2005 Year-End Tax Planning by mmcsx

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									                                                                                                                      9018 Balboa Blvd. #612, Northridge, CA 91325-2610
                                                                                                                                    Tel: (818) 775-9230 • (888) 860-8810
                                                                                                                                                     Fax: (818) 301-2689
                                                                                                                                                      www.adviseinc.com




2005 Year-End Tax Planning
by Peter Soh, CPA

Now that the end of the year is fast approaching, it is time to consider tax-planning strategies. This provisions
highlight current tax law. Currently the House has just passed Alternative Minimum Tax Relief for middle to
upper class taxpayers, an extension of the capital tax and dividend tax relief to 2010, Iraq combat pay tax
credits, and other tax provisions affecting the Katrina Gulf Coast area. We will keep you posted if and when
it passes the Senate and is signed by the President.

TABLE OF CONTENTS                                                                                           following year. The following are some strategies to
2005 Year End Tax Planning ......................................................... 1                      consider:
   Accelerating Income to 2005; Deferring Deductions to 2006
   Accelerating Deductions to 2005; Postponing Income for 2006
                                                                                                            (1) Collect as many accounts receivable as
    ................................................................................................... 1       possible before the end of the year or get
What!s New for 2005 ........................................................................                    customers to prepay for goods or services that
Personal Tax Incentives ................................................................. 2                     will be rendered next year;
   New State Sales Tax Deduction ............................................... 2
   Marriage Penalty Relief............................................................. 2                   (2) If planning an asset sale to match up sale with
   Child Tax Credit Changes ......................................................... 2                         any potential capital losses and to utilize the
   Combat Pay Included for Earned Income Credit Purposes ..... 3
                                                                                                                15% capital gain rate for long term assets (Over
   Change to Vehicle Donation Rules........................................... 3
   Educator Expenses Reinstated ................................................ 3                              1 year)
   Phase-Out of Electric Vehicle Credit Delayed.......................... 3                                 (3) If you have sold assets on the installment basis,
   Alternative Minimum Tax .......................................................... 3
   Retirement Savings Contributions and Catch-up Contributions                                                  accelerating payments from the buyer, if
    ................................................................................................... 3       possible, or negotiating with a third party to
   Tuition and Related Expenses .................................................. 4                            purchase the installment obligation;
   Changes in Taxation of Attorney Fees ..................................... 4
   Sale of a Residence Acquired in a Like-Kind Exchange.......... 4                                         (4) If you are over 59 and 1/2 years old who are
Business Tax Incentives ................................................................. 4                     covered by an IRA, recommend taking
   New SUV Depreciation Limitations........................................... 4                                additional distributions in 2005.
   Deduction for Income Attributable to Qualified Production
   Activity ....................................................................................... 4       With respect to deferring deductions:
   Deduction for Start-up and Organization Expenditures ........... 5
   Shorter Recovery Period for Restaurants and Leasehold                                                    (1) If you have receivables outstanding and there is
   Property ..................................................................................... 5             a question as to whether they will ever be
   Income Forecast Method for Small Film Production                                                             collectible, you should consider leaving the door
   Companies ................................................................................ 5                 open as to whether collection is possible by not
   Repatriation of Foreign Earnings .............................................. 5
S Corporation Changes .................................................................. 5                      exhausting all remedies to collect on the
   Standard Mileage Rates for 2005 ............................................. 5                              receivable (thus deferring the bad debt
Carryover Provisions from 2003..................................................... 6                           deduction);
   Dividends Tax Rate Reduction ................................................. 6
   Capital Gains Tax Rate Reduction ........................................... 6                           (2) Postpone paying deductible personal (e.g., state
   Top Marginal Tax Rate Reduction ............................................ 6                               taxes, mortgage interest) and business
   Bonus Depreciation ................................................................... 6                     expenses until 2006, where possible.
   Enhanced Section 179 .............................................................. 6
Conclusion....................................................................................... 6
                                                                                                            Accelerating   Deductions                  to      2005;
                                                                                                            Postponing Income for 2006
2005 YEAR END TAX PLANNING                                                                                  If you expect to be in a lower tax bracket in 2005,
                                                                                                            you should shift income into the following year or
                                                                                                            accelerate deductions into the current year. Ideas for
Accelerating Income to 2005; Deferring                                                                      shifting income include:
Deductions to 2006
                                                                                                            (1) Arrange for your employer to defer any bonus
If you expect to be in a significantly higher tax                                                               payments until 2006;
bracket in 2006, you can either accelerate income
into the current year or shift deductions into the

