Tax News

American Jobs Creation Act
Jobs Creation Act S Corporation
First-year Depreciation for 2003 and 2004
Increased Section 179 Expense Amount

American Jobs Creation Act of 2004 (HR4520)

Section 179 Expensing-- Expensing of up to $100,000 of assets was extended two years (for 2006 and 2007). This amount is phased out if more than $400,000 of qualified property is placed in service in one year. Both amounts are indexed for inflation.

The section 179 deduction for SUVs with weight of 14,000 pounds or less is limited to $25,000. The limitation does not apply to vehicles with a certain seating capacity, cargo area, and integral enclosure. Effective for property placed in service after the date of enactment.

Start-Up and Organizational Costs-- Taxpayers can elect to deduct up to $5,000 of start-up and $5,000 of organizational expenses in the first year of business. However, the $5,000 amounts are reduced by the amount by which the total cost of start-up or organizational expenses exceeds $50,000, respectively. Expenses not deductible in the first year of the business are amortized over 15 years, consistent with the amortization period for section 197 intangibles. Effective for expenses incurred after the date of enactment.

Credit for Production of Oil and Gas From Marginal Wells-- A new credit for production of crude oil or qualified natural gas is allowed as part of the general business credit. The credit is the sum of (1) $3.00 per barrel for the production of crude oil and (2) $.50 per 1,000 cubic feet of qualified natural gas production. The maximum amount of production on which credit can be claimed is 1,095 barrels or barrel equivalents. The credit is reduced as oil and gas prices increase. Unused credits can be carried back five years. If the production also qualifies for the credit for fuel from non-conventional sources, the taxpayer can only claim the new marginal wells credit if the taxpayer elects not to claim the credit for fuel from non-conventional sources, effective for production in taxable years beginning after December 31, 2004.

Cancellation of Indebtedness Income on Transfer of Partnership Interest-- In determining cancellation of indebtedness income, a partnership that transfers a partnership interest to a creditor in satisfaction of a debt is treated as if it paid cash equal to the fair market value of the partnership interest, effective for cancellations of indebtedness occurring on or after the date of enactment.

American Jobs Creation Act of 2004 (HR4520)
S Corporation Provisions

Number of Shareholders-- For purposes of the 75 shareholder limitation, all family members (up to six generations) may elect to be treated as one shareholder. In addition, the maximum number of eligible shareholders is increased from 75 to 100, effective for taxable years beginning after December 31, 2004. Transfer of Suspended Losses Incident to Divorce. Losses that are suspended because of basis and at risk limitations are transferred to the spouse who receives the stock as part of a divorce settlement, effective for taxable years beginning after December 31, 2004.

Agricultural Incentives

Livestock Sold on Account of Weather-Related Conditions-- Ranchers now have four years (rather than two) to replace livestock sold due to weather-related conditions in areas that are eligible for federal government assistance, and defer taxes on any gain from the sale. The IRS may extend the replacement period on a regional basis if the weather-related conditions continue for more than three years, effective for returns due (without regard to extensions) after December 31, 2002.

Farmers and Fishermen Income Averaging and AMT-- Beginning in 2004, fishermen may use the income averaging previously available only to farmers. In addition, income averaging and AMT are coordinated so the benefits of income averaging are not reduced or eliminated by AMT. For purposes of determining AMT, the taxpayer's regular tax liability (without averaging) is compared to the tentative minimum tax, effective for taxable years beginning after December 31, 2003.

Reforestation Expenses-- Taxpayers may now elect to deduct up to $10,000 ($5,000 MFS) of reforestation expenses in the year paid or incurred (instead of amortizing the expenses over 84 months).Trusts and estates must apportion the allowed deduction between the fiduciary and beneficiar(ies) based on forthcoming Treasury regulations.

Note: The reforestation tax credit is repealed for expenses paid or incurred after the date of enactment.

