Tax Update: Federal, New York, New Jersey, and Connecticut
Stewart Berger and Ben J. Bogdanowicz
JULY 2005 - In
October 2004, President Bush signed the Working Families Tax
Relief Act of 2004 and the American Jobs Creation Act of 2004.
The significant provisions in both acts, as well as changes
in state taxation for New York, New Jersey, and Connecticut,
will have important implications for tax planning and preparation.
Families Tax Relief Act
penalty” relief. The act extends earlier
legislation by increasing both the standard deduction and
the amount taxed at the 15% rate to twice the comparable
amounts for single taxpayers.
tax credit. The child tax credit for 2004
is $1,000 per qualifying child. The credit was scheduled
to decrease to $700 in 2005 and gradually increase to $1,000
in 2010. The new law retains the $1,000 credit until 2010.
definition of a child. The new law defines
a child for purposes of the dependency exemption, child
credit, dependent care credit, and head of household credit
as a natural or adopted child, a stepchild, or an eligible
foster child. An eligible foster child is a child placed
with a taxpayer by an authorized placement agency or an
appropriate court order.
exemption. In general, a child is a qualifying
child of a taxpayer if the child has the same principal
residence as the taxpayer for more than one half the tax
year, has a specified relationship to the taxpayer, and
has not reached a specified age. The new law retains the
special rule that—in certain cases in which the parents
are divorced or separated—the custodial parent can
release the claim to the exemption in favor of the noncustodial
new law also provides tiebreaker rules in which an individual
could be a qualifying child with respect to two or more
taxpayers and those taxpayers can each claim benefits based
on this status. A parent is preferred over other claimants
under tiebreaker rules. Preference between parents is given
to the parent with whom the child resided for the longest
period of time. If the child resided with each parent for
an equal period of time, the parent with the higher adjusted
gross income receives the exemption. If none of the claimants
is a parent, the taxpayer with the highest adjusted gross
income is entitled to the exemption.
care credit. Although it generally follows
current rules for determining the dependent care credit,
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—to be considered a qualifying
individual—a spouse or dependent (other than a child
under age 13) who is physically or mentally incapable
of caring for herself must have the same “principal
place of abode” as the taxpayer for more than one-half
of the taxable year.
credit. The new law generally retains the
current law’s rules for determining the child credit.
The child tax credit is available only if the child is under
age 17 (regardless of any disability).
Jobs Creation Act of 2004
income (ETI) repeal. As opposed to most European
taxpayers that are taxed only on income earned in the country
imposing the tax, U.S. taxpayers are taxed on their worldwide
taxable income regardless of the source. Prior to repeal
by the American Jobs Creation Act of 2004, the ETI rules—which
replaced the Foreign Sales Corporation rules—excluded
ETI from a U.S. exporter’s gross income. In theory,
the exclusion applied to all foreign trade income and therefore
did not favor goods produced in the United States.
ETI regime is repealed under the new law, and becomes fully
effective in 2007. For transactions in 2004, taxpayers retain
100% of their ETI benefits. For transactions in 2005, taxpayers
retain 80% of the benefits they would be entitled to under
the ETI provisions. For transactions in 2006, taxpayers
retain 60% of the benefits they would be entitled to under
the ETI provisions.
ETI phaseout will be accompanied by a phase-in of the domestic
production deduction. The domestic production deduction
is not available to exporters or other dealers that do not
engage in manufacturing production or extraction activities.
Taxpayers will receive a deduction equal to the lesser of
a phased-in percentage of taxable income or qualified production
activities income. The maximum deduction of 9% is phased
in over a five-year period.
production activities income is equal to the taxpayer’s
domestic production gross receipts, less the following:
The cost of goods sold that is allocable to those receipts;
Other deductions, expenses, and losses that are directly
allocable to those receipts; and
A proper share of other deductions, expenses, and losses
that are not directly allocable to those receipts or another
class of income.
