On Oct. 22, the president signed into law The American Jobs Creation Act of 2004. This law started out more than a year ago as an effort to re-energize a manufacturing sector that has seen the loss of millions of factory jobs in the past few years. Instead, it turned into the biggest rewrite of the corporation tax code since 1986. This is the fifth significant tax bill to be sent to the president since he took office in 2001. And while these tax changes deal primarily with tax changes for manufacturing activities and reforms in the taxation of multinational businesses, there are also provisions that will have an impact on individuals and small business owners. So let's take a few minutes to review them.
Bonus depreciation: Certain property is eligible for a bonus depreciation deduction of up to 50% of the cost of the property. This provision was set to expire for property placed in service after Jan. 1, 2005. Instead, the new law extends the bonus depreciation provisions for qualified property placed into service before Jan. 1, 2006.
Depreciation expensing: The new law extends the so-called "Section 179" expensing limitations first established by the Jobs and Growth Tax Relief Reconciliation Act of 2003 for an additional two years. Therefore, depreciation expensing of qualified property of up to $100,000 in the first year of purchase is not extended through 2008. This section of the old law was set to revert back to a $25,000 limit at the end of 2005 but has now been extended.
Deduction for state and local sales taxes: As most of you are aware, the itemized deduction for sales taxes went by the wayside many years ago with the 1986 tax law changes. But the new law brings them back in with a bizarre twist. Under the new law, taxpayers who itemize their deductions are now given a choice of deducting either their state and local income taxes or their state and local sales taxes, whichever is greater. Taxpayers can determine their deductible state and local sales taxes by using either actual receipts or deduction tables published by the IRS. Those using the tables may also add the taxes paid on "big ticket" items such as autos, boats, and other items specified by the IRS.
So those of you living in states that have no personal income taxes (Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming) have just realized a significant tax reduction, and this section of the new tax law should be of great interest to you since it will generate a brand new deduction that you haven't had in many years past. And those of you living in states that tax only intangibles and/or dividends (such as New Hampshire and Tennessee) will also be interested in these changes.
But those of you living in high tax states (such as California and New York) likely won't care much about this new tax provision, since the deduction is for the greater of state/local income taxes or state and local sales taxes. It's very likely, in most cases, that the state taxes that are paid will be much greater than the sales taxes allowed by the IRS table or that you actually paid. If you live in a state that imposes a very low personal income tax rate, then you might want to make a note of these tax provisions in order to compare your deduction for sales taxes with your state income tax deduction and claim the greater of the two. But essentially, this section of the law was enacted to assist voters -- oops, I meant taxpayers -- residing in states with no personal income taxes. And since this provision of the act becomes effective in 2004, this new deduction will be available when you file your taxes next year. But don't get too fond of the idea, since this part of the law is also set to expire at the end of 2005.
Depreciation of SUVs: The provision in the new law that will hit the hardest (especially here out West, where the SUV is king) is the new limitation on the deduction for sport utility vehicles (SUVs) from $100,000 to $25,000. Under the old law, vehicles weighing more than 6,000 lbs. were allowed a first-year depreciation deduction of up to $100,000 when used for business. And, under the old definitions, there was no distinction between a "work" vehicle such as a van or pickup truck and large luxury SUVs. But that distinction has now been drawn, and the amount of first-year depreciation allowed for a SUV used for business has been reduced to $25,000. More importantly, this provision of the new law might have blindsided some taxpayers, since the effective date of this change is the date of enactment, Oct. 22, when the president signed it into law. So, if you're thinking about buying a big SUV for business purposes between now and the end of the year, you might want to think again, or at least make sure that the reduction in first year depreciation doesn't make you want to change your plans.
Sale of principal residence: Because of the provisions excluding a gain on the sale of a principal residence (up to $500,000 for joint filers), many taxpayers were doing some tricky things with properties originally acquired in a tax deferred exchange, living in the property for a while, then selling the property as a principal residence and avoiding virtually all of the gain. While you can still play these games, the playing field has become much longer, since the new law prohibits the exclusion of the gain on the sale of a principal residence acquired in a like-kind exchange within the prior five years. This provision of the new law applies to sales of principal residences sold after Oct. 22. So if you have converted a business or rental property into a principal residence, and that property was originally purchasing using a tax deferred exchange, your new holding period in order to exclude the gain is increased to five years, up from the two-year holding period found in the old law.
Again, these are just a few of the provisions found in the new law but are those that will have an impact on most individual and small business taxpayers on a daily basis. Tax simplification? Hardly. In fact, Congress has seen fit to make complicated laws even more complicated by instituting long phase-in periods, temporary provisions, and distinctions between types of income. What's law today might not be law tomorrow... unless Congress meets and enacts continuation provisions. It makes tax planning virtually impossible. I'm personally convinced that Congress has no interest in making the tax code simpler, or even more economically neutral or efficient. Instead, it has become the playground for special interests and identifiable constituents, making compliance virtually impossible for the average taxpayer and IRS enforcement unattainable.
Roy Lewis lives in a trailer down by the river and is a motivational speaker when not dealing with tax issues, and he understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks he owns as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though.