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Significant
Individual Provisions The American Jobs Creation Act of 2004 (AJCA) affects several tax breaks for individual taxpayers and creates others. This article describes and analyzes AJCA provisions on charitable contributions, supplemental wage payment withholding, the sales tax deduction and more.
Martin Nissenbaum, J.D., LL.M., CPA
For more information about this article,
contact Mr. Nissenbaum at
martin.nissenbaum@ey.com. Executive Summary
The American Jobs Creation Act of 2004 (AJCA) was signed into law by President Bush on Oct. 22, 2004. This article describes some of the more significant AJCA provisions affecting individual taxpayers, and offers insights and planning points.
Deducting State and Local General Sales Taxes AJCA Section 501 allows taxpayers to elect an itemized deduction for state and local general sales taxes in lieu of the deduction for state and local income taxes. The provision is effective for tax years beginning after 2003 and before 2006. Taxpayers have two options for determining the sales tax deduction. First, they can deduct the actual total general state and local sales taxes paid if they have receipts. Alternatively, taxpayers may use tables provided in IRS Pub. 600, Optional State Sales Tax Tables. The tables are based on average consumption by taxpayers on a state-by-state basis, taking into account filing status, number of dependents, adjusted gross income and rates of state and local general sales taxes. Taxpayers who use the tables may also deduct, in addition to the table amounts, eligible general sales taxes paid on the purchase of motor vehicles, boats and other items specified by the IRS. Sales taxes for such items are not reflected in the tables. This provision is clearly intended to benefit residents of states with no state income tax. However, because it is available to all taxpayers, it may benefit those whose sales tax bill for the year exceeds their state income tax (e.g., in low-tax jurisdictions or in years they will incur large taxable expenditures). The sales tax deduction is a preference for alternative minimum tax (AMT) purposes and, thus, may be of little or no value to taxpayers exposed to the AMT. In such cases, if a taxpayer itemizes for state tax purposes and can claim the sales tax deduction, he or she may be better off deducting sales tax on the Federal return, even though the deduction results in no Federal tax savings.
Civil Rights Tax Relief AJCA Section 703 provides an above-the-line deduction for attorneys fees and costs paid by, or on behalf of, a taxpayer in connection with any action involving a claim of unlawful discrimination, certain claims against the Federal government or a private cause of action under the Medicare Secondary Payer statute. Under new Sec. 62(a)(19), the amount that may be deducted above-the-line cannot exceed the amount includible in the taxpayers gross income for the tax year on account of a judgment or settlement (whether by suit or agreement and whether as lump-sum or periodic payments) resulting from such claim.
Definition According to Sec. 62(e), unlawful discrimination is an act unlawful under certain provisions of any of the following:
This provision applies to fees and costs paid after Oct. 22, 2004 for any judgment or settlement occurring after that date. Prior to that, taxpayers required to include fee awards in gross income were allowed only an itemized deduction. The Supreme Court is considering this issue during the current term (i.e., whether contingent fee awards should be included in the plaintiffs gross income).1 Its opinion on contingent attorneys fees may still be relevant for non-civil rights type cases after the AJCA effective date and for all pre-AJCA contingent fee cases. However, AJCA Section 703 does not apply to personal injury awards or settlements; because they would be nontaxable, no deduction for attorneys fees would be available.
Principal Residence Exclusion for Like-Kind Exchange Property Under AJCA Section 840, exclusion of gain on the sale or exchange of a principal residence does not apply if the principal residence was acquired in a like-kind exchange in which any gain was not recognized within the prior five years. This provision adds Sec. 121(d) and is effective for sales or exchanges of principal residences after Oct. 22, 2004. Before the change, taxpayers who had rental property could exchange it tax free for residential property in a Sec. 1031 transaction. Then, after living there for two years, they could sell it and exclude any gain under Sec. 121, up to $250,000 ($500,000 if married filing jointly), including the gain that had been deferred on the exchange. The new provision closed that loophole.
