Tax Update Blog: November 2003 Archives

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2004 EXEMPTIONS AND STANDARD DEDUCTIONS

November 24, 2003

The IRS has issued a revenue procedure (Rev. Proc. 2003-85) for all income tax items that are adjusted for inflation for 2004. Some key numbers:

STANDARD DEDUCTION

-Married filing joint returns: $9,700
-Heads of households: $7,150
-Single taxpayers: $4,850
-Married filing separate: $4,850
-Dependent taxpayers: Greater of $800, or earned income plus $250, up to amounts above.
-Aged and blind addtional standard deduction: $950 ($1,200 for unmarried taxpayers other than surviving spouse.

PERSONAL EXEMPTIONS

The 2004 amount will be $3,100; the deduction for personal exemptions will start to phase out at the following income levels:

-Married filing joint returns: $214,050
-Heads of households: $176,350
-Single taxpayers: $142,700
-Married filing separate: $107,025

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IOWA DEPRECIATION - THE FUN NEVER ENDS

November 24, 2003

The "bonus depreciation" rules have been a boon for taxpayers buying (and selling) capital goods. Bonus depreciation was designed as a short-term boost to the economy, and most industries are slated to lose its benefits after 2004, when the provision expires.

Still, one sector will be stimulated by bonus depreciation for years: tax preparers.

THE JOYS OF NON-CONFORMITY

State income taxes are mostly based on the federal tax system as a convenience to both taxpayers and tax administrators. The downside of conforming to the federal system is that it puts state budgets at the mercy of Congress.

Most state legislatures decided that their budgets were too tight to tolerate a revenue loss from bonus depreciation. Iowa, for example, voted to continue to ignore bonus depreciation in the computation of Iowa taxable income; instead, Iowa depreciation is the same as federal depreciation would be if bonus depreciation had not been enacted.

Other states have enacted their own depreciation rules, some of them strange. For example, North Carolina disallowed bonus depreciation deductions entirely in 2002 and 70% in 2003 and 2004; the disallowed amount can be recovered over five years, starting in 2005. This is a hefty short-term tax increase for capital-heavy North Carolina taxpayers.

IT'S NOT JUST DEPRECIATION

It's not so bad as keeping separate depreciation schedules for different states. It's worse.

Changes in depreciation computatons ripple through other income computations. Inventory values reflect tax depreciation. The basis of depreciable property is reduced by the depreciation allowed. The basis of S corporation stock and partnership interests are reduced by depreciation. When state depreciation is different, all of these items have to be recomputed to complete the state tax return. For those of us charging by the hour, this is all wonderful; it's not so great for those paying for it.

IOWA EMBRACES NON-CONFORMITY...

..well, at least in the tax law. Iowa today released a policy letter on the ripple effects of Iowa's choice to not adopt bonus depreciation. In a policy letter dated October 30, 2003, the Department of Revenue confirmed that basis computations affected by depreciation, such as C corporation stock basis, must be recomputed for Iowa. Taxpayers with "passive" losses will also have different passive loss carryforwards resulting from the different depreciation.

It remains to be seen whether Iowa will embrace non-conformity in other areas.

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YEAR-END TAX TIP: COUNT YOUR WINNINGS, THEN TAKE YOUR LOSSES

November 24, 2003

It's been a decent year for the stock market. Some folks even have cashed out positions with capital gains. With every silver cloud, though, there is a dark lining - in this case, income taxes.

This is a good time to add up your winnings, and to try to make them go away - at least with respect to the IRS. We can do this by venturing into the dark recesses of our portfolios in search of losers - maybe that Enron stock we bought at 80, or that McLeodUSA stock that looked so promising not so long ago. If a position retains only sentimental value, you can convert it to income tax value by cashing out your losses.

LONG-TERM, SHORT-TERM?

Capital losses can offset capital gains of whatever flavor - short-term losses can offset long-term gains, and vice-versa. Individuals can deduct capital losses to the extent of capital gains, plus $3,000. If you overdo it on your losses, the excess carries forward to next year.

WHAT ABOUT CARRYFORWARDS?

Not a few taxpayers unwittingly prepared for capital gains in 2003 by cashing out large capital losses in 2001 and 2002. If not used already, these losses carry forward to 2003; when evaluating your 2003 capital gain situation, don't forget them.

ABSENCE MAKES THE HEART GROW FONDER...

When you say goodbye to a loss position, brace yourself for an extended separation. The "wash sale" rules say that you can't deduct a loss if you purchase another position in the stock within 30 days - before or after - of the loss sale. If you really think your WorldCom stock will come back, you have to hope it will wait 31 days to do so if you want to deduct that loss.

GAINS: HOLD 'EM OR FOLD 'EM?