2005 and 2006, the deduction is equal to 3% of the lesser
of the taxpayer’s taxable income or qualified production
activities income. For 2007 through 2009, the deduction
is 6% of the taxpayer’s taxable income or qualified
production activities income. The deduction is 9% for tax
year 2010 and thereafter.
lease, rental, license, sale or exchange, or other disposition
of qualifying production property that was manufactured,
produced, grown, or extracted by the taxpayer in whole or
in significant part within the United States qualifies as
domestic production gross receipts. The production deduction
does not apply to taxpayers that engage solely in sales
deduction will be applied by looking through flow-through
entities and applying the rules and limitations at the owner
level. The deduction is limited to 50% of W-2 wages paid
during the year.
expensing depreciation. The new law extends
the IRC section 179 maximum expense. The section 179 limitation
is $100,000 (indexed for inflation) and the investment limitation
is $400,000. For 2004, the section 179 deduction is $102,000
with a $410,000 acquisition cap.
changes. The new law limits the cost of a
sports utility vehicle weighing not more than 14,000 pounds
that may be expensed under IRC section 179 to $25,000 if
acquired after October 22, 2004, and it does not subject
such vehicle to IRC section 280F depreciation limitations.
Most pickup trucks, passenger vans, and small buses that
weigh at least 6,000 pounds are not subject to the annual
deduction limits that apply to passenger vehicles, but they
will be limited to an IRC section 179 deduction of $25,000.
leasehold improvements made to nonresidential property after
October 22, 2004, and before January 1, 2006, have a 15-year
recovery period. A qualified leasehold improvement is any
improvement to an interior portion of nonresidential real
property meeting the following requirements:
The improvement is made pursuant to a lease by the lessee,
any sublessee, or lessor.
The lease is not between related persons.
The building or portion of the improvement is occupied
by the lessee or sublessee.
The improvement is placed in service more than three years
after the date that the building was first placed in service.
of start-up and organization expenses. For
expenditures incurred after October 22, 2004, the new law
allows taxpayers to deduct up to $5,000 of start-up costs
and organization expenses in the tax year in which the trade
or business begins. The $5,000 amount must be reduced (but
not below zero) by the amount by which the costs exceed
$50,000. The remaining costs that are not deductible in
the year in which the trade or business begins must be amortized
over 180 months using the straight-line method, beginning
with the month the trade or business begins.
corporations and partnerships. The new law
has increased the number of eligible shareholders from 75
to 100. Family members from up to six generations can elect
to be treated as one shareholder for purposes of counting
the number of shareholders. The law also permits grandfathered
IRAs to hold shares in an S corporation bank and allows
suspended S corporation losses or deductions due to lack
of basis to be transferred to a spouse incident to divorce.
are required in certain cases to adjust the basis of partnership
property following a transfer of a partnership interest
to reflect differences in the transferee partner’s
basis and its proportionate share of the adjusted basis
of the property. This occurs when a partnership has a built-in
loss after the transfer. The IRC section 743 adjustment
is now mandatory when a partnership interest is transferred
and the partnership’s basis in its property exceeds
the fair market value by more than $250,000.
to deduct state and local general sales tax.
For 2004 and 2005, individual taxpayers may elect to deduct
either state and local income taxes or state and local general
sales tax as an itemized deduction on their federal income
tax returns. The amount of sales tax to be deducted is determined
by the actual amount of sales tax paid or by IRS general
tables plus the amount of any sales tax paid for motor vehicles,
boats, or other IRS-specified items.
compensation. The new law imposes new requirements
for nonqualified deferred compensation plans after December
31, 2004. Some of the requirements restrict acceleration
of benefits and the timing of distributions, limit the use
of offshore rabbi trusts, limit the available types of permitted
investment alternatives, and require the election of a deferral
before the services being compensated for occur. Plans in
effect prior to October 3, 2004, that are not materially
modified may still be operated in accordance with their
existing terms with respect to amounts deferred before January
of gain on sale of principal residence. When
an individual acquires a principal residence in a like-kind
exchange, the new law requires that the individual own the
property for at least five years prior to its sale or exchange
in order for the $250,000 or $500,000 principal residence
exclusion to apply.
of motor vehicles, boats, and airplanes. The
new law limits the deduction available for charitable contributions
made after 2004 of used motor vehicles, boats, and airplanes.
Charitable deductions are generally limited to the amount
the charity receives when it sells the vehicles. The charity
must estimate market value at the time of the donation when
it has made significant use of the vehicles or has made
improvements. Donors, including C corporations, that make
contributions other than cash, inventory, or publicly traded
securities must obtain an appraisal when claiming a deduction
exceeding $5,000. If the deduction exceeds $500,000, the
appraisal must be attached to the tax return.
provisions. Effective for cancellation of
indebtedness on or after October 22, 2004, the new law provides
that a partnership which satisfies an indebtedness by transferring
a capital or profits interest in itself can recognize cancellation
of indebtedness income from such a transfer to a creditor.
act creates a new tax penalty for any person who fails to
include on any return or statement any information regarding
a reportable transaction. A reportable transaction is any
transaction in which information is required to be included
with a tax return or statement, because the IRS has determined
that this type of transaction has the potential for tax
avoidance or evasion under the tax rules.
increases for 2004. Due to cost-of-living
adjustments, the IRS has announced the following pension
plan limits for 2005:
The maximum annual benefit in a defined benefit plan has
increased from $165,000 to $170,000.
