This letter briefly summarizes the "Working Families Tax Relief Act of 2004", enacted October 4, 2004, and the "American Family Jobs Creation Act of 2004", enacted October 11, 2004. Ten Percent Tax Bracket Increase Extended Through 2010 Tax cut legislation in 2001 created a new 10% income tax bracket below the 15% bracket, which previously had been the lowest tax bracket. In 2004, the amounts taxed at the 10% rate are (because of inflation adjustments) $7,150 for single filers, $10,200 for heads of household, and $14,300 for joint filers and surviving spouses. These amounts were scheduled to drop to $6,000, $10,000, and $12,000, respectively, in 2005 and to stay at those levels until 2008. The result would have been higher taxes because more income would have been taxed at the next higher rate of 15%. The new law prevents this result by retaining the 2003 and 2004 levels, with inflation adjustments, through 2010. Individual Alternative Minimum Tax Relief Extended Through 2005 The new law delays for one year a scheduled reduction in the exemption amounts for the individual alternative minimum tax (AMT). As a result, the following exemption amounts, which apply in 2004, will also apply in 2005: $40,250 for unmarried taxpayers (versus $33,750), $58,000 for joint filers and surviving spouses (versus $45,000), $29,000 for married filing separately (versus $22,500). The exemption amount for estates and trusts-$22,500-was not affected by the new law or previous tax cut legislation. Note that the exemption amount is phased out at certain income levels. The new law does not change this rule. The new law does, however, permit all nonrefundable personal credits to be used in full in calculating individual alternative minimum tax in 2004 and 2005. Previously, only the adoption credit, child credit, and IRA credit were to be allowed in full against the AMT in 2004 and later years. Marriage Penalty Relief Extended Through 2005 Previous legislation provided temporary marriage penalty relief for joint filers by increasing both the standard deduction and the amount of income taxed at the 15% rate to twice the comparable amounts for single taxpayers. Thus, in 2004, the standard deduction for joint filers and surviving spouses is $9,700 (versus $4,850 for single filers) and the amount taxed at 15% is $43,800 (versus $21,900 for single filers). These differentials were scheduled to drop in 2005 and not return to the 200% level until either 2008 (15% bracket) or 2009 (standard deduction). Under the new law, the differentials will remain at 200% through 2010. $1,000 Per Child Tax Credit Retained The child tax credit for 2004 is $1,000 per qualifying child. The credit was scheduled to decrease to $700 in 2005 and gradually increase to $1,000 again in 2010. The new law retains the $1,000 amount through 2010. Teachers' Out-of-Pocket Classroom Expense Deduction Extended Through 2005 Previous legislation permitted teachers and other "eligible educators" in grades kindergarten through 12 to take an "above-the-line" deduction in 2002 and 2003 of up to $250 for certain unreimbursed classroom expenses. The new law extends this provision through 2005, effective retroactively to the beginning of 2004. Therefore, teachers, instructors, counselors, principals, or aides in a school for at least 900 hours during a school year may deduct up to $250 of eligible out-of-pocket expenses in 2004 and 2005 without having to itemize and without being subject to the limitation on "miscellaneous itemized deductions." Eligible expenses include books, certain supplies, computer equipment (including related software and services), other equipment, and supplementary materials that the taxpayer uses in the classroom. Qualified Electric Vehicles and Clean-Fuel Vehicle Property Previous legislation provided temporary tax incentives for "qualified electric vehicles" and "clean-fuel vehicle property" placed in service before 2007. A credit of up to $4,000 was available for qualified electric vehicles purchased before 2004. A deduction of $2,000 ($5,000 or $50,000 for certain trucks and vans) was available for "qualified clean-fuel vehicle property" purchased before 2004. These maximums were scheduled to drop by 25% in 2004, 50% in 2005, and 75% in 2006. The new law repeals the scheduled reductions for 2004 and 2005. Thus, the full credit or deduction will be available in those years. The new law did not change the 75% reduction scheduled for 2006, or the termination of these special incentives thereafter. Deduction from Qualified Production Activities Income When fully phased in, the deduction could be as much as 9% of "qualified production activities income," which, in essence, is the net income attributable to "domestic production gross receipts." The latter term encompasses much more than income from U.S.