From Maxwell Shmerler & Co., CPAs

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2005 Tax Law Changes

Starting in 2005

Uniform Definition of a Qualifying Child. Beginning in 2005, there will be one definition of a qualifying child for:

• Dependency exemption
• Head of Household filing status
• Earned income credit
• Child tax credit
• Credit for child and dependent care expenses

This change simplifies the law in this area and establishes "tie-breaking" rules if more than one individual wishes to claim a child for a specific tax provision.

Increased Retirement Contribution Limits. The changes for 2005 are as follows:

• The maximum IRA (traditional or Roth) contribution increases from $3,000 to $4,000 per person.
• The maximum 401(k) and 403(b) employee contribution increases to $14,000.
• The maximum SIMPLE employee contribution increases to $10,000.
• Taxpayers who are at least age 50 before the end of 2005 can increase their contribution limits by the following amounts for the following plans (called the catch-up contribution limit):
  • An additional $500 for IRAs
  • An additional $4,000 for 401(k), 403(b), salary reduction SEP plans, and 457 plans
  • An additional $2,000 for SIMPLE plans

Higher Income Limits for Deductible IRAs. If you are covered by a retirement plan at work, you can take an IRA deduction if your modified adjusted gross income is less than $80,000 (married filing jointly) or $60,000 (single or head of household).

Business Standard Mileage Rate Increased. To compensate for high gasoline costs in 2005, the standard business mileage rate was raised from 40.5 cents per mile to 48.5 cents per mile for miles driven after 9/1/05.

Increased Section 179 Expense Deduction. The maximum amount increases from $102,000 to $105,000.

Additional First-Year Depreciation. The bonus depreciation allowance of 50 percent expires for qualifying property purchased after 2004.

Domestic Production Activities Deduction. Starting in 2005, certain businesses, including sole-proprietorships, can claim a new deduction of three percent of business net income. This deduction applies to businesses engaged in construction, engineering, or architectural services; film production; or the lease, rental, or sale of equipment you manufactured.

Clean Fuel Deduction Expires. The clean fuel deduction of $2000 for the purchase of a new hybrid vehicle expires at the end of 2005. This deduction is replaced by a tax credit in 2006.

Charitable Contributions after 8/27/05. Cash contributions after 8/27/05 to any charity are not subject to the 50 percent adjusted gross income limitation and are not subject to the phaseout of itemized deductions for high income taxpayers.

Charitable Mileage Rate Increased. A taxpayer who uses a vehicle to provide donated services to a charity related to Hurricane Katrina can claim a charitable mileage deduction of 34 cents per mile, rather than the regular charitable mileage deduction of 14 cents per mile.

Charitable Contributions of Vehicles and Boats. The amount you can deduct for donations of autos and boats for which the claimed value exceeds $500 depends on how the donated asset is used by the charity. If the charity sells the auto or boat without any significant use or improvement to it, the donor's deduction is limited to the gross sales price obtained by the charity. The fair market value of the car or boat based on comparable sales or appraisal doesn't apply in this situation. This rule applies to donations made after 2004.

Housing Katrina Victims. Providing free housing to victims of Hurricane Katrina for at least 60 days allows the taxpayer to claim an exemption deduction of $500 per person, up to a maximum of $2000. This new type of exemption is not subject to the income-based phaseouts of regular personal exemptions.

Katrina Casualty Losses Get Special Treatment. Personal casualty loss deductions must normally be reduced by $100 per occurance and by 10 percent of adjusted gross income. Personal casualty losses due to Hurricane Katrina do not need to be reduced by these amounts.

Debt Relief Not Taxable. Certain personal debt relief due to Hurricane Katrina is not taxable, even if the taxpayer is not insolvent or bankrupt. The debt must not be business-related and the taxpayer must have lived in the Hurricane Katrina disaster area.

May Claim 2004 Earned Income Credit and Refundable Child Credit in 2005. Taxpayers can elect to calculate their 2005 earned income credit and refundable child credit based on their 2004 income if their 2005 earned income is lower. The individuals must have lived in the Hurricane Katrina disaster area and have been displaced from their home due to the hurricane.

Exclusion of Gain on Personal Residence. For sales after October 22, 2004, you cannot claim the $500,000/$250,000 gain exclusion on the sale of your principal residence if you acquired the home in a like-kind exchange within the last five years. This would occur if you previously had an investment property, did a like-kind exchange and then converted it to your principal residence.

