Scott E. Vincent
Vincent, Fontg & Chartier LLC
Kansas City

Last year saw Congress and the President pass two significant tax law changes: the American Jobs Creation Act of 2004 (2004 Jobs Act) and the Working Families Tax Relief Act of 2004 (WFTRA). The extensive changes implemented by this legislation benefit many taxpayers, including manufacturers, agribusiness, energy companies, small businesses, farmers, and real estate investors. Also included, particularly in the WFTRA, are revenue raisers that affect individuals and businesses. With more tax law changes no doubt on the way this legislative session, we all need to start the new year with some of these key changes from last year in mind.

Manufacturing Deduction for "Production" Activities

One of the primary provisions in the 2004 Jobs Act included the repeal of special tax benefits for exports (which the World Trade Organization had declared an illegal subsidy) and adoption of a phased-in deduction for domestic "production." The deduction starts at three percent for 2005 and 2006, goes to six percent for 2007, 2008 and 2009, and then is set at nine percent by 2010. Qualified production activities for purposes of applying these percentages are limited to taxable income for the year. The deduction is also limited to 50 percent of Form W-2 wages paid for the year. This new deduction should benefit a significant number of industries, as production activities include traditional manufacturing, construction, architecture, licensing of computer equipment, engineering, processing of agricultural products and several other activities.

Deductions, Depreciation and Amortization

Congress enacted a safe harbor amortization period of 15 years for most intangibles. The new law also includes a 15-year depreciation period for certain leasehold and restaurant improvements that previously had much longer depreciation lives. Congress also extended the research credit, provided an augmented charitable deduction for C corporations contributing computer technology and equipment, and approved a new first-year deduction of $5,000 for both start-up expenses and organizational expenditures.

Tax Shelter Enforcement

The 2004 Jobs Act substantially increased penalties for tax shelter abuses and provided penalties for violations of the tax-shelter reporting rules. The IRS has also been very active in identifying "listed transactions." Notably, the IRS also issued much more stringent rules under Circular 230 for attorneys issuing tax shelter opinions. These Circular 230 rules govern attorney practice before the IRS.

Tax Forms

A new Schedule M-3 requires corporations to reveal more aggressive transactions. The IRS also revised and expanded Form 1023, the application for tax-exempt status. Also revised to increase available information is Form 990, the information return for all tax-exempt organizations.

S Corporations

Congress continues to make S corporations more broadly available, this time increasing the allowable shareholders from 75 to 100 and treating members of one family as a single shareholder. "Family" is defined as "the common ancestor, lineal descendants of the common ancestor, and the spouses (or former spouses) of lineal descendants or common ancestor." The person in question also must be no more than six generations removed from the youngest generation of shareholders who otherwise would be members of the family.

Vehicle Deductions

Congress did make an effort to limit abuses relating to luxury vehicles. Because the current $7,000 limit for luxury vehicle annual deductions does not apply to vehicles over 6,000 pounds, SUVs and other large passenger vehicles were previously exempt. A business could write off the entire SUV cost of $60,000 or more using the $100,000 allowance for expensing. The new law limits first-year SUV deductions to $25,000. The new limit took effect October 22, 2004, when President Bush signed the 2004 Jobs Act.

Congress also addressed abuses involving car donations to charity, which has become an active area. The 2004 Jobs Act tightens the rules for the deduction, basically limiting the deductible amount to the charity's sale price of the vehicle, rather than the blue book value, unless the charity retains and uses the vehicle.

State Sales Tax Deduction

For 2004 and 2005, taxpayers who itemize deductions can elect to deduct either their state and local income taxes or their state and local sales taxes. Individuals should consider saving their receipts in 2005 to substantiate sales tax deductions; IRS tables based on average consumption may also be available. This deduction should significantly benefit taxpayers in states with no state income taxes, as well as taxpayers who have high sales tax liabilities for the year from major purchases.

Health Savings Accounts

Congress extended medical savings accounts through 2005 and allowed amounts to be rolled over from a medical savings account to the new Health Savings Account (HSA). The IRS also issued additional new guidance on HSAs, which the Bush administration continues to push as a major health insurance reform. As insurance companies continue to develop HSA products, look for their use to substantially increase in 2005.

Discrimination Awards

Under current law, a party filing a discrimination suit could be taxable on the entire settlement or court award, even though a substantial amount was paid for attorney's fees. Congress provided relief, permitting the claimant to take an above-the-line deduction for attorney's fees and litigation expenses.

Continuing Changes?

Watch for Congress and the Bush administration to continue making significant and aggressive changes during the remainder of his term. Administration tax review panels will again discuss replacing the current income tax system with a national sales or consumption tax. More conservative efforts will probably include eliminating the individual alternative minimum tax and further incentives to encourage business investment in workers and equipment.