Tax Planning for 2004

Jeffrey J. Presogna, CPA CVA

New Legislation:

The Jobs and Growth Tax Relief Reconciliation Act of 2003 (the act) was signed into law by President Bush on May 28, 2003. The new law includes many new provisions, which will affect most individuals and corporations. Individuals will benefit through several provisions originally enacted by the Economic Growth and Tax Reconciliation Act of 2001 (EGTRRA), along with reductions in the tax rate on capital gains and dividends. Business provisions include expansion of bonus depreciation and the expensing of asset write-offs know as Section 179. Other corporate benefits include the repeal of collapsible corporation rules, reduction of tax rates on accumulated earnings and personal holding income, and delays in the estimated tax payment schedules.

The act accelerates the reductions in income tax rates that were scheduled to take effect in 2004 and 2006. For the tax year 2003, the new rates are 25 percent, 28 percent, 33 percent and 35 percent (reduced from 27 percent, 30 percent, 35 percent, and 38.6 percent).

The maximum rate on capital gains has been reduced to 15 percent from 20 percent for taxpayers subject to regular income tax or Alternative Minimum Tax. The new 15 percent rate applies to long-term gains recognized after May 6, 2003 including gains attributable to installment sale payments received after this date regardless of when the sale took place. The rate will revert to 20 percent in 2009.

Qualified dividend income will be taxed at the same rates as long-term capital gains. The 15 percent rate will apply to all taxpayers paying regular income tax and Alternative Minimum Tax. Not all dividend income will qualify for the new rate. Dividends paid by foreign companies whose shares are not listed as ADRs on a U.S. exchange, or are not subject to a tax treaty are excluded. Also excluded are dividends from Reits, tax-exempt companies, mutual savings banks, foreign personal holding companies, foreign investment companies and other foreign passive investments. Mutual funds will qualify only to the extent that the dividend is paid from a qualifying corporation.

The act accelerates relief from the marriage penalty by increasing the standard for married taxpayers and phasing those deductions in during 2003. For taxpayers with children, the act temporarily accelerates the maximum credit to $1,000 per child.

Planning Ideas for 2004:

Business Entity

Whether you currently own a business or are thinking of starting a new venture, deciding on the proper business entity will be one of the most important considerations you will have. Options such as the C corporation, S corporation, partnership, limited liability company and proprietorship exist depending on the number of owners your business will have. Each of the above-mentioned entities has substantially different tax effects and should be carefully considered before forming.

If you are considering the formation of a corporation, I.R.C. Sec. 1244 should be considered as a precautionary measure. Any losses from the disposition of your stock under this code section would be considered ordinary losses as opposed to capital losses and deducted fully in the year of disposition.

Additionally, some corporations may qualify for the small business stock gain exclusion. When certain requirements are met, non-corporate investors who have held "qualified small business stock" for more than five years may exclude from income 50 percent to 60 percent of the gain realized on the disposition of the stock. The remaining gain is taxed at 28 percent however, for an effective tax rate of approximately 28 percent. The taxpayer may also elect to rollover the entire gain by reinvesting the gain into replacement stock and deferring any tax liability until the replacement stock is sold.

Accounting Rules

When a new business is formed there are multitudes of expenses to get the business up and running. Travel, advertising and training employees are just a few examples of pre-opening costs a new business owner might experience. These costs are defined as start-up costs by the Internal Revenue Code. Start-up costs cannot be currently deducted but rather amortized over a period of at least 60 months provided the taxpayer makes the proper elections on the initial business tax return. If the proper elections are not made, the expenses are not deductible and must be capitalized.

Accrual basis taxpayers, those taxpayers that record income when earned and record expenses when incurred have the following deferral opportunities:

- Delay shipments until the following year.
- Consider shipping F.O.B. destination for year-end shipments. Income is not earned until title passes which would be in the next year.
- Expenses such as bonuses, vacation pay, etc. can be deducted if the expenses will be paid within 2.5 months after the close of the tax year.

Cash basis taxpayers may want to delay billings at year-end for income purposes and pay all expenses by year-end.

Depreciation

Due to new legislation enacted early in 2003, taxpayers may be able to benefit from a new provision, which provides an additional deduction of 30 percent of the cost of qualifying property 50 percent if the property is acquired after May 5, 2003 and before January 1, 2005. The bonus depreciation is available for most non-real estate assets and certain leasehold improvements and is in addition to regular depreciation.

Section 179 expensing is still available and will be limited to $100,000 of the first $400,000 of assets placed in service during 2003 through 2005. Section 179 allows the taxpayer to treat $100,000 of eligible property as an expense in the year the asset is placed in service. These levels will be adjusted for inflation during 2004 and 2005.

Business Automobiles

Due to new legislation enacted early in 2002, a taxpayer's first-year depreciation deduction has been increased by $4,600 for luxury automobiles placed in service before 2005. Taxpayers may also consider using the mileage method of expensing a vehicle.

Health Insurance
The health insurance deduction is now a 100 percent deduction for individuals who are now self-employed.

Retirement Plans
The use of retirement plans is probably the best way to defer tax liability while investing in the future of the business owner. Simple, 401(k), SEP-IRA, Keoghs are just an example of different types of plans available depending on how your business is organized.

The tax planning ideas mentioned above are just the tip of the iceberg. Many of the tax planning ideas mentioned in this article will vary depending on the type of business formation. Careful planning with a tax advisor should be on the top of your priority list as we enter the fourth quarter of the calendar year.

Jeffrey Presogna is Managing Partner of VERCOR.
Presogna and Company, P.C.
Vercor - Northeast Office
359 West 26th Street
Erie, PA 16508