2005 Year-End Tax Planning                                                                                                                                     Page 1
                                                                     9018 Balboa Blvd. #612, Northridge, CA 91325-2610
                                                                                   Tel: (818) 775-9230 • (888) 860-8810
                                                                                                    Fax: (818) 301-2689
                                                                                                     www.adviseinc.com




(2) Delay year-end billings so payments do not             the tax does not apply with respect to some or all of
    come until the following year; and                     such items is not taken into account in determining
(3) If you are in financial difficulty and working with    whether the tax applies with respect to a broad
    creditors     on      discharging       obligations,   range of classes of items. In addition, the fact that
    recommending that the client postpone finalizing       the rate of tax that applies to some or all of such
    any debt cancellation that will result in              items is lower than the general rate of tax is not
    cancellation-of-debt income until next year.           considered in determining whether the tax is
                                                           imposed at one rate.
As for accelerating deductions,
                                                           Except for food, clothing, medical supplies, or motor
(1) Prepay any January mortgage payment;                   vehicles, a deduction is not allowed for any general
(2) Prepay deductible (personal and business)              sales tax imposed with respect to an item at a rate
    expenses (e.g., state income taxes) in 2005            other than the general rate of tax. However, for
    rather than deferring payment until 2006 (and,         motor vehicles, if the rate of tax exceeds the general
    by using a credit card the cash outlay may be          rate, the excess should be disregarded and the
    postponed);                                            general rate treated as the rate of tax.
(3) Contribute the maximum amount allowed to any           Unfortunately, this will create an accounting
    retirement plan (i.e., for 2005, the maximum           nightmare for most individuals since we rarely keep
    elective deferral for a 401(k) plan is $13,000         our receipts for sales tax reasons. For California
    and individuals who will reach their 50th              residents, since our individual tax rates are higher
    birthday on or before December 31, 2005, may           (9.3%) vs the sales tax rate of (8.25%), I doubt this
    defer an additional $3,000 of income to a 401(k)       would be a large tax deduction for the effort to
    plan);                                                 maintain these sales receipts.
(4) Pay any contested deductible taxes in 2005;
    and                                                    Marriage Penalty Relief
(5) If you are planning a large business purchase,         The October 2004 tax legislation increased the basic
    make the purchase by the end of 2005 to take           standard deduction amount for joint taxpayers for
    advantage of the bonus depreciation deductions         2005 through 2008. Thus, for 2005, the standard
    that end in 2005.                                      deduction is twice the basic standard deduction
                                                           amount for single returns.
In addition, beginning in 2005, the deduction
available for donating a vehicle to a charity              The legislation also increased the size of the 15
(discussed below) is severely limited. Thus, if you        percent tax bracket to twice that for single taxpayers
are planning on donating a vehicle to charity, it          effective for 2005 through 2007. Thus, the size of the
should be done by the end of 2005.                         15 percent rate bracket for joint returns is twice the
                                                           size of the corresponding rate bracket for single
                                                           returns for 2005.
2005 TAX SUMMARY
The following are some of the changes that                 Child Tax Credit Changes
practitioners should be aware of for 2005.
                                                           For 2004, there is an increase in the child tax credit
                                                           that is refundable for low-income individuals with one
PERSONAL TAX INCENTIVES                                    or two children. The child tax credit is now
                                                           refundable to the extent of 15 percent of the
New State Sales Tax Deduction                              taxpayer!s taxable earned income in excess of
                                                           $11,000. For families with three or more children, the
Probably one of the biggest changes for individuals
                                                           credit is refundable up to the amount by which the
for the 2005 and 2006 tax years is the addition of a
                                                           social security taxes exceed the earned income
deduction for state and local general sales taxes in
                                                           credit, if that amount is greater than the refundable
lieu of a deduction for state income taxes.
                                                           credit based on the taxpayer!s taxable earned
The term “general sales tax” means a tax imposed at        income in excess of $11,000. This level of
one rate with respect to retail sales of a broad range     refundability will remain in effect for 2005.
of classes of items. However, for food, clothing,
medical supplies and motor vehicles, the fact that


