Many of the tax breaks in recent tax-relief bills were designed to be phased in over a number of years. To help you determine how these tax laws affect your long-term plans, this page explains many of the changes that come into effect through 2010.
Uniform Definition of a Qualifying Child. Beginning in 2005, there will be one definition of a qualifying child for:
This change simplifies the law in this area and establishes “tie-breaking” rules if more than one individual wishes to claim a child for a specific tax provision.
Increased Retirement Contribution Limits. The changes for 2005 are as follows:
Higher Income Limits for Deductible IRAs. If you are covered by a retirement plan at work, you can take an IRA deduction if your modified adjusted gross income is less than $80,000 (married filing jointly) or $60,000 (single or head of household).
Business Standard Mileage Rate Increased. To compensate for high gasoline costs in 2005, the standard business mileage rate was raised from 40.5 cents per mile to 48.5 cents per mile for miles driven after 9/1/05.
Increased Section 179 Expense Deduction. The maximum amount increases from $102,000 to $105,000.
Additional First-Year Depreciation. The bonus depreciation allowance of 50 percent expires for qualifying property purchased after 2004.
Domestic Production Activities Deduction. Starting in 2005, certain businesses, including sole-proprietorships, can claim a new deduction of three percent of business net income. This deduction applies to businesses engaged in construction, engineering, or architectural services; film production; or the lease, rental, or sale of equipment you manufactured.
Clean Fuel Deduction Expires. The clean fuel deduction of $2000 for the purchase of a new hybrid vehicle expires at the end of 2005. This deduction is replaced by a tax credit in 2006.
Charitable Contributions after 8/27/05. Cash contributions after 8/27/05 to any charity are not subject to the 50 percent adjusted gross income limitation and are not subject to the phaseout of itemized deductions for high income taxpayers.
Charitable Mileage Rate Increased. A taxpayer who uses a vehicle to provide donated services to a charity related to Hurricane Katrina can claim a charitable mileage deduction of 34 cents per mile, rather than the regular charitable mileage deduction of 14 cents per mile.
Charitable Contributions of Vehicles and Boats. The amount you can deduct for donations of autos and boats for which the claimed value exceeds $500 depends on how the donated asset is used by the charity. If the charity sells the auto or boat without any significant use or improvement to it, the donor’s deduction is limited to the gross sales price obtained by the charity. The fair market value of the car or boat based on comparable sales or appraisal doesn’t apply in this situation. This rule applies to donations made after 2004.
Housing Katrina Victims. Providing free housing to victims of Hurricane Katrina for at least 60 days allows the taxpayer to claim an exemption deduction of $500 per person, up to a maximum of $2000. This new type of exemption is not subject to the income-based phaseouts of regular personal exemptions.
Hurricane Katrina, Rita and Wilma Casualty Losses Get Special Treatment. Personal casualty loss deductions must normally be reduced by $100 per occurance and by 10 percent of adjusted gross income. Personal casualty losses due to Hurricanes Katrina, Rita or Wilma do not need to be reduced by these amounts.
Debt Relief Not Taxable. Certain personal debt relief due to Hurricane Katrina is not taxable, even if the taxpayer is not insolvent or bankrupt. The debt must not be business-related and the taxpayer must have lived in the Hurricane Katrina disaster area.
May Claim 2004 Earned Income Credit and Refundable Child Credit in 2005. Taxpayers can elect to calculate their 2005 earned income credit and refundable child credit based on their 2004 income if their 2005 earned income is lower. The individuals must have lived in the Hurricane Katrina, Rita or Wilma disaster area and have been displaced from their home due to the hurricane.
Exclusion of Gain on Personal Residence. For sales after October 22, 2004, you cannot claim the $500,000/$250,000 gain exclusion on the sale of your principal residence if you acquired the home in a like-kind exchange within the last five years. This would occur if you previously had an investment property, did a like-kind exchange and then converted it to your principal residence.
Penalty-free Retirement Plan Distributions for Victims of Hurricanes Katrina, Rita or Wilma. An individual who lived in the Hurricane Katrina, Rita or Wilma disaster areas and lost property can take a distribution from a retirement plan between the date of the disaster and 1/1/07 without incurring a penalty. The distribution is taxable over a three-year period.
Gulf Opportunity Zone Created to Help Hurricane Victims. The areas most affected by Hurricanes Katrina, Rita and Wilma have been declared a “Gulf Opportunity Zone” (GO Zone). Certain business property placed in service in the GO Zone after the date of the hurricane and before 12/31/07 (12/31/08 for qualifying real estate) is eligible for a 50% special depreciation allowance in the first year placed in service. Certain business property placed in service in the GO Zone after the date of the hurricane and before 12/31/07 is eligible for an extra $100,000 in immediate tax write-off under Section 179. These provisions are designed to encourage rebuilding of the affected areas.
Net Operating Losses for Hurricane Victims. A Net Operating Loss created by Gulf Opportunity Zone (GO Zone) casualty losses, certain moving expenses, temporary housing expenses, depreciation deductions of qualified GO Zone property, and certain repair expenses is allowed a five year carryback, rather than a two year carryback. This provision is designed to allow the taxpayer to get an earlier refund of taxes paid in prior years.
Increased Retirement Contribution Limits. The changes for 2006 are as follows:
Higher Income Limits for Deductible IRAs. If you are covered by a retirement plan at work, you can take an IRA deduction if your modified adjusted gross income is less than $85,000 (married filing jointly) or $60,000 (single or head of household).