Penalty-free Retirement Plan Distributions for Hurricane Katrina Victims. An individual who lived in the Hurricane Katrina disaster area and lost property can take a distribution from a retirement plan between 8/25/05 and 1/1/07 without incurring a penalty. The distribution is taxable over a three-year period.

Use the following to estimate your 2005 taxes. Do not use it to do your 2004 taxes. Taxable income is income less adjustments less exemptions less deductions.

• Taxable income includes wages, salaries, bonuses, interest, dividends, some Social Security, alimony, unemployment benefits, etc. It does not include child support, food stamps, or TANF (Temporary Assistance for Needy Families) benefits, etc.
• Adjustments are in addition to itemized or standard deductions. They are subtracted to figure your adjusted gross income. Common adjustments are alimony paid, contributions to regular (not Roth) Individual Retirement Accounts (IRAs), educator expenses, student loan interest, tuition and fee deductions, contributions to Health Savings Accounts (see below), and moving expenses.
• The Exemption amount for 2005 is $3,200 per exemption. You get an exemption for yourself, your spouse, and qualified dependents such as children and elderly parents. Personal exemptions are phased out if your adjusted gross income (income less adjustments) is over $145,950 if you file as single, $218,950 for married filing jointly or as a surviving spouse, $182,450 for head of household, and $109,475 for married filing separately.
• You may take either standard OR itemized deductions but not both. The standard deductions for 2005 are $5,000 if you file as single, $10,000 for married filing jointly or as a surviving spouse, $7,300 for head of household, and $5,000 for married filing separately. You get an additional $1,000 for each exemption who is over 65 and/or blind.

Changes in Tax Schedules: Single - Schedule X

If taxable income:		Then the tax is:
Is over	But not over	This amount	Plus	Of the amount over
$0	$7,300	-	10%	$0
$7,300	$29,700	$730.00	15%	$7,300
$29,700	$71,950	$4,090.00	25%	$29,700
$71,950	$150,150	$14,652.50	28%	$71,950
$150,150	$326,450	$36,548.50	33%	$150,150
$326,450	-	$94,727.50	35%	$326,450

Married Filing Jointly or Qualifying Widow(er) - Schedule Y-1

If taxable income:		Then the tax is:
Is over	But not over	This amount	Plus	Of the amount over
$0	$14,600	-	10%	$0
$14,600	$59,400	$1,460.00	15%	$14,600
$59,400	$119,950	$8,180.00	25%	$59,400
$119,950	$182,800	$23,317.50	28%	$119,950
$182,800	$326,450	$40,915.50	33%	$182,800
$326,450	-	$88,320.00	35%	$326,450

Head of Household - Schedule Z

If taxable income:		Then the tax is:
Is over	But not over	This amount	Plus	Of the amount over
$0	$10,450	-	10%	$0
$10,450	$39,800	$1,045.00	15%	$10,450
$39,800	$102,800	$5,447.50	25%	$39,800
$102,800	$166,450	$21,197.50	28%	$102,800
$166,450	$326,450	$39,019.50	33%	$166,450
$326,450	-	$91,819.50	35%	$326,450

Married Filing Separately - Schedule Y-2

If taxable income:		Then the tax is:
Is over	But not over	This amount	Plus	Of the amount over
$0	$7,300	-	10%	$0
$7,300	$29,700	$730.00	15%	$7,300
$29,700	$59,975	$4,090.00	25%	$29,700
$59,975	$91,400	$11,658.75	28%	$59,975
$91,400	$163,225	$20,457.75	33%	$91,400
$163,225	-	$44,160.00	35%	$163,225

Child Tax Credit:
The child tax credit is $1,000 for every child under the age of 17 at the end of the tax year.

Earned Income Credit:

Number of Qualifying Children
	One	Two or More	None
Earned Income Amount	$7,830	$11,000	$5,220
Maximum Amount of the Credit	$2,662	$4,400	$399
Threshold Phaseout Amount	$14,370	$14,370	$6,530
Completed Phaseout Amount	$31,030	$35,263	$11,750
Threshold Phaseout Amount Married filing jointly	$16,370	$16,370	$8,530
Completed Phaseout Amount Married filing jointly	$33,030	$37,263	$13,750

Your earned income credit will be denied if your investment income exceeds $2,700. See IRS Publication 596 for more details.

