family members as one shareholder.
Suspended losses and deductions with respect to stock transferred to a spouse, or former spouse, incident to a divorce will be treated as incurred with respect to the transferee in the succeeding tax year.
There are other favorable rules for electing small-business trusts, qualified subchapter S trusts and qualified subchapter S subsidiaries.
Also, traditional and Roth IRAs can be bank S corporation shareholders in certain circumstances.
Generally, these changes are effective for tax years beginning after 2004.
Exclusion of Gain on Sale or Exchange of Principal Residence
Effective for sales or exchanges after Oct. 22, 2004, the new law denies the exclusion if the residence was acquired within the previous five years in a Sec. 1031 like-kind exchange.
The new law clarifies that, despite a contrary implication in the Rite Aid case [255 F.3d 1357 (Fed. Cir. 2001)], the Treasury has authority to prescribe regulations treating corporations filing consolidated returns differently than corporations filing separate returns. This clarification applies retroactively to all open years.
Under the new law, the foreign tax credit carryover period will be 10 years (rather than five years) and the carryback period will be one year (instead of two years).
The new carryover period applies to excess foreign taxes that may be carried to any tax year ending after Oct. 22, 2004. The new carryback period applies to excess foreign taxes arising in tax years beginning after this date.
Under the old law, AMT foreign credits could not offset more than 90 percent of a taxpayer's AMT. The new law repeals this 90 percent limitation for tax years beginning after 2004.
The new law also reduces the old law's nine foreign tax credit limitation baskets to only a general category income basket and a passive category income basket, generally effective for tax years beginning after 2006, subject to a transition rule for tax years beginning after 2004.
Under the new law, an 85 percent dividends received deduction can be elected for both regular tax and AMT for certain earnings repatriated during either the taxpayer's first tax year beginning on or after Oct. 22, 2004, or the taxpayer's last tax year beginning before this date.
The new law repeals the foreign personal holding company rules and the foreign investment company rules, generally effective for foreign corporations' tax years beginning after 2004 and U.S. shareholders' tax years within which such corporate tax years end.
Tax Shelters and Other Abusive Transactions
For inadequately disclosed listed transactions, the statute of limitations is extended to one year after the date that the required information is adequately provided or a material adviser satisfies a list maintenance request regarding the transaction, effective for tax years for which the statute of limitation has not expired before Oct. 22, 2004.
For actions taken after Oct. 22, 2004, the new law allows censure of practitioners violating Circular 230 rules of practice before the IRS and also allows monetary penalties to be imposed on practitioners and their employers if the employer reasonably should have known of the practitioner's conduct.
Various penalties have been increased with varying effective dates.
Box 1 Transitional Schedule Production ETI Activities Year Exclusion Deduction 2004 100% 0% 2005 80% 3% 2006 60% 3% 2007 0% 6% 2008 0% 6% 2009 0% 6% 2010/later 0% 9%
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 CaICPA's Committee on Taxation, can be reached at (619) 469-6999 or email@example.com.
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|Title Annotation:||federal tax|
|Author:||Josephs, Stuart R.|
|Date:||Dec 1, 2004|
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