2005 Year-End Tax Planning                                                                                    Page 2
                                                                      9018 Balboa Blvd. #612, Northridge, CA 91325-2610
                                                                                    Tel: (818) 775-9230 • (888) 860-8810
                                                                                                     Fax: (818) 301-2689
                                                                                                      www.adviseinc.com




New for 2004, combat pay that is otherwise                 powered primarily by an electric motor has been
excluded from gross income is treated as earned            repealed. Thus, a taxpayer who purchases a
income, which is taken into account in computing           qualifying vehicle can claim 100 percent of the
taxable income for purposes of calculating the             otherwise allowable credit (i.e., $4,000) for vehicles
refundable portion of the child care credit. Thus, low-    purchased in 2005. For vehicles placed in service in
income members of the military who receive combat          2006, however, the credit is reduced by 75 percent.
pay can receive more benefit from the refundability        The credit is not available for vehicles placed in
of the credit.                                             service after 2006.
Finally, the child tax credit will remain $1,000 for
both 2005 and 2006. Previously, it had been                Alternative Minimum Tax
scheduled to decrease to $700 for 2005.                    New tax legislation repealed the decrease in the
                                                           AMT exemption amount scheduled for 2005. Thus,
Combat Pay Included for Earned Income                      for 2004 and 2005, the amount of income exempted
Credit Purposes                                            from the AMT is $58,000 for married individuals filing
                                                           joint returns and for surviving spouses, $40,250 for
New for 2004, any taxpayer can elect to treat
                                                           unmarried individuals, and $29,000 for married
combat pay that is otherwise excluded from gross
                                                           individuals filing separately.     These exemption
income as earned income for purposes of the
                                                           amounts, however, are phased out by an amount
earned income credit. This election is available with
                                                           equal to 25 percent of the amount by which the
respect to 2004 and 2005.
                                                           taxpayer!s AMT exceeds $112,500 in the case of
                                                           unmarried individual taxpayers, including heads of
Change to Vehicle Donation Rules                           households, $150,000 in the case of married
Beginning in 2005, the deduction for charitable            taxpayers filing joint returns and surviving spouses,
contributions of vehicles (generally including             and $75,000 in the case of married individuals filing
automobiles, boats, and airplanes for which the            separate returns.
claimed value exceeds $500 and excluding inventory         Originally in 2004, only the adoption credit, child
property) depends upon the use of the vehicle by the       credit, and savers! credit were to be allowed against
donee organization. If the donee organization sells        AMT liability, and all the other non-refundable
the vehicle without any significant intervening use or     personal tax credits were to be allowed only to the
material improvement of such vehicle by the                extent that the individual!s regular income tax liability
organization, the taxpayer!s deduction can not             exceeded the individual!s tentative minimum tax,
exceed the gross proceeds received from the sale.          determined without regard to the minimum tax
OBSERVATION: Generally, charities sell these               foreign tax credit.
donated vehicles for a fraction of their fair market       However, as a result of recent tax law changes, the
value. Thus, a taxpayer!s charitable contributions for     provision allowing the non-refundable personal
such donations will be substantially limited in 2005.      credits to the full extent of the regular tax and the
                                                           AMT is extended to 2004 and 2005.
Educator Expenses Reinstated                               In addition, for 2005, for purposes of computing
The deduction for educator expenses that expired at        AMT, the regular tax liability of a farmer or fisherman
the end of 2003 has been reinstated for 2004 and           is determined without regard to income averaging.
2005. Thus, up to $250 of expenses incurred by a K-        (THIS PROVISION WILL CHANGE PENDING NEW
12 teacher, instructor, counselor, principal or aide for   LAW)
books, supplies, computer equipment and other
equipment, and supplementary materials used by the         Retirement Savings Contributions and
eligible educator in the classroom may be deducted
                                                           Catch-up Contributions
as an above-the-line deduction.
                                                           For 2005, the maximum elective deferral for a 401(k)
Phase-Out of Electric Vehicle Credit                       plan is $14,000. Individuals who will reach their 50th
                                                           birthdays on or before December 31, 2005, may
Delayed                                                    defer an additional $4,000 of income to a 401(k) plan
The scheduled phase-out of the 10 percent credit           for a total of $18,000.
provided for the cost of a motor vehicle that is

