Number Desk Guide
pdf (112KB) published 1-10-2005
Working Families Tax Relief Act of 2004
of Year Tax Planning published
2004 draws to a close, there is still time to
reduce your 2004 tax bill and plan ahead for
2005. This letter highlights several potential
tax-saving opportunities for you to consider.
I would be happy to meet with you to discuss
Numbers You Need To Know
Because many tax benefits are tied to or limited
by adjusted gross income (AGI)—IRA deductions,
for example—a key aspect of tax planning
is to estimate both your 2004 and 2005 AGI.
Also, when considering whether to accelerate
or defer income or deductions, you should be
aware of the impact this action may have on
your AGI and your ability to maximize itemized
deductions that are tied to AGI. Your 2003 tax
return and your 2004 pay stubs and other income-
and deduction-related materials are a good starting
point for estimating your AGI.
Another important number is your "tax bracket,"
i.e., the rate at which your last dollar of
income is taxed. The tax rates for 2004 are
10%, 15%, 25%, 28%, 33%, and 35%. Although tax
brackets are indexed for inflation, if your
income increases faster than the inflation adjustment,
you may be pushed into a higher bracket. If
so, your potential benefit from any tax-saving
opportunity is increased (as is the cost of
overlooking that opportunity).
IRA, Retirement Savings Rules for 2004
More tax-saving opportunities continue for retirement
planning in 2004 than in previous years due
to the availability of Roth IRAs, changes that
make regular IRAs more attractive, and other
retirement savings incentives.
Traditional IRAs: Individuals who are not active
participants in an employer pension plan may
make deductible contributions to an IRA. The
annual deductible contribution limit for an
IRA for 2004 is $3,000. Depending on AGI, individuals
who are active participants in a plan may make
deductible contributions to an IRA. For 2004,
the AGI phase-out range for deductibility of
IRA contributions is between $45,000 and $55,000
of modified AGI for single persons (including
heads of households), and between $65,000 and
$75,000 of modified AGI for married filing jointly.
Above these ranges, no deduction is allowed.
For 2004, a $500 "catch-up" contribution
deduction is allowed for taxpayers age 50 or
older by the close of the taxable year who meet
the other qualifications for IRA deductions.
Thus, the total deductible limit for these individuals
may be as high as $3,500.
In addition, an individual will not be considered
an "active participant" in an employer
plan simply because the individual's spouse
is an active participant for part of a plan
year. Thus, you may be able to take the full
deduction for an IRA contribution regardless
of whether your spouse is covered by a plan
at work, subject to a phase-out if your joint
modified AGI is $150,000 to $160,000. Above
this range, no deduction is allowed.
Roth IRA: This type of IRA permits nondeductible
contributions of up to $3,000 a year. Earnings
grow tax-free, and distributions are tax-free
provided no distributions are made until more
than five years after the first contribution
and the individual has reached age 59 1/2. Distributions
may be made earlier on account of the individual's
disability or death. The maximum contribution
is phased out for persons with AGI above certain
amounts: $150,000 to $160,000 for joint filers,
and $95,000 to $110,000 for single filers (including
heads of households). For 2004, a $500 "catch-up"
contribution is allowed for taxpayers age 50
or older by the close of the taxable year, making
the total limit $3,500 for these individuals.
Roth IRA Conversion Rule: Funds in a traditional
IRA may be rolled over into a Roth IRA. Such
a rollover, however, is treated as a taxable
event, and you will pay tax on the amount converted.
No penalties will apply if all the requirements
for such a transfer are satisfied.
A taxpayer's AGI (whether married filing jointly
or single) is limited to $100,000 to make such
a conversion and the taxpayer must not be a
married individual filing a separate return.
401(k) Contribution: The 401(k) elective deferral
limit is $13,000 for 2004, up from $12,000 in
2003. If your 401(k) plan has been amended to
allow for catch-up contributions for 2004 and
you will be 50 years old by December 31, 2004,
you may contribute an additional $3,000 to your
401(k) account, for a total maximum contribution
of $16,000 ($13,000 in regular contributions
plus $3,000 in catch-up contributions).
