Working Families Tax Relief Act of 2004
This letter briefly summarizes the “Working Families Tax Relief Act of 2004,” enacted October 4, 2004.
True to its name, the new law primarily affects individual taxpayers, particularly families. Also, it contains several short-term extensions of business or investment tax benefits, plus technical corrections to previous legislation.
For most individuals, the new law means a continuation of the income tax rates, credits, and deductions that have applied in recent years, plus a one-year extension of alternative minimum tax relief. And for at least some businesses, the new law may provide tax-saving opportunities in 2004 and 2005.
For some individuals, the new law may affect eligibility for, or the amount of, several tax benefits relating to family members or others with whom the taxpayer has a close connection: the dependency exemption, the child tax credit, the earned income credit, the dependent care credit, and head-of-household filing status. These provisions, which are primarily intended to simplify the tax code, generally go into effect in 2005.
Highlights of the new law follow. Please feel free to contact our office for further information on any topic of interest to you.
Tax Cut Extensions for Individuals
The new law extends several previously-enacted tax cuts that were scheduled to be eliminated or reduced in 2005. Hence, these provisions will prevent many individuals from incurring increased tax liability in 2005 and perhaps in subsequent years as well.
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.
Note that the new law does not change the rule that the maximum credit amount is phased out for taxpayers with income exceeding certain levels. For example, in 2004, the phase-out range for joint filers begins at $110,000 of “modified adjusted gross income” (gross income plus certain nontaxable income).
The new law does, however, accelerate a scheduled increase in the refundable amount of the child tax credit. Also, nontaxable combat pay is treated as earned income for purposes of calculating the refundable amount.
Thus, in 2004, the refundable amount will be 15% (versus 10%) of earned income—including nontaxable combat pay—in excess of $10,750. The 15% rate will continue through 2010 and the $10,750 amount will be indexed for inflation.
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.
Uniform Definition of Child
The new law seeks to simplify the tax code by applying a uniform definition of “child” for purposes of the dependency exemption, the child credit, the earned income credit, the dependent care credit, and head-of-household filing status. These provisions will not generally apply until after tax year 2004, and therefore will not affect individual returns to be filed next April.
In most cases, the new rules will produce the same or greater tax benefits than the pre-2005 rules. But this will not necessarily be the result in every case. Therefore, taxpayers need to consider the potential impact of the new rules and to plan accordingly.
A taxpayer’s “child” under the new rules is a natural or adopted child, a stepchild, or an “eligible foster child.” The latter term means an individual placed with the taxpayer by an authorized placement agency or an appropriate court order. A child is considered “adopted” when lawfully placed with the taxpayer for legal adoption by the taxpayer.
The key definitions under the new rules are “qualifying child” and “qualifying relative.” An individual who fits either of these definitions is considered a “dependent” of the taxpayer. Note, however, that these terms are somewhat misleading, because, just as under the pre-2005 rules, certain individuals can qualify as dependents of a taxpayer even though they are neither children nor relatives of the taxpayer.
The most notable superficial difference from current law is that the “qualifying child” standard does not include either the “support test” or the “gross income test,” although it does bar a dependency exemption for any individual who is self-supporting.
These tests are replaced by a residency requirement, under which the individual being claimed as a dependent must have had the same “principal place of abode” as the taxpayer for more than one-half of the relevant taxable year. Note, however, that the new law retains the special rule under current law that, in certain cases in which the parents are divorced or separated, in effect permits the custodial parent to release the claim to the exemption in favor of the noncustodial parent.
The new law provides “tie breaker” rules for any taxable year in which an individual could be a qualifying child with respect to two or more taxpayers and those taxpayers each claim benefits based on the individual’s status as a qualifying child. For example, an individual who lived with his father and grandmother in the same residence could be a qualifying child with respect to each. Or, an individual who lived with her two aunts in the same residence could be a qualifying child with respect to each.
Under the tie breaker rules, a parent is preferred over other claimants. As between parents, preference is given to the parent with whom the child resided for the longest period of time during the year. If the child resided with each parent for an equal period of time, the parent with the higher adjusted gross income gets the exemption. If none of the claimants is a parent, the taxpayer with the highest adjusted gross income is entitled to the exemption.