New Credit for Nonbusiness Energy Property. From 2006 to 2008, a taxpayer may claim a lifetime credit of $500 ($200 for windows) for making qualifying energy saving improvements to his residence. Qualifying expenditures include installation of certain energy-efficient insulation materials, exterior windows and doors, electric heat pumps, and central air conditioning. The credit is 10 percent of the cost of qualifying materials.
New Credit for Residential Energy Efficient Property. From 2006 to 2008, a taxpayer may claim a $2000 credit for the installation of solar water heating equipment, photovoltaic or fuel cell equipment in his residence. The credit is 30 percent of the cost of the equipment. No credit is allowed for equipment used to heat a swimming pool or hot tub.
New Credit for Purchase of New Energy Efficient Vehicles. Beginning in 2006, the purchase of qualifying vehicles will allow you to claim a tax credit. This replaces the Clean Fuel Deduction, which expired at the end of 2005. A credit is available for a variety of alternative fuel vehicles. New hybrid vehicles are eligible for a tax credit up to $3400, depending on the fuel-efficiency of the vehicle. This credit is limited, however, to the first 60,000 vehicles sold after 1/1/06 per auto manufacturer.
Increased Section 179 Expense Deduction. The maximum amount increases from $105,000 to $108,000 in 2006.
Tuition & Fees Deduction. This deduction expires for tax years after 2005.
Educators’ Deduction. This deduction expires after 2005 and therefore is no longer available in 2006.
Sales Tax Deduction. The sales tax deduction expires after 2005.
Reduction in Itemized Deduction Limits for High-Income Taxpayers. Currently, itemized deductions are phased out (reduced) as your income rises. Starting in 2006, the deduction phase-out will be reduced by one third. In 2008, it will be reduced by two thirds, and in 2010, the phase-out will disappear entirely.
Alternative Minimum Tax (AMT) exemptions reduced. Beginning in 2006, the AMT exemptions revert to their 2002 levels. The AMT exemption for couples married filing jointly will drop from $58,000 in 2005 back to $45,000 in 2006. This will cause more individuals to pay AMT.
Some personal credits not allowed against AMT. Beginning in 2006, certain personal credits will no longer be allowed against the Alternative Minimum Tax. These credits include the dependent care credit, credit for the elderly and permanently and totally disabled, mortgage interest credit, hope and lifetime learning credits, and the DC first-time homebuyer credit.
Gift Tax Annual Exclusion Increased. In 2006, the annual amount of cash that you can give to someone else without filing a gift tax return increases from $11,000 to $12,000.
Nontaxable Combat Pay Allowed for Earned Income Credit. You can make an election to include nontaxable combat pay in the calculation of earned income for the earned income credit. This provision was previously set to expire at the end of 2005, but has been extended to include 2006.
Retirement Contribution Credit. This credit expires , which first came into effect in 2002, expires after 2006 and therefore is no longer available.
Higher Income Limits for Deductible IRAs. If you are covered by a retirement plan at work, you can take an IRA deduction if your modified adjusted gross income is less than $100,000 (married filing joint) or $60,000 (single or head of household).
Domestic Production Activities Deduction. In 2007, this deduction increases to 6% of qualifying business net income. This deduction applies to businesses engaged in construction, engineering or architectural services, film production, or the lease, rental, or sale of equipment you manufactured.
Reduction in Capital Gains Tax Rates. Capital gains are income from sales of capital assets (stocks, mutual funds, and so forth). Before 2003, the maximum long-term (held longer than one year) capital gains tax rate was 20 percent. A lower 10 percent tax rate was used by individuals in the 10 and 15 percent tax brackets. For tax years 2003 through 2007, the 2003 tax legislation replaces the 20 percent maximum tax rate with 15 percent, and replaces the 10 percent maximum rate with five percent. In 2008, the five percent maximum rate drops to zero percent. The 15 percent tax rate stays the same.
Reduction in Dividend Tax Rates. Before 2003, most dividend income from stocks and mutual funds was taxed as ordinary income at the taxpayer’s highest marginal tax rate. For tax years 2003 through 2007, the 2003 tax bill made dividends taxable at 15 percent for taxpayers above the 15 percent tax bracket, and at five percent for taxpayers in the 10 and 15 percent tax brackets. In 2008, the five percent tax rate for dividends drops to zero percent. The 15 percent tax rate stays the same.
Increased Retirement Contribution Limits. The only change to retirement contribution limits for 2008 is that the maximum IRA (traditional or Roth) contribution increases from $4,000 to $5,000.
Decreased Section 179 Expense Deduction. Taxpayers who purchase qualifying business property may elect to deduct the cost of the property (new or used) in the year that it is placed in service. This is referred to as a Section 179 deduction. In the tax years through 2007, the maximum amount of property that may be taken as a Section 179 deduction is $100,000, as indexed for inflation. In 2008 and future years, the maximum deduction drops to $25,000.
Increase in Capital Gains and Dividend Tax Rates. The tax rate reductions for long-term capital gains and dividends, which are in effect from 2003 to 2008, expire this year.
Child Tax Credit. The credit of $1,000 per eligible child is no longer available after 2010.
Domestic Production Activities Deduction. In 2010, this deduction increases to nine percent of qualifying business net income. This deduction applies to businesses engaged in construction, engineering or architectural services, film production, or the lease, rental, or sale of equipment you manufactured.