“Taxpayers will remember many things from 2004, including a heated presidential election, varying degrees of business growth and failures, and the enactment of two major tax acts: the Working Families Tax Relief Act and the American Jobs Creation Act of 2004,” said Mike Monaghan, tax attorney for Plante & Moran. “Virtually every U.S. business or individual will be impacted by this new legislation.”

The Working Families Tax Relief Act of 2004 provides $146 billion of tax relief by extending several tax breaks for individuals and businesses that had either expired or were scheduled to expire at the end of the year. Surprisingly, very few new provisions are included in this legislation. The American Jobs Creation Act of 2004, on the other hand, represents one of the largest and most comprehensive restructurings of business taxes that has occurred in several years.

The Working Families Tax Relief Act provides $146 billion of tax relief to both families and businesses. This Act principally extends previously enacted rate reductions and credits that were set to expire this year. Included are extensions of the $1,000 per child tax credit, the expanded 10 percent individual tax bracket, and “marriage penalty” relief through an expanded 15 percent bracket and an increased standard deduction.

The Act also provides a slightly higher alternative minimum tax exemption for individual taxpayers and extends the $250 expense deduction for teachers and the Archer Medical Savings Account provisions through 2005. The research development credit, work opportunity credit and welfare-to-work credit are also extended through 2005.

More comprehensive tax legislation is contained in the Jobs Creation Act. This Act provides $138 billion of tax relief, which is offset by the phase-out of the extraterritorial income exclusion (ETI) for export sales, and a myriad of other revenue raisers addressing perceived tax loopholes and abusive transactions.

The centerpiece of the legislation is a new deduction for a percentage of domestic manufacturing income. This new deduction is often described as a domestic manufacturing incentive, but it will also apply to construction activities, engineering and architectural services, the production of computer software, and a number of other “qualified production activities.”

The deduction applies to activities conducted within the United States and, unlike the ETI, is not tied to export sales. It is available to individuals as well as corporations and to the owners of flow-through entities.

The deduction equals three percent of qualified production activities income for years beginning in 2005. The percentage increases to six percent for 2006 through 2009 and to nine percent thereafter. When fully phased in, the deduction will reduce the effective federal tax rate for qualifying activities by approximately three percentage points for taxpayers in the highest tax bracket.

The Jobs Creation Act also contains numerous provisions that are more narrowly targeted but which will be extremely important to taxpayers engaged in certain types of activities or transactions. Among the more common transactions affected are certain transfers of property to partnerships and corporations and sales or redemptions of partnership interests involving an inherent loss.

The Act also:

• Liberalizes the foreign tax credit rules.
• Permits corporate owners of controlled foreign corporations to repatriate funds at reduced rates.
• Increases the permissible number of shareholders for S corporations to 100.
• Extends the $100,000 expense deduction for business equipment through 2008.
• Limits the deduction for charitable contributions of automobiles and intellectual property.
• Changes the rules for deducting business organization and start-up expenses.
• Creates a new 15-year recovery period for restaurant equipment and certain leasehold improvements.
• Permits individuals to elect to deduct sales taxes instead of state and local income taxes.
• Limits the maximum first-year depreciation deduction for SUVs to $25,000.
• Expands the definition of related corporations that must share the lower corporate rate brackets and the minimum tax and accumulated earnings exemptions.
• Contains widely applicable rules that restrict the deferral of compensation under “nonqualified” plans.
• Restricts tax shelters through expanded disclosure and penalty provisions.

“It is noteworthy that the 50 percent first-year bonus depreciation deduction was not extended to property placed in service after December 31, 2004,” offers Mike Monaghan. “As a result, many taxpayers may want to accelerate equipment acquisitions to qualify for the special depreciation rules that still apply this year.”

The Jobs Creation Act is the culmination of several years of negotiations between the United States, its European trading partners and the World Trade Organization (WTO) regarding the legality of the extraterritorial income exclusion (ETI exclusion).

This provision was enacted in 2000 to assist U.S. exporters after the WTO determined that the former Foreign Sales Corporation (FSC) rules violated our international trade agreements. In 2002, the WTO ruled that the ETI exclusion was also an illegal export subsidy.

In March of this year, the WTO imposed sanctions in the form of tariffs on certain products produced in the U.S. for the failure to repeal the ETI exclusion. The tariffs had climbed to 12 percent by October and are scheduled to reach a maximum of 17 percent in March 2005. The new deduction for qualified production activities income has been heavily debated in Congress and is intended as a partial replacement for the repealed ETI exclusion.

Article provided by Plante & Moran, who recently created the Emerging Tax Issues Committee to provide technical support and response on important court rulings and proposed legislation.

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