If your capital gains are long-term gains - that is, held for over one year - remember that your top effective tax rate is 15%. Iowa has no capital gain break for most assets, so Iowans pay capital gain taxes at rates up to 8.98%. If you have confidence in your portfolio, it always makes sense to hold on and avoid capital gain taxes - especially if you lack losers to offset your gains.

Still, the capital gain rates are low enough to make it easier to close out any of your stocks that seem scary-high; even after taxes, 85% of a capital gain beats 100% of a capital loss any day.

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SAME-SEX MARRIAGE? NOT ON FORM 1040!

November 18, 2003

Now that the Massachussets Supreme Court has apparently opened the door to single-sex marriages, one urgent question immediately occurs to the tax practitioner: can a married same-sex couple file a joint federal tax return?

Up until 1996, the answer might have been "yes." A 1958 revenue ruling held: "The marital status of individuals as determined under state law is recognized in the administration of the Federal income tax laws."

Things changed in 1996 when President Clinton signed P.L. 104-199, the "Defense of Marriage Act." Section 3 of that act seems to limit the tax planning opportunities available to single-sex married couples:

“In determining the meaning of any Act of Congress, or of any ruling, regulation or interpretation of the various administrative bureaus or agencies of the United States, the word “marriage” means only a legal union between one man and one woman as husband and wife, and the word “spouse” refers only to a person of the opposite sex who is a husband or a wife.”

Until the courts get to work on the definitions of "man," "woman," or "opposite," a joint single-sex return seems out of the question. As a practical matter, this actually will work out well for such couples, most of which are likely to have two wage-earners - they won't face the tax law "marriage penalty."

WHAT ABOUT IOWA?

A March 14, 1973 technical memorandum seems to leave the door open to same-sex joint returns when it says "Iowa also recognizes as valid a marriage entered into in another state, if it is valid in that state." But Iowa also adopts the Internal Revenue Code, which is interpreted in light of the Defense of Marriage Act; therefore, Iowa probably follows the federal rules here.

This is also unlikely to affect many same-sex couples. Few "joint" Iowa returns are filed because the benefits of being married on Iowa returns are usually minimal. Same-sex couples won't flock to Iowa, at least not for tax reasons.

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SPLIT-DOLLAR DEADLINE LOOMS

November 18, 2003

Our (lengthy) thoughts on the upcoming decision deadline of December 31 for compensation-related split-dollar arrangements may be found here.

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CALCULATING YOUR MINIMUM IRA DISTRIBUTION

November 14, 2003

The Benefitsblog notes a newspaper article that presents a nice explanation of the rules for determining the required minimum distribution from an IRA after age 70 1/2. The table for computing the withdrawal can be found here.

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YEAR-END PLANNING TIP

November 11, 2003

Self-employed taxpayers should start to consider whether a "Keogh" plan is right for them. Keogh plans are full-blown "qualified" plans for self-employed taxpayers. If combined with a 401(k) feature (a "solo-k" plan), these can enable taxpayers to put a lot of money away for retirement while getting a tax deduction.

For example, a sole proprieter (under age 50) with $100,000 of pre-tax income could put away $30,653: the $12,000 maximum 401(k) deferral, plus 25% of the remaining income (after reduction for 1/2 of self-employment tax). By contrast, a SEP plan for the same taxpayer would yield a maximum deductible contribution of $18,653.

You can play with the numbers using this Keogh-401(k) calculator.

IS THIS ALWAYS SUCH A GOOD DEAL?

No. If you already participate in a 401(k) plan as an employee, and the employer matches it, you have little use for a 401(k) - Keogh plan if you also have self-employment income. Your total annual 401(k) participation is limited to $12,000 (plus $2,000 for taxpayers 50 or over). If your employer matches, you should take advantage - unless you plan to quit before you vest in the match, of course. Keogh plans can also be troublesome if you own more than one business or if you have other employees.

Keogh plans are full-blown qualified plans, so they require annual Form 5500 filings and the other compliance headaches of such plans. If you don't plan to go whole-hog on your contributions, you may be better off with the much easier to manage SEP plan.

WHY IS THIS A YEAR-END TIP?

A Keogh plan must be in place no later than December 31 to be available for 2003. If you want to get one in place, you'd best get moving.

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PRESIDENT MARKS VETERANS DAY BY SIGNING MILITARY TAX RELIEF BILL

November 11, 2003

President Bush today signs the "Military Family Tax Relief Act of 2003" (HR 3365). One provision of the bill will allow Armed Forces personnel to claim refunds for as far back as 1997, in some cases.

Key provisions of the bill include:

Relief for residency requirements for home sale exclusion.

The tax law permits taxpayers to exclude from income gains from a principal residence; to qualify for the exclusion, taxpayers must use the sold dwelling as their principal residence for two of the five years preceding the sale.
HR 3365 permits taxpayers to exclude from the 5-year test any periods when they (or their spouses) are on "qualified official extended duty as a member of the uniformed services or in the Foreign Service of the United States." This includes deployments at least 50 miles away that are indefinite or over 90 days.