-based manufacturing activities. In addition to traditional manufacturers, any business might qualify if it: produces, grows, or extracts, "in whole or in significant part within the United States," any tangible personal property, computer software, or sound recordings; and derives income from any "lease, rental, license, sale, exchange, or other disposition of" such property. Other qualifying activities include: performing construction in the United States; performing engineering or architectural services in the United States for construction projects in the United States; producing electricity, natural gas, or potable water in the United States; producing films for which at least 50% of the total compensation was paid for services in the United States. Taxpayers eligible for the deduction include individuals and pass-through entities such as S corporations, partnerships, and limited liability companies (LLCs), as well as C corporations. With the new rule set to go into effect in taxable years beginning after December 31, 2004, such guidance presumably will be high on the government's priority list. Nonqualified Deferred Compensation Rules Toughened The new law significantly changes the law of nonqualified deferred compensation and imposes potentially large tax penalties for noncompliance. Unless a nonqualified deferred compensation (NQDC) plan meets the requirements of a new tax Code section, amounts deferred under the plan are includible in income back to the time of deferral or, if later, when no longer subject to a substantial risk of forfeiture, and are subject to interest at the underpayment rate plus 1% and a 20% additional tax. The new law imposes requirements on NQDC plans with regard to participant elections, distributions, acceleration and funding that likely will necessitate amendments to most NQDC plans. A participant must make an election to defer compensation by the end of the taxable year preceding the year in which the employee will perform services for the company. Employees who are newly eligible must elect to defer within 30 days of becoming eligible. For performance-based compensation for services provided over a period of at least 12 months, the election must be made no later than six months before the end of the service period. The plan or the election must include the timing and form of a distribution. Except as provided by regulations yet to be issued, distributions are permitted only upon the following triggers: separation from service; death of the participant; a specified time or pursuant to a fixed schedule (but not upon a specified event); change in control of the corporation; an unforeseeable emergency; or disability of the participant. Also except as provided by regulations, a plan may not accelerate a distribution. This provision negates such commonly used approaches as "haircuts," that permit a participant to take a distribution at any time, but the participant must forfeit a portion of his or her account balance over the amount of the distribution. The new law provisions apply to amounts deferred after December 31, 2004. Earnings on amounts deferred prior to that date generally are not subject to the new requirements. However, if a plan is "materially modified" after October 3, 2004, amounts deferred to a plan generally will be subject to the new law. Small Business "Expensing" Increases Extended Previous legislation increased the annual allowance for taxable years beginning after 2002 and before 2006 to $100,000 (from $25,000) and the "phase-out" threshold to $400,000 (from $200,000), with annual inflation adjustments, and added off-the-shelf software as eligible property. For taxable years beginning after 2005, the dollar amount was scheduled to revert back to $25,000. The new law extends the increased annual allowance through taxable years beginning before 2008. S Corporation Rules Liberalized Several new rules make it easier to qualify as an S corporation or to retain that status. Among other things, the new law: treats certain family members as one shareholder for purposes of the limit on the number of eligible shareholders; increases the number of eligible shareholders to 100; provides relief from inadvertently invalid qualified subchapter S subsidiary ("QSST") elections; Itemized Deduction for State and Local Sales Taxes Individuals who itemize their deductions can now elect to deduct state and local sales taxes instead of state and local income taxes. Although the principal beneficiaries are residents of states that do not have an income tax, the new deduction provides an alternative for taxpayers living in states that impose both income and sales taxes. The amount of the deduction can be based on actual taxes paid or by using IRS-prepared tables. This provision is retroactive to January 1, 2004. Therefore, the deduction will be available for individual returns due next April. SUV Expensing Allowance Limited to $25,000 Previously, SUVs weighing more than 6,000 pounds were not subject to the limitations imposed on so-called "luxury" automobiles because their weight put them outside the limitation-triggering definition of "passenger" automobiles. The new law creates a separate category for such SUVs (including those rated at a gross vehicle weight of not more than 14,000 pounds) and imposes a $25,000 limit on the deduction. This limit will be effective for property placed in service on the date the President signs the legislation. Charitable Deduction Rules Tightened After December 31, 2004, you may no longer use the "Blue Book" value because your deduction is limited to the amount for which the charity later sells the vehicle. In addition to this limitation on the amount of your deduction, the charity must prepare, and you must attach to your return, a statement identifying the vehicle and stating the amount for which it was sold. Failure to attach the statement will result in disallowance of your deduction.