THE AMERICAN JOBS CREATION ACT OF 2004

BY MARK J. IERARDI, J.D.
SENIOR TAX MANAGER

On October 22, 2004, President Bush signed into law the American Jobs Creation Act of 2004 ("the Act") which replaces the U.S. export tax regime with broad-based tax relief for domestic manufacturing, U.S. multinationals, S-Corporations and a wide variety of other businesses and industries.

Here's what you need to know right now about this important new legislation:

ETI REPEAL AND NEW MANUFACTURING ACTIVITY DEDUCTION
Repeal of exclusion for extraterritorial income (ETI).

At the heart of the Act is the repeal of the exclusion for extraterritorial income (ETI), an export break that the World Trade Organization ruled to be an illegal subsidy. Specifically, the Act repeals the ETI system of tax benefits for transactions after 2004, with transition relief for 2005 and 2006 and grandfather rules for contracts entered into before Sept. 18, 2003.

New deduction for U.S. production activities.
The Act replaces ETI with a new tax break for domestic production activities. The deduction is a percentage of the net income from those activities-3% in 2005- 2006, 6% for 2007-2009, 9% after 2009. (The 9% deduction percentage is intended to be equivalent to a 3% rate cut.)

The U.S. production activities deduction is allowed with respect to a taxpayer’s qualified production activities income, which is the taxpayer's domestic production gross receipts net of expenses. “Domestic production gross receipts” are receipts derived from any of the following:

Any lease, rental, license, sale, exchange, or other disposition of:

• ... qualifying production property (i.e., tangible personal property, any computer software, and certain sound recordings) that was manufactured, produced, grown, or extracted in whole or in significant part by the taxpayer within the U.S.;
  
  As well as:
  
• ... any qualified film produced by the taxpayer; or
• ... electricity, natural gas, and potable water produced by the taxpayer in the U.S.
• construction performed in the U.S.;
• or engineering and architectural services performed in the U.S. for construction projects in the U.S.

The deduction is available to all taxpayers with qualified production activities income. For pass-thru entities (such as S-corporations, partnerships, estates and trusts), the deduction generally is determined at the shareholder, partner or similar level by taking into account, at that level the proportional share of the qualified production activities income of the entity. The deduction is allowed for AMT purposes.

BUSINESS TAX INCENTIVES
In addition to the new deduction for U.S. production activities, the Act spreads billions of dollars of tax breaks throughout the business world.

Significant tax incentives include:

• Sec. 179 expensing - an extension of enhanced Code Sec. 179 expensing so that qualifying businesses can immediately expense over $100,000 (with indexing) of new investments through 2007. For example, in 2004, businesses can deduct $102,000 of qualifying property and $410,000 of property can be placed into service before the $102,000 deduction amount must be reduced.
• Start up expenses - Up to $5,000 in start up expenditures is deductible in the year a new trade or business begins. Additional expenses are amortized over 15 years.
• Qualified leasehold improvements - 15-year MACRS recovery period for qualified leasehold improvements placed in service after October 22, 2004 and before 2006.
• Qualified restaurant property - the depreciation period of qualified restaurant property is set at 15 years for property placed in service after October 22, 2004 and before 2006.
  
  S-CORPORATION REFORM
• The Act has provisions that make it easier for businesses to qualify and operate as S-Corporations, including raising the maximum number of shareholders from 75 to 100 and allowing family members to be counted as one shareholder.
  
  INTERNATIONAL TRANSACTIONS
• The Act includes several provisions to reduce double taxation of U.S.-based companies, including reducing the foreign tax credit (FTC) baskets from nine to two and allowing FTCs to be carried forward for 10 years instead of five.
• The Act repeals the 90-percent limitation on the use of FTCs against AMT.
• The Act encourages companies to reinvest foreign earnings in the U.S. by temporarily allowing an 85% dividends-received deduction on distributions from controlled foreign corporations (CFCs).
  