This provision is effective retroactively to 1997; a special one-year extension of the statute of limitations begins today, enabling qualifying taxpayers to amend returns for closed years to take advantage of this rule.

Death gratuity increased and made fully tax-free.

The death gratuity for service personnel killed on active duty is increased to $12,000, and made fully tax-free. It was $6,000, of which $3,000 was tax free.

Above-the-line deduction for overnight travel expenses of National Guard and Reserve members

Unreimbursed travel expenses of Guard and Reserve personnel will now be deductible whether or not the taxpayer itemizes when they are for trips to Guard or Reserve meetings over 100 miles away, if they require an overnight stay. The expenses will also fully deductible for alternative minimum tax (AMT). Under old rules these expenses were only deductible for itemizers, and only to the extent miscellaneous itemized deductions exceeded 2% of adjusted gross income; they were not deductible at all for AMT.

For further reading:

Explanation of the bill by the Congressional Joint Committee on Taxation (pdf file)

Text of the Bill (HR 3365)

Other Military Tax Provisions

The tax law provides other breaks that are unaffected by HR 3365:

EXTENSIONS are automatically granted for those serving in combat zones. The extensions to file returns and pay taxes run until 180 days after leaving the combat zone or 180 days after continuous hospitalization from combat zone injuries.

EXCLUSIONS. Armed forces personnel can exclude a number of items from their income:

-Active duty pay earned in any month served in a combat zone.

-Imminent danger/hostile fire pay and military pay earned while hospitalized as a result of wounds, disease or injury incurred in the combat zone.

-A reenlistment bonus if the voluntary extension or reenlistment occurs in a month served in combat zone.

-Pay for accrued leave earned in any month served in combat zone. (The Department of Defense must determine that the unused leave was earned during that period.)

-Pay received for duties as a member of the Armed Forces in clubs, messes, post and station theaters and other non- appropriated fund activities earned in a month served in a combat zone.

-Awards received for suggestions, inventions or scientific achievements because of a submission made in a month in a combat zone

The IRS has a web page that fully discusses special tax provisions for Armed Forces personnel.

IOWA TAX BREAKS FOR MILITARY PERSONNEL

Iowa follows federal rules for extensions and combat pay exclusions. Iowa is likely to adopt the provisions of HR 3365. Iowa already has deductions for reservist travel and fully excludes the death gratuity.

The Iowa Department of Revenue has a summary of Iowa rules for Armed Forces personnel here.

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PROCRASTINATOR OF THE YEAR?

November 06, 2003

On October 17, 1977, the IRS issued a $5,335 check to Stanley and Toni Goss as their 1975 tax refund. The check went missing, and the Gosses and the IRS spend several years negotiating over the check. Ten years later, in October 1987, the IRS sent a voucher form to Mr. and Mrs. Goss; the IRS promised to reissue the check upon return of the form. The Gosses balked because the voucher form did not include interest. In December 1999, the IRS said that they could still seek interest if they signed the voucher.

Communication then ceased between the Gosses and the IRS.

Thirteen years after they received their last letter from IRS, the Gosses sued the IRS for a new check.

WHATEVER THE STATUTE OF LIMITATIONS IS, IT'S NOT 13 YEARS

The IRS said that two statutes of limitations apply: a one-year statute for claims resulting from checks, and a six-year statute on general claims against the government. The court agreed that the statute had run, one way or another.

THE MORAL?

Thirteen years is enough time for your kindergartner to start attending college classes; if you lose your IRS check, you need to take action by middle school.

Cite: STANLEY B. GOSS, ET AL. v. US, DC-ND OH, 9/18/03 (no link available).

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THE BAD NEWS: HIGH, COMPLICATED TAXES. OH, THAT'S BAD NEWS?

November 04, 2003

Economics blogger Tyler Cowan notes a Cato Institute study on how the United States has some of the highest effective corporate tax rates, especially on overseas income. In bad tax news, we practitioners always find a silver lining, and Mr. Cowan's post is no exception:

In a 1999 report, the National Foreign Trade Council concluded that “U.S. anti-deferral rules have been subject to constant legislative tinkering, which has created both instability and a forbiddingly arcane web of rules, exceptions, exceptions to exceptions, interactions, cross references, and effective dates, giving rise to a level of complexity that is intolerable.” ...

When you charge by the hour, no level of complexity is intolerable. Until I make a mistake, of course; then it's unfairly complicated!

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YOU KNOW YOU'VE HAD A BAD DAY (II)...

November 03, 2003

When your website looks like this:

The Judge is apparently unimpressed by Mr. Prater's "Section 861 argument" that domestic source income is exempt from U.S. taxes. It is, of course, a losing argument; we hope Mr. Prater's clients didn't pay too much of their fees for his advice up front.

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