2005 Year-End Tax Planning                                                                                     Page 3
                                                                    9018 Balboa Blvd. #612, Northridge, CA 91325-2610
                                                                                  Tel: (818) 775-9230 • (888) 860-8810
                                                                                                   Fax: (818) 301-2689
                                                                                                    www.adviseinc.com




For 2006, the maximum elective deferral for a 401(k)     the residence was acquired in a like-kind exchange
plan is $15,000. Individuals who will reach their 50th   in which gain was not recognized within the previous
birthdays on or before December 31, 2006, may            five years.
defer an additional $5,000 of income to a 401(k) plan
for a total of $20,000.                                  BUSINESS TAX INCENTIVES
Similarly, eligible taxpayers can make a tax-free
contribution of up to $4,000 to an individual            New SUV Depreciation Limitations
retirement account for 2005 and 2006. Taxpayers
                                                         Previously, business taxpayers were able to
who are at least 50 years old by the end of 2005
may contribute an additional $500 to their IRAs.         immediately expense under Code Section 179 up to
Taxpayers who are at least 50 years old by the end       $100,000 of the cost of a sports utility vehicle (SUV)
of 2006 may contribute an additional $1,000 to their     in the first year. As of October 22, 2004, these
IRAs. Taxpayers have until April 15, 2006, (i.e., the    taxpayers are now limited to Code Section 179
due date of the return, without extensions) to make      deductions of $25,000. Also note that properties
their 2005 contributions. For SIMPLE plans, the          acquired on January 1, 2005 and after are not
maximum allowed deferral for 2005 is $10,000. For        eligible for the bonus depreciation of 30% and 50%.
taxpayers 50 or older, the maximum allowed deferral      Remember that only SUV!s over 6,000 lbs gross
is $12,000.                                              weight qualify.


Tuition and Related Expenses                             Deduction for Income Attributable to
                                                         Qualified Production Activity
For 2005, eligible taxpayers may deduct as an
adjustment to income (in other words, an above-the-      One of the most talked about changes for
line deduction) up to $4,000 (up from $3,000 in          businesses involves a new deduction. Beginning in
2003) of qualified higher education tuition and          2005, businesses can deduct from taxable income
related expenses, if their modified adjusted gross       an amount equal to 3 percent of the lesser of (1)
income (MAGI) is not more than $65,000 ($130,000         qualified production activities income for the year, or
for a joint return). A taxpayer can deduct expenses      (2) taxable income. The percentage doubles to 6
for herself, her spouse, or her dependent, even if the   percent for 2007 through 2009. For all tax years after
taxpayer does not itemize deductions on Schedule         2009, the deduction is equal to 9 percent.
A, Form 1040. Taxpayers with MAGIs exceeding             Generally, qualified production activities income is
$65,000 but not $80,000 (exceeding $130,000 but          domestic production gross receipts, reduced by the
not $160,000 for married taxpayers) are entitled to a    sum of: (1) the costs of goods sold that are allocable
$2,000 above-the-line deduction for qualified            to those receipts; (2) other deductions, expenses, or
educational expenses.                                    losses that are directly allocable to those receipts;
CAUTION: Married individuals must file a joint return    and (3) a proper share of other deductions,
to claim the deduction.                                  expenses, and losses that are not directly allocable
                                                         to such receipts or another class of income. The
Changes in Taxation of Attorney Fees                     definition of “domestic production gross receipts” is
                                                         very broad and many businesses are now busy
From 2004, an above-the-line deduction is allowed        evaluating their activities to see if the receipts from
for attorney fees and costs paid by, or on behalf of,    those activities qualify for the deduction or, if they do
an individual in connection with any action involving    not, how their activities may be rearranged to take
a claim of unlawful discrimination, certain claims       advantage of this new provision.
against the federal government, or a private cause of
                                                         Contractors, engineering firms, software design firms
action under the Medicare Secondary Payer statute.
                                                         and other domestic companies that work with
                                                         domestic manufacturers can now qualify this tax
Sale of a Residence Acquired in a Like-                  break.
Kind Exchange
New for sales or exchanges of a principal residence
after October 22, 2004, a taxpayer may not exclude
any gain on the sale or exchange of the residence if