  INDIVIDUAL INCOME TAX PROVISIONS
• Deduction of state and local general sales taxes - In a move that will primarily benefit individuals in states with sales taxes but with no or limited individual income taxes (i.e., Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming), taxpayers, who itemize, will be able to deduct on their federal tax returns for 2004 and 2005 either what they pay in state and local income taxes or what they pay in sales taxes. Previously, only state and local income tax payments were deductible. Taxpayers who itemize may deduct their actual sales taxes or use IRS-published tables.
• Principal residence - a principal residence acquired in a like kind exchange must be held for at least five years in order for any gain on its sale to be excludable.
  
  OTHER MISCELLANEOUS TAX INCENTIVE PROVISIONS
  The Act also:
• Excludes from unrelated taxable income of tax-exempt investors gain or loss from the sale or exchange of a qualifying brownfield property and excepts such property from the debt-financed property rules.
• Allows an above-the-line deduction for attorney's fees and court costs incurred in connection with an unlawful discrimination claim.
• Expands the credit for electricity produced from renewable resources to include open-loop biomass, geothermal and solar energy, small irrigation power, landfill gas, trash combustion and refined coal production facilities.
• Allows the tax credits for alcohol fuels and the production of electricity to be applied against AMT.
• Provides a variety of tax breaks for farmers and other agricultural interests.
  
  REVENUE PROVISIONS - HOW WILL WE PAY FOR THE TAX CUTS?
  To pay for the benefits, the Act imposes a number of new costs on taxpayers.
  
  Charitable Organizations
• Donated vehicles - taxpayers must obtain a contemporaneous written acknowledgement for donations of qualified vehicles, including cars, boats and aircraft, that have a claimed value over $500.
  Exempt organizations can be penalized for failing to provide accurate receipts. Beginning in 2005, the deduction is limited to the gross proceeds received by the charity upon the resale of the property.
• Intellectual property - for patents and most other intellectual property donated to a charitable organization after June 3, 2004, the donor's deduction is limited to the lesser of the donor's basis in the property or its fair market value.
• Compensation and Pension Plans
  Non-qualified deferred compensation plans - requirements for nonqualified deferred compensation plans are consolidated and supplemented. Deferrals are included in the employee's gross income and additional tax is imposed as a result of certain plan features related to distributions, accelerated benefits and elections.
• ISO's and ESPP options - FICA wages do not include remuneration arising from the acquisition of stock under an incentive stock option (ISO) or employer stock purchase plan (ESPP) option, or from the disposition of such stock. Employers are not required to withhold federal income tax when an employee realizes gain on disqualifying disposition of stock acquired from ISOs and ESPPs. When federal conflict of interest rules require a shareholder to divest stock, the stock is treated as meeting the holding period requirements for ISO's and ESPP options.
  
  Other Miscellaneous Revenue Provisions
• Limiting the amount of the cost of an SUV that may be expensed in a single year from $100,000 to $25,000, effective for vehicles placed in service after October 22, 2004.
• Reducing tax avoidance through corporate inversions and individual expatriation.
• Shutting down abusive tax shelters.
• Closing various loopholes.
• Combating fuel tax evasion.
• Extending IRS user fees.

Please keep in mind that we have described only the highlights of the most important changes in the new law. Please contact your Amper tax advisor for more details on how you may be affected by this important tax legislation.

CAUTIONARY WORDS ON CHANGING DOMICILE — “Paper Trail”

STEPHEN J. BERCOVITCH, J.D.
SENIOR TAX MANAGER

The concept of your "domicile" dates back to Old English Common Law, but it may have a very current and significant impact on your level of state taxes. Your domicile is the place you consider to be your permanent home. You can have many residences, but you can have only one domicile. The ultimate determination for tax purposes will depend in large part upon the use of the residence as a home, the use pattern in terms of “lifestyle” and family, and the taxpayer's intent. Generally, the place where the family as a whole considers its home to be is the “marital domicile.” It is very unusual that a husband and a wife have separate domiciles. Also, children will attend school in the state of domicile of the parents. The state tax auditor will focus on the taxpayer's overall living pattern, volunteer activities, leisure activities and the like.