Tobacco Buyout-- The current federal tobacco support program is repealed. Tobacco quota holders will receive $7 per pound on their basic quota allotment paid in equal installments over 10 years, beginning in 2005. Tobacco producers will receive transition payments of $3 per pound based on their effective quota, paid in equal installments over 10 years, beginning in 2005. If a farmer or producer dies prior to receiving all payments, the right to the payments transfers to the surviving spouse, if none, to the estate of the farmer or producer.

Foreign Income

Foreign Tax Credit Baskets-- Beginning in 2007, the foreign tax credit limitation categories of income are reduced from nine to two - passive income and general category income. Note: Taxes paid or accrued in a tax year beginning before 2007 and carried to 2007 or later years are treated as if the new rule applied when the taxes were paid or accrued.

Foreign Tax Credit Carryforward/ Carryback-- The foreign tax credit carryforward period is extended to 10 years (from five) and the carryback period is reduced to one year (rather than two). The extension of the carryforward period is effective for excess credits that are carried to a tax year ending after the date of enactment. The one year carryback period is effective for excess credits arising in tax years beginning after the date of enactment.

Foreign Tax Credit and AMT-- The current 90% limitation on the use of foreign tax credits against corporate AMT is repealed beginning in 2005.

U.S. Possessions - Residence Rules-- A two-part test applies for purposes of determining who is a resident of certain U.S. possessions (i.e., Guam, American Samoa, the Northern Mariana Islands, Puerto Rico, or the Virgin Islands).

The person must be present in the U.S. possession for 183 days each taxable year,
The person must not have a tax home outside the U.S. possession during the year and must not have a closer connection to the United States or a foreign country during the year.

This change is effective for tax years ending after the date of enactment.

Preparer Regulation

Regulation of Individuals Practicing Before IRS-- Censure and monetary penalties have been added to the sanctions the IRS may impose, effective for actions taken after the date of enactment.

First-year Depreciation for 2003 and 2004
The Job Creation and Workers Assistance Act of 2002 included a provision that allows up to 30% of qualified property to be deducted in the year the asset is placed into service. This bonus depreciation may be claimed on qualified property acquired or constructed after September 10, 2001, and before September 11, 2004.
The new law increases the bonus depreciation to 50% for qualified property placed in service after May 5, 2003 and before January 1, 2005. Taxpayers may elect the 30% additional depreciation rate for any class of property. If they make the election, the 50% amount does not apply to any property in that class.

Who Benefits?
Small businesses that want to write off assets faster. A larger deduction can reduce income tax as well as self-employment taxes.

Our Advice
Before making a decision to write-off assets, be sure to compare how a faster write-off will affect your taxes in future years. Also consider the effect of lowering your social security contributions on future social security benefits.

Increased Section 179 Expense Amount for 2003-2005

Under prior law, up to $25,000 of certain assets placed in service may be expensed under Code section 179. This amount was phased out if more than $200,000 of qualifying property is placed in service in one year. The election was generally required to be made on the original return and could be revoked only with consent of the Commissioner.

Under the new law, up to $100,000 (2003) may be expensed. This amount is phased out if more than $400,000 of qualified property is placed in service in one year. Both amounts are indexed for inflation. The new law also allows the election to be made on an original or amended return and can be revoked without permission.

Example: Assume Sam Smith's net income from self-employment (Schedule C) is $75,000, after claiming a section 179 expense deduction of $25,000 (on $50,000 of qualified purchases). Assuming Sam's income is taxed at 30% (based on total taxable income), Sam pays income tax of $22,500 on his Schedule C income. Self-employment tax of $10,597 is also paid.

Disregarding the change in depreciation, Sam could reduce his Schedule C income to $50,000. His income tax bill would decrease to $15,000, and his SE tax would be reduced to $7,065. Sam's total tax savings due to the increased section 179 expense election would be $10,502 ($7,500 - ($1,767 x 30% reduced SE tax adjustment) + $3,532).

Who Benefits?
The provision helps larger businesses deduct assets faster. Smaller businesses derive little or no benefit from the provision, because their annual asset acquisitions generally are not as large.