Standard Mileage Deduction
The business related mileage deduction for 2005 is 40.5 cents per mile. The medical and move related rate is 15 cents. The deduction for miles driven for charity is 14 cents, the same as 2004.

Annual Exclusion for Gifts
The annual exclusion for gifts is $11,000 per person.

Wage Limit for Social Security Tax
The wage limit for Social Security tax increases to $90,000. Dividends from Stocks and Mutual Funds and Net Capital Gains If you receive dividends on stocks and mutual funds, based on your tax bracket you will pay less tax on that income. The dividends must be from domestic corporations or foreign corporations that pay corporate taxes to the United States and whose stock is traded on an established U.S. securities exchange. You ALSO must own the stock for at least 60 days before the ex-dividend date (the date the dividend is declared). Dividends will be taxed similar to capital gains.

1. If you are in the 10% or 15% tax bracket, you will only pay 5% on dividends from 2003-2007, and no tax in 2008.
2. All other tax brackets will be taxed at the 15% rate through 2008.
3. In 2009 taxation reverts back to taxing them as ordinary income.
4. If you have net capital gains, the same rules apply as for dividends for gains after May 6, 2003, with at least a oneyear holding period.
5. Some sales may be taxed differently. For example the capital gains rate on collectibles is 28%. See IRS Publication 544, Sales and Other Dispositions of Assets.

Pension Plan Contributions

• The limit on deferred contributions to qualified pension plans increases to $14,000 ($18,000 for people 50 and over). SIMPLE plan contributions increase to $10,000 ($12,000 for people 50 and over).
• The deduction for IRAs increases to $4,000 ($4,500 if you are over 50) in 2005.

Tuition and fees deductions
This is an adjustment to gross income. In 2005 the deduction remains at $4,000 if your modified adjusted gross income is not more than $65,000 ($130,000 if you are married filling jointly). It is a maximum of $2,000 for income from $65,000 through $80,000 ($130,000 through $160,000) and disappears for incomes over $80,000 ($160,000). See Chapter 21 of IRS publication 17 for what are allowable education expenses.

Distributions from Qualified Tuition Programs
Distributions from Qualified Tuition Programs maintained by eligible education institutions can be excluded from income if the amount distributed is not more than qualified education expenses. For more information see Chapter 8 of IRS Publication 970, Tax Benefits for Education.

Health Savings Accounts (HSA)
An HSA is a tax-exempt custodial account that must be used in conjunction with a high deductible health plan. It is not the same as the medical spending account that you contribute to through your employer that must be spent each year. If you start an HSA:

• You can claim a tax deduction for your contributions (a new adjustment).
• Contributions made by your employer may be excluded from your gross income.
• The contributions remain in your account from year to year.
• Interest and other earnings on the assets in the account are tax free.
• Distributions may be tax free if you pay qualified medical expenses.
• The HSA is portable so it stays with you if you change jobs or leave the work force.

To qualify to have an HSA:

• You must have a high-deductible health plan such as a major medical plan with a deductible that is higher than normal for that type of plan. (The minimum annual deductible is $1,000 for an individual and $2,000 for a family. The maximum annual deductible is $5,100 for an individual and $10,200 for a family.)
• You have no other health insurance coverage (except disability, dental care, vision care, long-term care, workers compensation, specific illness, and fixed amount per day of hospitalization plans).
• You are not entitled to Medicare benefits.
• You cannot be claimed as a dependent on someone else's 2005 tax return.

In 2005, you can contribute up to your health plan deductible but not more than $2,650 ($3,100 if you are 55 or older) if you have self-only coverage. If you have family coverage, you can contribute up to your family deductible but not more than $5,250 ($5,650 if you are 55 or older). If either spouse has family coverage, both spouses are treated as having family coverage. If both spouses have family coverage, you are limited to the lower annual deductible. The HSA must be in effect the entire year to contribute to the full amount. For each full month you did not have a high deductible health plan, you must reduce your contribution by 1/12.

For more information and other changes see Publication 553 when the 2005 version is published.

Source: U.S. Department of the Treasury, Internal Revenue Service