In an actual case, a New York couple hung a Modigliani painting in their New York City Park Avenue apartment for eleven years, changed their domicile to another state in December, and sold the painting at auction the following May for $8.5million (a $7million gain). The state sought to impose the income tax on the gain because of the location of the artwork at the time of its sale. The painting remained in the City pending its transfer to the auction house while renovations were being made to the new home out of state. Because the couple had clearly established a change in domicile before the beginning of the year the painting was sold, the state lost the case.

Amper Observation: Only because the couple had clearly proven a documented change of domicile could they prevail. Had the couple not shown a clear and permanent change of their residence, the tax would have been imposed on the gain.

Tax on stock options exercised is another area where clients should consult with their tax advisor about a state tax “paper trail.” Most states tax stock option income in the year of exercise - taxing the excess of market price over the exercise price. When a taxpayer changes his domicile from one state to another, he or she may have worked in one state but exercised the option in the new home state. In that event, some states use a “grant-to-exercise” allocation period. If the taxpayer had worked for any length of time in the state where the option was earned, and returns to that state, he or she may be called upon, years later, to determine what days were worked outside of the state during the interim years the options were held. A former resident, of course, may not have any purpose for maintaining such records.

Amper Observation: In both the state where the income was earned and the state where the option is exercised, the taxpayer is required to document the days that are not taxable.

These are just a few of the many instances that show the amount of state taxes an individual pays when changing domicile may have as much to do with his or her record keeping as with what is the “right” or “wrong” amount of tax. The obligation of the taxpayer is to effectuate a clear and convincing “paper trail” in order to obtain optimal tax results. This effort can and should be supported and guided by your tax advisor.

HOWARD KLEIN CPA
TAX PARTNER

Enacted October 4, 2004 and true to its name, the “Working Families Tax Relief Act of 2004” primarily affects individual taxpayers…particularly families. It contains several short-term extensions of business or investment tax benefits, as well as technical corrections to previous legislation.

For most individuals, the new law means a continuation of the income tax rates, credits, and deductions that have applied in recent years, plus a one-year extension of alternative minimum tax relief. For at least some businesses, the new law may provide taxsaving opportunities in 2004 and 2005. For some individuals, the new law may affect eligibility for, or the amount of, several tax benefits relating to family members or others with whom the taxpayer has a close connection: the dependency exemption, the child tax credit, the earned income credit, the dependent care credit, and head-of-household filing status. These provisions, which are primarily intended to simplify the tax code, generally go into effect in 2005.

Tax Cut Extensions for Individuals
The new law extends several previously enacted tax cuts that were scheduled to be eliminated or reduced in 2005. Hence, these provisions will prevent many individuals from incurring increased tax liability in 2005 and perhaps in subsequent years as well.

Ten Percent Tax Bracket Increase Extended Through 2010
Tax cut legislation in 2001 created a 10% income tax bracket below the 15% bracket, which previously had been the lowest tax bracket. In 2004, the amounts taxed at the 10% rate are $7,150 for single filers, $10,200 for heads of household, and $14,300 for joint filers and surviving spouses.

These amounts were scheduled to drop to $6,000, $10,000, and $12,000, respectively, in 2005 and to stay at those levels until 2008. The result would have been higher taxes because more income would have been taxed at the next higher rate of 15%. The new law prevents this result by retaining the 2003 and 2004 levels, with inflation adjustments, through 2010.

Individual Alternative Minimum Tax Relief Extended Through 2005
The new law delays for one year a scheduled reduction in the exemption amounts for the individual alternative minimum tax (AMT). As a result, the following exemption amounts, which apply in 2004, will also apply in 2005:

• $40,250 for unmarried taxpayers (versus $33,750),
• $58,000 for joint filers and surviving spouses (versus $45,000),
• $29,000 for married filing separately (versus $22,500).
• The exemption amount for estates and trusts-$22,500-was not affected by the new law or previous tax cut legislation.

Note that the exemption amount is phased out at certain income levels. The new law does not change this rule. The new law does, however, permit all nonrefundable personal credits to be used in full in calculating individual alternative minimum tax in 2004 and 2005. Previously, only the adoption credit, child credit, and IRA credit were to be allowed in full against the AMT in 2004 and later years.