2005 Year-End Tax Planning                                                                                   Page 4
                                                                    9018 Balboa Blvd. #612, Northridge, CA 91325-2610
                                                                                  Tel: (818) 775-9230 • (888) 860-8810
                                                                                                   Fax: (818) 301-2689
                                                                                                    www.adviseinc.com




Deduction for Start-up and Organization                  Repatriation of Foreign Earnings
Expenditures                                             Certain cash dividends (with a few exceptions for
Effective for expenditures incurred after October 22,    non-cash) received by a US corporation from a
2004, taxpayers may elect to deduct up to $5,000 of      controlled foreign corporation are eligible for 85%
start-up and $5,000 of organizational expenditures in    dividends received deduction. Taxpayers must elect
the tax year in which the trade or business begins.      whether to take the deduction for dividends received
However, each $5,000 amount is reduced by the            either during the first tax year before enactment of
amount by which the cumulative cost of start-up or       the new law or during the last tax year before
organizational expenditures, respectively, exceeds       enactment. The new law does require taxpayers to
$50,000. Start-up and organizational expenditures        identify how they plan to reinvest the dividends in the
that are not deductible in the year in which the trade   United States. Examples include 1) Hiring workers,
or business begins must be amortized over a 15-          2) Financial stabilization 3) R&D 4) Capital
year period, consistent with the amortization of         Reinvestment. The plan needs to be signed by the
acquired intangibles.                                    CEO or an authorized board member. The effective
                                                         tax rate on this one-time dividend would be 5.25%
Start-up and organizational expenditures that are
                                                         on a 35% top corporate rate.
incurred on or before October 22, 2004, continue to
be eligible to be amortized over a period of 60
months. However, all start-up and organizational         S CORPORATION CHANGES
expenditures related to a particular trade or            The tax legislation modified the rules for S
business, whether incurred before or after October       corporations, generally for tax years beginning 2005.
22, 2004, are considered in determining whether the      The changes include an increase to 100 in the
cumulative cost of start-up or organizational            number of eligible S shareholders and an election to
expenditures exceeds $50,000.                            treat all family members as a single shareholder.

Shorter Recovery Period for Restaurants                  Standard Mileage Rates for 2005
and Leasehold Property
                                                         The IRS provided the optional standard mileage
A new 15-year recovery period applies for qualified      rates for use in 2005 in computing the deductible
leasehold improvement property and qualified             costs of operating an automobile for business,
restaurant property placed in service after October      charitable, medical, or moving expense purposes.
22, 2004 and before January 1, 2006. Qualified
                                                         Starting in January 1, 2005, the standard mileage
leasehold improvements include improvements
                                                         rates for use of a car (including vans, pickups, or
pursuant to a lease to an unrelated party (cannot be
                                                         panel trucks) will be:
related parties), building is exclusively occupied by
the lessee, is a structural component, and the           •   44.5 cents a mile for 1/1/06 to 12/31/06.
improvement is place in service 3 years after the        •   48.5 cents a mile for all business miles driven
building was first placed in service.                        temporarily from 9/1/05 to 12/31/05
Prior to this new law, restaurant and leasehold          •   40.5 cents a mile for all business miles driven,
improvements were depreciated over 39 years.                 up from 37.5 cents a mile in 2004;
                                                         •   22 cents a mile for medical and moving from
Income Forecast Method for Small Film                        9/1/05 to 12/31/05
Production Companies                                     •   15 cents a mile when computing deductible
Small film production companies (Up to $15MM in              medical or moving expenses, up from 14 cents a
gross production costs), can immediately expense             mile in 2004; and
their production costs rather than capitalizing and
                                                         •   14 cents a mile when giving services to a
depreciating over their useful life.    The gross
                                                             charitable organization (unless related to Katrina
production costs are higher for companies in low
                                                             hurricane relief efforts)
income distressed areas (Up to $20MM).




