December 2004 - A Time to Catch Your Breath - Or Brace for More Change?
On November 4, 2004, much of the political rancor from the past several years had died to a dull roar; leaving a trail of web pages, web blogs, political commercials, buttons, signs and numerous other mementos of what proved to be a very expensive and very caustic presidential race. It was also the end to most of the federal legislative races for the next congressional term.
To many, November 4, 2004 was a time to breathe a heavy sigh of relief that the political wars were over, if only for a moment. Fortunately, and also unfortunately, November 4, 2004 also signaled the end of a rather prolific period of tax law changes. Forget about the effects of the tax law changes through 2003, many of which were temporary, because what happened in 2004, while supposedly less extensive than prior years, had far-reaching implications for our future. In November, we talked about some of these changes in our various columns and really had not intended to publish a detailed year-end checklist since the changes noted in our November article plus our December 2003 article, which did go into detail about year-end tax maneuvers, basically provided everything you needed to know.
What a difference a month makes! As we continued to think about the December article, and gained more familiarity with the new tax law, we changed our minds. While it is true that you already have the basic tools to make sound year-end tax decisions, we decided the change in tax law, coupled with the hectic pace of the year-end holidays, dictated we provide you with a brief checklist of items you might want to consider at year-end. Hence, below you will find our December 31, 2004 Year-End Tax Planning Checklist. The checklist is in no way a complete list of items you may want to consider due to the numerous tax laws, but it is representative of the general items you should consider.
Year-End Tax Planning Checklist
December 31, 2004
- Income - Cash Basis Taxpayers
- If you have a bonus due, check with the boss to see if you can defer the bonus into 2005.
- If you can, ask the boss if it's possible to defer this yearÂ’s December 31 paycheck until January 1, 2005. This is really only fully effective for the first year it is tried, but if you have an ever-increasing income (don't laugh, some people do), there will be some small advantage to continuing the practice in the future. Your boss should make this a company-wide or at least employee classification - wide policy. It looks fishy if you are the only one receiving this "perk."
- If you are an employee of a corporation, but also a more than 50% owner of the corporation and want to minimize the corporation's income, make your salary payment by December 31, 2004 to deduct year-end bonus payments. This applies only to C Corporations. If you company is an S Corporation, the less salary you pay, the less FICA and Medicare taxes you pay since these taxes don't apply to distributions from an S Corporation. Remember, generally all of the income of an S Corporation is taxable to the shareholders.
- Individuals whose income is subject to self-employment tax, including general partners in a partnership, sole proprietors and members of an LLC that are treated as if they are subject to self-employment tax
- Postpone collection of income to subsequent years. In general, you can't just not record income. If you have possession of a check or cash in payment for your product or service, you have income and avoiding depositing the check to misstate income is a violation of law. A more practical method of postponing income is to send your billings late. If a customer does not pay until you send a billing other than your original sales ticket, wait until near year-end to send the billing.
- Treat all customers alike, which means all customers receive bills late in the month.
- Make sure you don't harm the tax planning of a good customer by keeping that customer from sending payment until 2005.
- If yours is a cash on delivery business, try to schedule as many deliveries as you can until the first of January 2005, but DO NOT go so far as to lose a sale over the delivery date. This is not good business and your first objective is to make sound business decisions.
- Whatever you do regarding Items 1.b.i-ii, do not jeopardize your ability to effectively manage the business and your creditor relationships by killing your cash flow.
- All individuals
- Investment income
- If possible, consider putting your money into a certificate of deposit that matures after December 31. This will avoid some interest income as the income is not received until 2005.
- Be careful of the timing of mutual fund purchases. Don't purchase a mutual fund before its ex-dividend date. While it may be great to get a big chunk of cash just after you purchased a mutual fund, in reality, you are only creating a tax liability when one needn't exist.
- If you are presently showing large gains on security sales, see if there is anything you want to sell that will provide a loss to offset the gain.
- Sell only if you believe the security producing the loss has permanently lost value or if you are willing to take a chance of being out of the security for 31 days.
- Remember "wash sale" provisions. You can't sell a stock, take a loss and immediately repurchase the stock. You must wait 31 days before you repurchase the stock or the original sale will be disregarded.
- Consider investment interest expenses. If you have a great deal of investment interest expense, remember you can only deduct the expense to the extent you have investment income. Certain capital gains can be considered investment income.