Marriage Penalty Relief Extended Through 2005
Previous legislation provided temporary marriage penalty relief for joint filers by increasing both the standard deduction and the amount of income taxed at the 15% rate to twice the comparable amounts for single taxpayers. Thus, in 2004, the standard deduction for joint filers and surviving spouses is $9,700 (versus $4,850 for single filers) and the amount taxed at 15% is $43,800 (versus $21,900 for single filers).

These differentials were scheduled to drop in 2005 and not return to the 200% level until either 2008 (15% bracket) or 2009 (standard deduction). Under the new law, the differentials will remain at 200% through 2010.

$1,000 Per Child Tax Credit Retained
The child tax credit for 2004 is $1,000 per qualifying child for up to three qualifying children. The credit was scheduled to decrease to $700 in 2005 and gradually increase to $1,000 again in 2010. The new law retains the $1,000 amount through 2010.

Note that the new law does not change the rule that the maximum credit amount is phased out for taxpayers with income exceeding certain levels. For example, in 2004, the phase-out range for joint filers begins at $110,000 of “modified adjusted gross income” (gross income plus certain nontaxable income).

The new law does, however, accelerate a scheduled increase in the refundable amount of the child tax credit. Also, nontaxable combat pay is treated as earned income for purposes of calculating the refundable amount.

Thus, in 2004, the refundable amount will be 15% (versus 10%) of earned income-including nontaxable combat pay-in excess of $10,750. The 15% rate will continue through 2010 and the $10,750 amount will be indexed for inflation.

Teachers' Out-of-Pocket Classroom Expense Deduction Extended Through 2005
Previous legislation permitted teachers and other “eligible educators” in grades kindergarten through 12 to take an “above-the-line” deduction in 2002 and 2003 of up to $250 for certain unreimbursed classroom expenses. The new law extends this provision through 2005, effective retroactively to the beginning of 2004.

Therefore, teachers, instructors, counselors, principals, or aides in a school for at least 900 hours during a school year may deduct up to $250 of eligible out-of-pocket expenses in 2004 and 2005 without having to itemize and without being subject to the limitation on “miscellaneous itemized deductions.” Eligible expenses include books, certain supplies, computer equipment (including related software and services), other equipment, and supplementary materials that the taxpayer uses in the classroom.

Qualified Electric Vehicles and Clean-Fuel Vehicle Property
Previous legislation provided temporary tax incentives for “qualified electric vehicles” and “clean-fuel vehicle property” placed in service before 2007. A credit of up to $4,000 was available for qualified electric vehicles purchased before 2004. A deduction of $2,000 ($5,000 or $50,000 for certain trucks and vans) was available for “qualified clean-fuel vehicle property” purchased before 2004. These maximums were scheduled to drop by 25% in 2004, 50% in 2005, and 75% in 2006.

The new law repeals the scheduled reductions for 2004 and 2005. Thus, the full credit or deduction will be available in those years. The new law did not change the 75% reduction scheduled for 2006, or the termination of these special incentives thereafter.

Uniform Definition of Child
The new law seeks to simplify the tax code by applying a uniform definition of “child” for purposes of the dependency exemption, the child credit, the earned income credit, the dependent care credit, and head-of-household filing status. These provisions will not generally apply until after tax year 2004, and therefore will not affect individual returns to be filed this April.

In most cases, the new rules will produce the same or greater tax benefits than the pre-2005 rules; however, this will not necessarily be the result in every case. Therefore, taxpayers need to consider the potential impact of the new rules and to plan accordingly.

A taxpayer's “child” under the new rules is a natural or adopted child, a stepchild, or an “eligible foster child.” The latter term means an individual placed with the taxpayer by an authorized placement agency or an appropriate court order. A child is considered “adopted” when lawfully placed with the taxpayer for legal adoption by the taxpayer.

Dependency Exemption
The key definitions under the new rules are “qualifying child” and “qualifying relative.” An individual who fits either of these definitions is considered a “dependent” of the taxpayer. Note, however, that these terms are somewhat misleading because, just as under the pre-2005 rules, certain individuals can qualify as dependents of a taxpayer even though they are neither children nor relatives of the taxpayer.