2005 Year-End Tax Planning                                                                                   Page 5
                                                                     9018 Balboa Blvd. #612, Northridge, CA 91325-2610
                                                                                   Tel: (818) 775-9230 • (888) 860-8810
                                                                                                    Fax: (818) 301-2689
                                                                                                     www.adviseinc.com




CARRYOVER PROVISIONS FROM                                Bonus Depreciation
2004                                                     To boost capital expenditures by businesses,
                                                         Congress raised from 30 to 50 percent the additional
                                                         first-year depreciation available for depreciable
Dividends Tax Rate Reduction
                                                         personal property, such as machinery and
The most publicized change is the new tax rate           equipment, acquired or self-constructed between
structure for dividends received by individual           May 6, 2003 and December. 31, 2004.
shareholders from domestic and certain foreign
                                                         Special provision for bonus depreciation on
corporations. For taxable years beginning in 2003,
                                                         noncommercial aircraft extended till January 1, 2006
dividends will be taxed at a 15 percent and at a 5
                                                         if placed in service by that date. Otherwise this
percent (for low-income investors) tax rate for
                                                         provision has expired as of December 31, 2004.
regular and alternative minimum tax (AMT)
purposes. The 5 percent tax rate will drop to zero in
2008. (THIS PROVISION MAY EXTEND TO 2010)                Enhanced Section 179
The new tax rate structure for dividends is intended     Taxpayers will be able to expense up to $100,000
to alleviate the burden of double taxation faced by      per year in depreciable assets placed in service in
shareholders who have to pay a second tax on after-      taxable years beginning in 2003 through 2007. The
tax distributed corporate earnings. Although the         benefit of this provision will be phased out for annual
original drafts of this measure were intended to         asset acquisitions in excess of $400,000. Both dollar
equalize tax outcomes between flow-through               limitation amounts are indexed for inflation. 2005
entities, such as S corporations and partnerships,       Limit is 105,000; 2006 Limit is 108,000 The definition
including limited liability companies, and "regular"     of the property that qualifies for the expensing has
corporations, the new measure does not accomplish        been extended to include off-the-shelf computer
this goal as dividends remain subject to taxation.       software.      There is an exception for SUV in
Expires on December 31, 2008 and reverts back to         previously discussed section. (THIS PROVISION
previous tax treatment as ordinary income.               MAY CHANGE SUBJECT TO PENDING NEW LAW)

Capital Gains Tax Rate Reduction                         CONCLUSION
For both regular tax and AMT purposes, the current       Many of these tax planning suggestions should be
tax rates for net capital gains will drop to 5 percent   reviewed prior to the end of this year. Also some of
and 15 percent for low-income and other individual       these strategies should be identified for next year.
taxpayers, respectively, for assets held more than       Please feel free to call me at 818-775-9230 for any
one year. The new provision is applicable to sales       questions. Also more information is available at
and exchanges taking place on or after May 6, 2003.      www.adviseinc.com.
In 2008, the rate for low-income taxpayers will drop
                                                         Regards,
to zero. As is the case with the reduction in the
dividend tax rates, this measure is designed to
stimulate investment in the capital markets. This
provision expires on December 31, 2008. (THIS
PROVISION MAY EXTEND TO 2010)                            Peter Soh

Top Marginal Tax Rate Reduction
As a further measure of relief for individual
taxpayers; the top marginal tax rate has been
reduced from 38.6 percent to 35 percent. Tax rates
for lower income levels have been correspondingly
reduced. The tax rate cuts will be effective for 2003
through 2010.




2005 Year-End Tax Planning                                                                                    Page 6

								
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