If an individual is not a “qualifying child” with respect to the taxpayer (or any other taxpayer), the dependency exemption may be based on the individual’s status as a “qualifying relative.” In general, the new law incorporates the present-law dependency exemption rules for this purpose.
Thus, as under current law, the individual’s relationship to the taxpayer can be quite broad, including parents and stepparents, aunts and uncles, nieces and nephews, and certain in-laws, among others. More importantly, the present-law gross income and support tests continue to apply, including the special rules concerning multiple support agreements, income of handicapped dependents, and support of students.
Dependent Care Credit
Although the new law generally retains the current law rules for determining the dependent care credit, e.g., a child generally must be under age 13 in order to be a “qualifying individual,” the new law:
- eliminates the requirement that a taxpayer provide more than one-half of the cost of maintaining a household in order to claim the credit; and
- adds a requirement that, for a spouse or a dependent (other than an child under age 13) to be a qualifying individual, that individual must have the same “principal place of abode” as the taxpayer for more than one-half of the taxable year.
The new law generally retains the current law rules for determining the child credit. Thus, for example, the child tax credit is available only if the child is under age 17 (whether or not disabled). However, the new law eliminates the requirement that foster children and certain other children be cared for “as the taxpayer’s own” children.
Earned Income Credit
The new law generally retains the current law rules for purposes of determining the earned income credit.
Thus, for example, a child may be a qualifying child for purposes of the earned income credit even if the child is self-supporting or the taxpayer cannot claim the child as a dependent because of the special rule permitting the noncustodial parent to claim the exemption. Also, the new law retains the requirement that the taxpayer’s principal place of abode must be the United States.
However, the new law eliminates the requirement that foster children
and certain other children be cared for “as the taxpayer’s own” children.
Head of Household Status
The new law generally retains the current law rules for determining head of household status. Thus, for example, a child may be a qualifying child for this purpose even though the taxpayer cannot claim the child as a dependent because of the special rule permitting the noncustodial parent to claim the dependency exemption.
Extensions of Business or Investment Tax Benefits
The new law extended several business or investment incentives through 2005. Some of these were scheduled to expire at the end of 2004. Provisions that had already expired were extended retroactively.
Research Credit. Extended through 2005, retroactive to July 1, 2004. Hence, “qualified amounts” paid or incurred before 2006 will continue to qualify for the credit.
Work Opportunity and Welfare-to-Work Credit. Extended through 2005, retroactive to January 1, 2004. Thus, these credits are available for wages paid or incurred for individuals beginning work in 2004 or 2005.
Enhanced Deduction for Corporate Donations of Computer Technology and Equipment. Extended through 2005, retroactive to January 1, 2004. Thus, the enhanced deduction applies to qualifying donations in taxable years beginning before January 1, 2006.
Expensing of Brownfields Environmental Remediation Costs. Extended through 2005, retroactive to January 1, 2004. Thus, taxpayers will be able to deduct (rather than capitalize) qualifying expenditures paid or incurred through 2005.
Credit for Electricity Produced from Certain Renewable Resources. Extended through 2005, retroactive to January 1, 2004. Thus, the credit will be available with respect to wind energy facilities, “closed-loop” biomass facilities, and poultry waste facilities placed in service before 2006.
Suspension of Taxable Income Limit on Percentage Depletion from Oil and Natural Gas Produced from Marginal Properties. Extended through 2005, retroactive to January 1, 2004. Thus, the net income limitation will not apply to production from qualifying properties in taxable years beginning in 2004 and 2005.
With respect to investments relating to the “New York Liberty Zone” provisions (created by legislation in 2002), the new law:
- extended the authority to issue “qualified New York Liberty Bonds” through 2009;
- extended additional refunding authority through 2005 and made bonds of the Municipal Assistance Corporation eligible for refunding.
Other provisions, generally extended through 2005, include:
- Archer Medical Savings Accounts;
- Qualified Zone Academy Bonds;
- Tax Incentives for Investment in the District of Columbia;
- Indian Employment Tax Credit;
- Accelerated Depreciation for Business Property on Indian Reservations.
We hope the preceding summary has been informative and useful.
Please contact our firm for further details of interest to you.