The most notable difference from current law is that the “qualifying child” standard does not include either the “support test” or the “gross income test,” although it does bar a dependency exemption for any individual who is self-supporting.

These tests are replaced by a residency requirement, under which the individual being claimed as a dependent must have had the same “principal place of abode” as the taxpayer for more than one-half of the relevant taxable year. Note, however, that the new law retains the special rule under current law that in certain cases in which the parents are divorced or separated the new law, in effect, permits the custodial parent to release the claim to the exemption in favor of the non-custodial parent.

The new law provides “tie breaker” rules for any taxable year in which an individual could be a qualifying child with respect to two or more taxpayers and those taxpayers each claim benefits based on the individual's status as a qualifying child. For example, an individual who lived with his father and grandmother in the same residence could be a qualifying child with respect to each. Or, an individual who lived with her two aunts in the same residence could be a qualifying child with respect to each.

Under the tie breaker rules, a parent is preferred over other claimants. As between parents, preference is given to the parent with whom the child resided for the longest period of time during the year. If the child resided with each parent for an equal period of time, the parent with the higher adjusted gross income gets the exemption. If none of the claimants is a parent, the taxpayer with the highest adjusted gross income is entitled to the exemption. If an individual is not a “qualifying child” with respect to the taxpayer (or any other taxpayer), the dependency exemption may be based on the individual's status as a “qualifying relative.” In general, the new law incorporates the present-law dependency exemption rules for this purpose.

Thus, as under current law, the individual's relationship to the taxpayer can be quite broad, including parents and stepparents, aunts and uncles, nieces and nephews, and certain in-laws, among others. More importantly, the present-law gross income and support tests continue to apply, including the special rules concerning multiple support agreements, income of handicapped dependents, and support of students.

Dependent Care Credit
Although the new law generally retains the current law rules for determining the dependent care credit, e.g., a child generally must be under age 13 in order to be a “qualifying individual,” the new law:

• eliminates the requirement that a taxpayer provide more than one-half of the cost of maintaining a household in order to claim the credit; and
• adds a requirement that, for a spouse or a dependent (other than a child under age 13) to be a qualifying individual, that individual must have the same “principal place of abode” as the taxpayer for more than one-half of the taxable year.

• extended the authority to issue “qualified New York Liberty Bonds” through 2009;
• extended additional refunding authority through 2005 and made bonds of the Municipal Assistance Corporation eligible for refunding.
  
  Other provisions, generally extended through 2005, include:
• Archer Medical Savings Accounts;
• Qualified Zone Academy Bonds;
• Tax Incentives for Investment in the District of Columbia;
• Indian Employment Tax Credit;
• Accelerated Depreciation for Business Property on Indian Reservations.

NEW JERSEY TECH NEWS October 2004

A Publication of the New Jersey Technology Council and the Education FOundation

TECHNEWS — Technology Council Acknowledges Phil Politziner


PHIL POLITZINER HONORED
BY NJ TECHNOLOGY COUNCIL


We are proud to announce that the New Jersey Technology Council selected Phil Politziner as recipient of its John H. Martinson Technology Supporter Award. This prestigious award honors an individual who has “demonstrated a significant commitment to the support and advancement of technology in New Jersey.” The award was presented at the Technology Council's Annual Awards Gala in November.

Phil's vision of creating a specialty serving the region's technology companies, and the hard work and talent of the firm's Technology Group, have combined to create a practice that has earned a coveted reputation for exceeding our clients’ expectations and helping them prosper.

Please click here to view the PDF version of the Review, which contains the profile that appeared in Tech News. Please join all of us here at Amper in congratulating Phil on this well-deserved honor.

RICHARD LICHTIG CPA
TAX PARTNER

Previous years have brought about an array of alternatives for people to consider when saving for retirement. Some of the more common types of plans include traditional Individual Retirement Accounts (IRAs), Roth IRAs, 457 Plans, 403(b) Plans, Simplified Employee Pensions (SEPs), and, of course, 401(k) Plans.