Charitable Deductions Increased Reporting for Noncash Charitable Contributions AJCA Section 883(a) requires increased donor reporting for certain charitable contributions of property, other than cash, inventory or publicly traded securities. If the property contribution exceeds $500,000, the donor (whether an individual, partnership or corporation) must attach a qualified appraisal to its return. For purposes of this threshold, property and all similar items of property donated to one or more donees are treated as one property. According to the provision, a donor that fails to substantiate a charitable contribution of property, as required by the IRS, is denied a charitable deduction. For partnership or S corporation donors, the denial is at the partner or shareholder level. The deduction denial does not apply if the donor shows that the failure to substantiate was due to reasonable cause and not to willful neglect. AJCA Section 833(a), which adds Sec. 170(f)(11), is effective for contributions made after June 3, 2004. Except for the new $500,000 rule, however, it merely strengthens the need for solid substantiation when claiming a charitable deduction.
Limited Charitable Deduction for Vehicle Donations Under AJCA Section 884(a), the deduction for a charitable contribution of a vehicle (generally including automobiles, boats and airplanes for which the claimed value exceeds $500 (excluding inventory property)) depends on how the donee uses the vehicle. As is discussed below, if the donee sells it without any significant intervening use or material improvement, the deduction cannot exceed the gross sale proceeds. New Sec. 170(f)(12) is effective for contributions made after 2004. Substantiation: The AJCA imposes new substantiation requirements when the claimed value of a contributed vehicle exceeds $500 (excluding inventory). A deduction is not allowed unless the taxpayer substantiates the contribution with a contemporaneous written acknowledgement by the donee. The acknowledgement must contain the donors name and taxpayer identification number (TIN) and the vehicle identification number (VIN) (or similar number). In addition, if the donee sells the vehicle without a significant intervening use or material improvement, the acknowledgement must (1) certify that the vehicle was sold in an arms-length transaction between unrelated parties and (2) state the gross proceeds from the sale. The deduction cannot exceed such gross proceeds. In all other cases, the acknowledgement must contain a certification (1) of the intended use or material improvement; (2) of the intended duration of such use; and (3) that the vehicle will not be transferred in exchange for money, other property or services before completion of such use or improvement. The donee must notify the IRS of the information contained in an acknowledgement, in a time and manner to be provided by the Secretary. An acknowledgement is contemporaneous if provided (1) within 30 days of sale of a vehicle not significantly improved or materially used by the donee; or (2) in all other cases, within 30 days of the contribution. The IRS may prescribe regulations or other guidance that exempts vehicle sales in direct furtherance of the donees charitable purposes from the requirement that the (1) donor may not deduct an amount in excess of the gross sale proceeds; and (2) donee certify the vehicle will not be transferred in exchange for money, other property or services before completion of a significant use or material improvement. For example, an organization could directly further its charitable purposes by selling automobiles to needy persons at a price significantly below fair market value. Material improvement: Congress intends that a material improvement would include major repairs to the vehicle or other improvements that improve its condition in a manner that significantly increases its value. Cleaning the vehicle, minor repairs and routine maintenance are not material improvements. Significant-use test: To meet the significant-use test, an organization must actually and significantly use the vehicle to substantially further the organizations regularly conducted activities. A donees use is not significant if, under the facts and circumstances, the use is incidental or not intended at the time of the contribution. Whether a use is significant also depends on frequency and duration.
The use requirement is met if D actually uses a donated qualified vehicle to deliver food to the needy, because delivering meals substantially furthers Ds regularly conducted activity. However, Ds use also must be significant, which depends on nature, extent and frequency. If D used the vehicle only once or a few times to deliver meals, it would not meet that requirement; however, if it used the vehicle to deliver meals every day for a year, it would. Likewise, if D drove the vehicle 10,000 miles while delivering meals, such use would be significant. However, use of the vehicle in such an activity for only one week or several hundred miles generally would not be a significant use.
This use would not be significant if a volunteer merely uses the vehicle over a brief period to drive to or from Bs premises. On the other hand, if at the time B accepts the qualified vehicle contribution, it intends to use it as a regular and ongoing means of transport for its volunteers, and follows through with that intention, B would likely meet the significant-use test.
Under the AJCA, Ys use of the vehicle constitutes a significant intervening use prior to the sale; thus, Ts deduction is not limited to the gross sale proceeds Y received. In many cases, except in the apparently rare situation when the charity actually uses the vehicle, the AJCA will limit the deductible amount to the proceeds received by the charity on saleeven if the vehicles value is actually higher.