- If you have no gains or small gains, but have loss stock you want to sell, try to sell enough to reach the $3,000 maximum net capital loss deductible against ordinary income in any one year. If you go over the $3,000 limit, you will be able to carry the excess loss to future years.
- Try to structure property sales resulting in a gain to take advantage of the installment method of reporting income
- Receive enough cash to pay taxes in each affected year.
- Gain on equipment and other tangible personal property is taxable to the extent the gain is recapture of depreciation. Make sure you get enough to pay tax on any such gain.
- Better option is to postpone sale until January 2005, if the decision is also a good business decision.
- Try to close on transactions producing losses before year-end.
- Postpone withdrawals from retirement accounts if doing so won't push you into a higher bracket in following years.
- If you have any taxable income resulting from litigation proceeds, try to postpone receipt of the income until January 2005.
- Income - accrual basis taxpayers
- Accrual basis taxpayers pay tax on income when it is earned, even if not received.
- Generally doesn't affect non-owner employees.
- Partners and other business owners need to guard against completing a project that will provide a significant amount of income.
- If postponing income is not practical, accelerate expenses as discussed later.
- Business expenses - cash basis taxpayers
- To reduce taxable income, accelerate expenses.
- Purchase supplies before year-end; prepay rent; make sure all vendors have billed you to allow you to make payment by year-end.
- Don't get overzealous and pay the next five years' rent and other expenses. Generally, you can expect that any payment that will not expire within one year will be disallowed on audit.
- Make sure you don't kill yourself next year by taking too much expense in the current year. Sometimes, overdoing it on expenses puts next year in a higher bracket and doesn't reduce this year's rate. This will cause an overall increase in tax paid.
- Purchase depreciable assets that are subject to Code Section 179 expensing.
- Maximum expense in 2004 is $102,000 in tangible personal property and certain other items.
- Don't go over a total of $410,000 in property eligible for expensing election or you will start losing the some of the $102,000 maximum.
- These higher amounts were to expire in 2005, but have been extended to include years beginning in 2006 and 2007.
- Maximum expense allowed under Code Section 179 for SUVs with gross vehicle weight over 6,000 pounds, but less than 14,000 is $25,000.
- Don't forget additional first year depreciation for assets placed in service before December 31, 2004.
- First year bonus is 50% of depreciable amount, in general.
- Must be qualified property. Call us for details.
- Must be acquired and be first use property (i.e., used equipment purchased will not qualify for the bonus).
- Use this technique only if you planned on property additions in 2005 regardless of tax savings. For all intents and purposes, the tax savings are always less than the actual cash out-of-pocket.
- Take a look at last year's year-end transactions to jog your memory on additional expense acceleration.
- Business expenses - accrual basis taxpayers.
- As long as you have incurred an expense by the end of the year, the bill needn't be paid to deduct the expense.
- The vendor must have done everything to have the right to require payment from you.
- For property and equipment, the item must be on your premises and operating for the purpose for which you purchased the equipment.
- Certain items, like insurance and other prepayments, can be deducted when paid rather than amortized over the period they benefit if the period is less than one year. Call us to discuss this further.
- While accrual of expenses to third parties can be deducted if paid within 2 ½ months of year-end, related parties (generally greater than 50% owners) must be paid by year-end.
- Adjustments to gross income
- Make deductible contributions to retirement plans, including IRAs.
- Certain plans must be in place by December 31.
- Certain payments must be made by December 31 to qualify for deferral (generally relates to partners and owners of businesses, not wage earners).
- Some payments can be deferred until April 15, while others can be extended until October 15. Check with us before filing your return.
- Student loan interest paid, subject to phase-out rules.
- Tuition fees and deductions.
- Moving expenses.
- Self-employed health insurance deduction for premiums paid.
- Alimony payments.
- Itemized deductions
- Pay medical expenses to the extent they exceed 7.5% of adjusted gross income.
- If expenses donÂ’t reach 7.5% of adjusted gross income, consider paying in 2005 if 2004 and 2005 expenses will exceed 7.5% of expected adjusted gross income.
- Pay anticipated income taxes due to state and local governments before December 31 if you itemize and if the deduction will help you.
- For 2004 and 2005, you can elect to deduct the greater of your sales tax paid or your state and local income taxes paid.
- Key is the amounts must be paid.
- IRS is to come out with average sales taxes by income category that can be used to prepare returns. IRS tables won't include taxes on big ticket items like cars, etc. You will need to add these taxes to the table taxes for the total deduction.