Regardless of which plan is best (or available), there are some things that everyone should consider before funding their retirement plan. Individuals should consider their choices now. A new year is about to start and most plans allow for new elections at the beginning of the year. Waiting too long may hinder effective retirement planning.

DOLLAR COST AVERAGING One planning technique is to make sure you take advantage of dollar cost averaging. Dollar cost averaging is an investing technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the current share price. Dollar cost averaging allows you to buy more shares when the price per share is low and fewer shares when the price is higher. Dollar cost averaging lessens the risk of making a large investment when the investment is at a high point.

Example
Assume the per share price of XYZ Inc. is $15 on January 1, $12 on April 1, $10 on July 1, and $15 on October 1. If you invest $15,000 of XYZ stock on January 1 you will have bought 1,000 shares and the value of your holdings would be $15,000 at the end of the year (ignoring dividends, etc.). Contrast this with someone who instead invested $3,750 on the first day of each calendar quarter. That investor would have 1,187.5 shares, or over 18% more shares. The total amount invested is the same $15,000, but the second person had a far greater return.

[The investor who bought all $15,000 early in the year would, of course, wind up being better off if the share price went up throughout the year. The point, however, is that dollar cost averaging reduces the risk of buying when a stock is at its high point.]

This technique is often overlooked when self-employed people make contributions to their retirement plan (e.g., Keogh Plans, SEPs, etc.). Often, their accountant will advise them that the maximum they can deduct is $40,000 and the investment must be made by the due date of the tax return. Many clients will invest the $40,000 on April 15. Abetter way might be to extend the due date for filing the tax return to August 15 and invest $10,000 each month for the next 4 months (or a lesser amount over 6 months, if you extend the due date to October 15). Another alternative might be for the self-employed person to invest, maybe, $2,000 each month during the tax year and have catch up contributions amounting to $16,000 after the end of the tax year (from January 1 through the extended due date of the return).

MAXIMIZING AN EMPLOYER'S MATCHING CONTRIBUTION
Asecond technique is best suited for people whose employer matches an employee's contribution to the retirement plan. Although many 401(k) plans have this feature, there could be several variations in employer matching. One common arrangement is where employees can invest up to 15% of their salary in the employer's 401(k) plan (up to the statutory limit) and the employer will match half of the first 6% the employee contributes. An employee who fully funds his plan as early as possible may not be taking advantage of the employer's matching provision.

Example
Assume an employee elects to contribute $14,000 to his employer's 401(k) plan for tax year 2005 and the employer's plan has a matching provision as described in the preceding paragraph. Further assume that the employee's salary is $233,333/year.

If the employee contributes as much as he can as early in the year as possible, he will have “maxed out” on his $14,000 contribution in May. That is, he will have contributed $2,916.66 from each of his paychecks in January through April with another $2,333.36 out his May paycheck; the employer will have made matching contributions totaling $2,916.66.

Had the employee in this example contributed 6% of his salary to the 401(k) plan (instead of 15%), he still would have contributed $14,000 over the course of the year, but his employer would have made matching contributions totaling $7,000, or an additional $4,083.34.

An additional benefit to spreading out the contribution would be the advantage of dollar cost averaging (discussed above). Two possible downsides come to mind for the employee who takes this approach. One would be tax-free deferral in the 401(k) plan over a shorter period. However, the greater overall amount being deferred should more than make up for this. The second downside could apply in situations where the employee is contemplating a change of jobs and the new employer has a waiting period before employees can participate in its 401(k) plan. For example, if the employee starts work at a new employer in April and the new employer has a one-year waiting period before employees can participate in its 401(k) plans, the employee may not be able to fund his retirement plan with $14,000 for the year. Though this could apply, a more common waiting period is 6 months and the employee would likely still reap greater benefits by electing the smaller deferral.

There are many tax and investment planning strategies that should be considered sooner rather than later. And don't forget. Self employed persons hoping to take a tax deduction for a contribution to a Keogh plan must open the plan before the start of the new year. It can be funded later, but the plan must have been opened by December 31.