SIMPLE Plan Contribution: The SIMPLE plan deferral
limit is $9,000 for 2004, up from $8,000 in
2003. If your SIMPLE plan has been amended to
allow for catch-up contributions for 2004 and
you will be 50 years old by December 31, 2004,
you may contribute an additional $1,500.
Catch-Up Contributions for Other Plans: If you
will be 50 years old by December 31, 2004, you
may also contribute an additional $3,000 to
your 403(b) plan or SEP.
Saver's Credit: A nonrefundable tax credit is
available based on the qualified retirement
savings contributions to an employer plan made
by an eligible individual. Only taxpayers filing
joint returns with AGI of $50,000 or less, head
of household returns with AGI of $37,500 or
less, or single returns (or separate returns
filed by married taxpayers) with AGI of $25,000
or less, are eligible for the credit. The amount
of the credit is equal to the applicable percentage
(10% to 50%, based on filing status and AGI)
of qualified retirement savings contributions
up to $2,000.
Maximize Retirement Savings: In many cases,
employers will require you to set your 2005
retirement contribution levels before January
2005. You may want to increase your contribution
to lower your AGI in order to take advantage
of some of the tax breaks described above. In
addition, maximizing your contribution is generally
a good tax-saving move.
Deferring Income to 2005
If you expect your AGI to be higher in 2004
than in 2005, or if you anticipate being in
the same or a higher tax bracket in 2004, you
may benefit by deferring income into 2005. Deferring
income will be advantageous so long as the deferral
does not bump your income to the next bracket.
Some ways to defer income include:
Delay Billing: If you are self-employed, delay
year-end billing to clients so that payments
will not be received until 2005.
Interest and Dividends: Interest income earned
on Treasury securities and bank certificates
of deposit with maturities of one year or less
is not includible in income until received.
To defer interest income, consider buying short-term
bonds or certificates that will not mature until
next year. If you have control as to when dividends
are paid, arrange to have them paid to you after
the end of the year.
Accelerating Income Into 2004
In limited circumstances, you may benefit by
accelerating income into 2004. For example,
you may anticipate being in a higher tax bracket
in 2005, or perhaps you will need additional
income in order to take advantage of an offsetting
deduction or credit that will not be available
to you in future tax years. Note however that
accelerating income into 2004 will be disadvantageous
if you expect to be in the same or lower tax
bracket for 2005. In any event, before you decide
to implement this strategy, we should "crunch
If accelerating income will be beneficial, here
are some ways to accomplish this:
Accelerate Collection of Accounts Receivable:
If you are self-employed and report income and
expenses on a cash basis, issue bills and attempt
collection before the end of 2004. Also see
if some of your clients or customers might be
willing to pay for January 2005 goods or services
in advance. Any income received using these
steps will shift income from 2005 to 2004.
Year-End Bonuses: If your employer generally
pays year-end bonuses after the end of the current
year, ask to have your bonus paid to you before
the beginning of 2005.
Retirement Plan Distributions: If you are over
age 59 1/2 and you participate in an employer
retirement plan or have an IRA, consider making
any taxable withdrawals before 2005.
You may also want to consider making a Roth
IRA rollover distribution, as discussed above.
Deduction timing is also an important element
of year-end tax planning. Deduction planning
is complex, however, due to factors such as
AGI levels and filing status. If you are a cash-method
taxpayer, remember to keep the following in
• Deduction In Year Paid: An expense is
only deductible in the year in which it is actually
• Payment By Check: Date checks before
the end of the year and mail them before January
• Promise To Pay: A promise to pay or
providing a note does not permit you to deduct
the expense. But you can take a deduction if
you pay with money borrowed from a third party.