Limited Expensing of SUVs AJCA Section 910 added Sec. 179(b)(6), to limit the expensing of certain vehicles not subject to Sec. 280F, to $25,000, instead of the regular Sec. 179 limit of $102,000 (in 2004). The provision is effective for property placed in service after Oct. 22, 2004. It was included after the media publicized egregious cases of professionals and small business proprietors writing off the cost of sport utility vehicles (SUVs) purchased for business use. New Sec. 179(b)(6) applies to SUVs rated at 14,000 pounds gross vehicle weight or less (instead of the pre-AJCA 6,000 pound rating). For this purpose, an SUV excludes any vehicle that (1) is designed for more than nine individuals seating rearward of the drivers seat; (2) is equipped with an open cargo area, or a covered box not readily accessible from the passenger compartment, of at least six feet in interior length; or (3) has an integral enclosure, fully enclosing the driver compartment and load-carrying device, does not have seating rearward of the drivers seat and has no body section protruding more than 30 inches ahead of the leading edge of the windshield.
Under the AJCA, A is first allowed a $25,000 deduction under Sec. 179. A is also allowed additional first-year depreciation (Sec. 168(k)) of $22,500, based on $45,000 of adjusted basis ($70,000 original cost, less the $25,000 Sec. 179 deduction). Finally, the remaining adjusted basis of $22,500 ($45,000 adjusted basis, less $22,500 additional first-year depreciation) is eligible for an additional $4,500 depreciation deduction under the general depreciation rules (automobiles are five-year recovery property). The remaining $18,000 ($70,000 original cost, less $52,000 deductible currently) would be recovered in 2005 and subsequent years under the general depreciation rules.
Increased Withholding on Supplemental Wage Payments Under AJCA Section 904, annual supplemental wages paid to an employee after 2004 that exceed $1 million are subject to withholding at the highest income tax rate (35% for 2005), regardless of any other withholding rules and the employees Form W-4, Employees Withholding Allowance Certificate. The original proposal would have amended the supplemental withholding rate, but would have allowed regular withholding based on a Form W-4. Because of situations in which taxpayers claimed numerous exemptions to avoid withholding, the enacted provision requires ignoring Form W-4 in the case of a described supplemental payment. This may result in substantial overpayments for clients in certain circumstances. For example, if an employee exercises a stock option and donates the stock immediately to charity, the new provision requires 35% withholding, even though there is an offsetting deduction. Adjusting withholding on regular wages may partially mitigate this result.
Personal Use of Company Aircraft and Other Entertainment Expenses AJCA Section 907 amended Sec. 274(e)(2) and (9) so that, in the case of covered employees, the exceptions to the general entertainment expense disallowance rule for expenses treated as compensation or includible in income apply only to the extent of the amount of expenses treated as compensation or includible in income. Covered employees are individuals who, with respect to an employer or other service recipient, are subject to the requirements of Section 16(a) of the Securities and Exchange Act of 1934 (34 Act), or would be subject to such requirements if the employer or service recipient were an issuer of equity securities referred to in 34 Act Section 16(a). Such individuals generally include officers (as defined by 34 Act Section 16(a)), directors and 10%-or-more owners of private and publicly held companies. No deduction is allowed for expenses for a (1) nonbusiness activity generally considered to be entertainment, amusement or recreation or (2) facility (e.g., an airplane) used in connection with such activity, to the extent that such expenses exceed the amount treated as compensation or includible in the covered employees income. For example, a companys deduction attributable to aircraft operating costs for a covered employees vacation use of company aircraft is limited to the amount reported as employee compensation. As under present law, the deduction cannot exceed the actual cost. The provision is intended to overturn Sutherland Lumber-Southwest, Inc.,2 with respect to covered employees, and is effective for amounts incurred after Oct. 22, 2004. As under present law, the exceptions apply only if amounts are properly reported by the company as compensation and wages or otherwise includible in income. In a legal memorandum,3 the IRS had extended the result of Sutherland Lumber to an S corporation that owned an airplane used 95% for personal employee use. The Service concluded that the planes full operating cost was deductible. This provision would reverse that result as well, because, unlike the original proposal, the disallowance has been extended to executives of private companies and 10% owners. The original proposal would have affected only public companies and only with respect to their top employees.
AMT FTC AJCA Section 421 repeals the 90% limit on using the AMT foreign tax credit, effective for tax years beginning after 2004. This reverses a provision that had been enacted during the Reagan Administration to discourage investment in high-tax foreign jurisdictions. |