- You can use your actual sales tax expense if you kept records for that amount and it is greater than what the IRS would allow.
- Pay real estate and personal property taxes by December 31.
- Home mortgage interest.
- Make your January 1 mortgage payment by December 31 to accelerate interest deduction. This is a must if you paid your January payment early.
- For acquisition loans with origination fees and discount points, close by December 31 to deduct the payments in 2004.
- Payment of origination fees and discount points must be amortized over life of loan for loan refinancing. Early closing doesnÂ’t provide significant tax savings.
- Investment interest
- Defined as interest paid on debt acquired to purchase investments.
- Includes margin interest.
- Must be paid by December 31 and you must have enough investment income (interest, dividends, capital gains) to offset expense amount.
- Excess expense carried forward for 5 years.
- Dividends and gains used to offset interest are not subject to the lower 15% rates.
- Cash contributions are easy, right?
- Contributions of $250 or more require receipt from donee.
- Can't split up one large contribution to avoid rules.
- Pay by credit card if you are short of cash.
- Noncash contributions
- If total claimed noncash contributions are over $500, but less than $5,000, they must be reported on separate form.
- Contributions of property over $5,000 must be accompanied by certification that a qualified appraisal has determined the deduction.
- Other rules relate to certain nonpublicly traded securities and art. Call us if you have such contributions.
- If you have appreciated capital gain property, consider gifting the property instead of selling it and donating the cash.
- Gain is not recognized.
- Generally, reduces allowable contributions from 50% of income to 30% for the portion related to the appreciated property.
- Does not cause a decrease in allowable itemized deductions due to phase out for higher income taxpayers.
- Available deduction for automobiles, boats and planes with a value of over $500 is limited to the amount the charity actually receives at auction after December 31, 2004. Accelerate these deductions if you wish to claim blue book value.
- In general, subject to limits noted in the prior bullets, individual deductions are limited to 50% of adjusted gross income. Corporations are limited to 10% of taxable income before the charitable deduction.
- Casualty losses are deductible under certain circumstances. Due to the rules on calculating such losses, we suggest you obtain qualified assistance in making the determination of the period to take the deduction.
- Gambling losses are deductible as itemized deductions, but only to the extent they offset gambling winnings.
- Pay miscellaneous itemized deductions by year end.
- Unreimbursed employee business expenses.
- Union dues.
- Safe deposit box fees if used to protect documents related to income-producing activities.
- Investment expenses.
- Tax return preparation and tax planning fees.
- Subject to a floor of 2% of adjusted gross income.
The preceding checklist is by no means exhaustive and could literally go on for thousands of pages. These are the more common items that an individual may need to consider. We suggest that you seek professional advice if you have unusual transactions in 2004.
While the preceding checklist is geared toward individuals, its principals can be applied to businesses as well. One major item to consider if you operate your business as a C Corporation, aside from related party transactions, is the availability of a deduction for the cost of inventory items plus ½ or the normal gross profit if you donate the items to a qualified charitable organization. Before you do this, however, run the calculations to see if the contribution will be advantageous.
So far, the discussion in this article hasn't fully addressed the title of this article. We hope to make you think about the numerous changes made in tax law over the past several years. The volume of changes is breathtaking and would seem to argue for a moratorium on changes to allow the taxpaying public to understand what has happened under the current Administration. Based on published reports, this is not what Congress and the President have in mind over the next four years.
So, what do we suggest you glean from all of these changes and the stated intentions of our lawmakers? First, if you have any questions, please call us. You simply cannot fully rely on past law to make informed decisions regarding current transactions. This is true mainly of significant, unusual transactions, but can also relate to planning for normal transactions. For example, assume you are a manufacturer with both foreign and domestic sales. While it would make sense in general terms to minimize your income in 2004, due to the new laws concerning foreign sales, you may wish to accelerate foreign sales while significantly limiting domestic income.
Secondly, we suggest you do the best you can in your year-end tax planning and hope Congress doesn't make changes to blow your planning in 2005. You should of course feel free to call us if you have any questions.
Finally, relax on New Year's Day, but brace yourself for the coming changes. The President has said he wants to overhaul our present tax system and Congress will try to help him make those changes. How far he will get is anyoneÂ’s guess, but you can bet there will likely be some significant changes in the future.
Our last bit of advice is have a great holiday season and a wonderful and prosperous new year.