Hence, if you pay by credit card in 2004, you
can take the deduction even though you won't
pay your credit card bill until 2005.
AGI Limits: The AGI limits on itemized deductions
affect deduction planning. For 2004 returns,
overall itemized deductions are reduced by 3%
of the AGI exceeding $142,700 ($71,350 if married
filing separately). Similarly, certain deductions
may be claimed only if they exceed a percentage
of AGI: 7.5% for medical expenses, 2% for miscellaneous
itemized deductions, and 10% for casualty losses.
Standard Deduction Planning: Deduction planning
is also affected by the standard deduction.
For 2004 returns, the standard deduction is
$9,700 for married taxpayers filing jointly,
$4,850 for single taxpayers, $7,150 for heads
of households, and $4,850 for married taxpayers
filing separately. If your itemized deductions
are relatively constant and are close to the
standard deduction amount, you will obtain little
or no benefit from itemizing your deductions
each year. But simply taking the standard deduction
each year means you lose the benefit of your
itemized deductions. To maximize the benefits
of both the standard deduction and itemized
deductions, consider adjusting the timing of
your deductible expenses so that they are higher
in one year and lower in the following year.
Medical Expenses: Medical expenses, including
amounts paid as health insurance premiums, are
deductible only to the extent that they exceed
7.5% of AGI. Consider bunching medical expenses
into years when your AGI is lower.
State Taxes: If you anticipate a state income
tax liability for 2004 and plan to make an estimated
payment, consider making the payment before
the end of 2004. Note that beginning with the
2004 tax year and ending with the 2005 tax year,
you can choose to deduct as an itemized deduction
state and local sales taxes instead of income
Charitable Contributions: Consider making your
charitable contributions at the end of the year.
This will give you use of the money during the
year and simultaneously permit you to claim
a deduction for that year. You can use a credit
card to charge donations in 2004 even though
you will not pay the bill until 2005. A mere
pledge to make a donation is not deductible,
however, unless it is paid by the end of the
year. Note, however, for claimed donations of
cars, boats and airplanes of more than $500
made after 2004, the amount available as a deduction
will significantly depend on what the charity
does with the donated property, not just the
fair market value of the donated property. If
the organization sells the property without
any significant intervening use or material
improvement to the property, the amount of the
charitable contribution deduction cannot exceed
the gross proceeds received from the sale. If
you are planning to donate such property in
the near future, doing so by the end of 2004
could be a significant tax savings strategy.
To avoid capital gains, you may want to consider
giving appreciated property to charity.
• Self-Employed Health Insurance Premiums:
Self-employed individuals are allowed to claim
100% of the amount paid during the taxable year
for insurance that constitutes medical care
for themselves, their spouses and dependents
as an above-the-line deduction, without regard
to the 7.5% of AGI floor.
• Equipment Purchases: If you are in business
and purchase equipment, you may make a "Section
179 Election," which allows you to expense
(i.e. currently deduct) otherwise depreciable
business property. In general, you may elect
to expense up to $102,000 of equipment costs
(with a phase-out for purchases in excess of
$410,000) if the asset was placed in service
during 2004. In addition, careful timing of
equipment purchases can result in favorable
depreciation deductions in 2004. In general,
under the "half-year convention,"
you may deduct six months worth of depreciation
for equipment that is placed in service on or
before the last day of the tax year. (If more
than 40% of the cost of all personal property
placed in service occurs during the last quarter
of the year, however, a "mid-quarter convention"
applies, which lowers your depreciation deduction.)
A popular strategy in recent years is to purchase
a vehicle (usually an SUV) for business purposes
that exceeds the depreciation limits set by
statute (i.e., a vehicle rated over 6,000 pounds).
Doing so would not subject the purchase to the
statutory dollar limit, $2,960 for 2004. Therefore,
the vehicle would qualify for the full equipment
expensing dollar amount. However, for SUVs (rated
between 6,000 and 14,000 pounds gross vehicle
weight) placed in service after October 22,
2004, the expensing amount is limited to $25,000.
• First-Year Bonus Depreciation: For qualified
property placed in service in 2004, you may
take an additional depreciation allowance of
50% of the adjusted basis of the property (30%
of the basis if elected). The adjusted basis
of the qualified property is reduced by this
additional allowance before computing any other
depreciation. (However, the first-year §179
expensing amount described above is computed
before this additional allowance is computed.)
A 30% additional allowance applies to qualified
New York Liberty Zone property—property
meeting certain requirements and located in
the vicinity of the 9/11 tragedy in New York
City. Because property qualifying as NYLZ property
is not eligible for the 50% allowance, it would
be beneficial to meet the tests for 50% allowance,
but not for the NYLZ allowance. In general,
the 50% allowance is scheduled to expire on
December 31, 2004, so any plans to acquire and
place into service eligible property might be
beneficial doing so before the end of 2004.
• NOL Carryback Period: If your business
suffers net operating losses in 2004, you may
apply those losses against taxable income going
back two tax years. Thus, for example, the loss
could be used to reduce taxable income—and
thus generate tax refunds—for tax years
as far back as 2002.
Education and Child Tax Benefits
Child Tax Credit: A tax credit of $1,000 per
qualifying child under the age of 17 is available
on this year's return. The credit is phased
out at a rate of $50 for each $1,000 (or fraction
of $1,000) of modified AGI exceeding the following
amounts: $110,000 for married filing jointly;
$55,000 for married filing separately; and $75,000
for all other taxpayers. A portion of the credit
may be refundable.
Credit for Adoption Expenses: For 2004, the
adoption credit limitation is $10,390 of aggregate
expenditures for each child, except that the
credit for an adoption of a child with special
needs is deemed to be $10,390 regardless of
the amount of expenses. The credit ratably phases
out for taxpayers whose income is between $155,860
HOPE Credit and Lifetime Learning Credit: The
maximum HOPE credit is $1,500 (100% on the first
$1,000, plus 50% of the next $1,000) for qualified
tuition and fees paid on behalf of a student
(i.e., the taxpayer, the taxpayer's spouse,
or a dependent) who is enrolled on at least
a half-time basis. The credit is available for
only the first two years of the student's post-secondary
The Lifetime Learning credit maximum in 2004
is $2,000 (20% of qualified tuition and fees
up to $10,000). A student need not be enrolled
on at least a half-time basis so long as he
or she is taking post-secondary classes to acquire
or improve job skills. As with the HOPE credit,
eligible students include the taxpayer, the
taxpayer's spouse, or a dependent.
For 2004, both the HOPE credit and the Lifetime
Learning credit are phased out at modified AGI
levels between $85,000 and $105,000 for joint
filers, and between $42,000 and $52,000 for
Coverdell Education Savings Account: Beginning
in 2004, the aggregate annual contribution limit
to a Coverdell education savings account is
$2,000 per designated beneficiary of the account.
This limit is phased out for individual contributors
with modified AGI between $95,000 and $110,000
and joint filers with modified AGI between $190,000
and $220,000. The contributions to the account
are nondeductible but the earnings grow tax-free.
Student Loan Interest: You may be eligible for
an above-the-line deduction for student loan
interest paid on any "qualified education
loan." The maximum deduction is $2,500
in 2004. The deduction is phased out at a modified
AGI level between $100,000 and $130,000 for
joint filers in 2004, and between $50,000 and
$65,000 for individual taxpayers.
Qualified Higher Education Expenses: For 2004,
you also may be eligible to deduct qualified
tuition and related expenses as an above-the-line
deduction. In 2004, a taxpayer with modified
AGI of not more than $65,000 ($130,000 for a
married couple filing jointly) who is not claimed
as a dependent on another person's return is
entitled to a maximum deduction of $4,000. For
taxpayers with modified AGI of $65,000 or more
but not more than $80,000 ($130,000/$160,000
for a married couple filing jointly), the maximum
deduction is $2,000.
Rules are in effect to coordinate education
provisions, such as the qualified higher education
expense deduction, the Hope and Lifetime Learning
credits, Coverdell education savings accounts,
and qualified tuition plans, to prevent double
Small Employer Pension Plan Startup Cost Credit:
For 2004, certain small business employers that
did not have a pension plan for the preceding
three years may claim a nonrefundable income
tax credit for expenses of establishing and
administering a new retirement plan for employees.
The credit applies to 50% of the first $1,000
in administrative and retirement-education expenses
for each of the first three plan years.
Employer-Provided Child Care Credit: For 2004,
employers may claim a credit of up to $150,000
for supporting employee childcare or childcare
resource and referral services. The credit is
allowed for a percentage of "qualified
child care expenditures" including for
property to be used as part of a qualified child
care facility, for operating costs of a qualified
child care facility and for resource and referral
Investment Planning and Gift Planning
The following rules apply for most capital assets
• Capital gains on property held one year
or less are taxed at an individual's ordinary
income tax rate.
• Capital gains on property held for more
than one year are taxed at a maximum rate of
15% (5% if an individual is in the 10% or 15%
marginal tax bracket).
Timing of Sales: You may want to time the sale
of assets so as to have offsetting capital losses
and gains. Capital losses may be fully deducted
against capital gains and also may offset up
to $3,000 of ordinary income ($1,500 for married
filing separately). In general, when you take
losses, you must first match your long-term
losses against your long-term gains, and short-term
losses against short-term gains. If there are
any remaining losses, you may use them to offset
any remaining long-term or short-term gains,
or up to $3,000 (or $1,500) of ordinary income.
When and whether to recognize such losses should
be analyzed in light of the changes in the capital
gains rates applicable to your specific investments.
Dividends: Qualifying dividends received in
2004 will be subject to rates similar to the
capital gains rates. Therefore, qualifying dividends
will be taxed at a maximum rate of 15%. Qualifying
dividends includes dividends received from domestic
and certain foreign corporations.
Gifts: To avoid capital gains, you may want
to consider giving appreciated property to children
or grandchildren if they are in a lower tax
bracket than your own. For 2004, each person
is entitled each year to give gifts of $11,000
to an unlimited number of donees without incurring
any gift tax. For example, you can annually
give $11,000 to each of your children, their
spouses, and your grandchildren without utilizing
any of your applicable credit amount. Your spouse
can agree to "gift-split" thus doubling
the amount of these gifts. (The applicable credit
available against the gift tax is $1 million
Depending on the recipient's modified AGI and
the amount of Social Security benefits, a percentage—up
to 85%—of Social Security benefits may
be taxed. To reduce that percentage, it may
be beneficial to defer receipt of other retirement
income. One way to do so is to elect to receive
a lump sum distribution from a retirement plan
and to rollover that distribution into an IRA.
Alternatively, it may be beneficial to accelerate
income so as to reduce the percentage of your
Social Security taxed in 2005 and later years.
Other Tax Planning Opportunities
We also can discuss the potential benefits to
you or your family members of other planning
options available for 2004, including §529
qualified tuition programs, the above-the-line
deduction for teachers for classroom-related
expenses, and the deductions for qualified electric
vehicles and clean-fuel vehicle property.
Alternative Minimum Tax
Some of the standard year-end planning ideas
will not reduce tax liability if you are subject
to the alternative minimum tax (AMT) because
different rules apply. Because of the complexity
of the AMT, it would be wise for us to analyze
your AMT exposure.
If you have any questions, please do not hesitate
to call. I would be happy to meet with you at
your convenience to discuss the strategies outlined
above. There is still time to implement these
strategies to minimize your 2004 tax liability.
Very truly yours,
Kevin J. Mullins
hope the preceding summary has been informative
Please contact our
firm for further details of interest to