The limit of contributions to defined contribution plans
has increased from $41,000 to $42,000.
Catch-up contributions for those age 50 or over have increased
from $3,000 to $4,000.
York State Tax Update
August 20, 2004, New York State enacted the 2004 Budget
Act, which amended New York State law as well as the New
York City Administrative Code.
taxes. An MTA surcharge on all corporations
other than S corporations was extended to taxable years
ending on or before December 31, 2009. The MTA surcharge
is calculated on the franchise tax rates in effect on June
New York State minimum fixed-dollar tax, which includes
S corporations, has been increased. The fixed-dollar minimum
tax shall be computed, based on gross payroll, as follows:
Gross payroll of $500,000 or less: $100.
Gross payroll $1 million or less but more than $500,000:
Gross payroll $6,250,000 or less but more than $1 million:
Gross payroll less than $25 million but more than $6,250,000:
$5,000 (formerly $1,500).
Gross payroll $25 million or more: $10,000 (formerly $1,500).
$800 fixed-dollar minimum tax remains in effect for corporations
with gross payroll, total receipts, and average gross assets
each totaling less than $1,000.
of hearing rights upon notice of demand. The
act eliminated a taxpayer’s right to a prepayment
hearing if the taxpayer disagrees with a notice of demand
or a notice of additional tax due because of a mathematical
or clerical error. A taxpayer who wants to contest the notice
issued must first pay the tax due plus all interest and
tax. Effective for estates of decedents dying
on or after January 1, 2002, the credit for tax paid to
other states is not limited to tax actually paid. The credit
will be calculated by multiplying the federal credit for
state death taxes by the ratio of non–New York property
to total property.
property taxes. Effective August 20, 2004,
New York City may require the payment of real property taxes
by electronic funds transfer where the annual real property
tax liability is equal to or greater than $300,000.
Jersey Tax Update
June 2004, New Jersey enacted the Fair and Immediate Relief
Act. The highlights of this tax legislation follow.
in gross income tax. The act increases the
top gross income tax rate from 6.37% to 8.97% on taxable
income in excess of $500,000, retroactive to January 1,
operating loss carryover. Corporation tax
law prohibited the use of net operating losses in 2002 and
2003. For the years 2004 and 2005, corporations can offset
up to 50% of their entire net income with net operating
decoupling. For assets placed in service on
or after January 1, 2004, all taxpayers must decouple from
federal bonus depreciation. The IRC section 179 limit for
expensing fixed asset purchases is $25,000. New Jersey no
longer allows 50% bonus depreciation.
funds transfer. The act lowers the threshold
for mandatory use of electronic transfer as a means of filing
state taxes. Electronic transfers of taxes must be used
by taxpayers whose prior-year liability was $10,000 or more.
of New Jersey real property. Effective August
1, 2004, estimated tax payment will be required on the sale
of New Jersey real estate by nonresident individuals, estates,
or trusts. The estimated tax will be based on the gain on
the sale and will be at the highest personal income tax
2004 composite payment tax requirements for S corporations
and partnerships. An S corporation is now
required to file Form CT-1065/CT-1120SI (Connecticut Composite
Income Tax Return) and make a composite Connecticut income
tax payment on behalf of each nonresident shareholder where:
1) the shareholder’s pro rata share of the S corporation’s
income derived from or connected with Connecticut sources
is $1,000 or more; and 2) an election to be included on
Form CT-G (Connecticut Group Income Tax Return) has not
been made by such nonresident shareholder.
an S corporation was not required to make a composite Connecticut
income tax payment on behalf of any nonresident shareholder
who elected to pay Connecticut income tax by filing Form
CT-1NA (Nonresident Income Tax Agreement) with the S corporation.
The new law precludes this election and, if the election
was previously made, nullifies this election for taxable
years of S corporations beginning on or after January 1,
determine the composite payment due from each nonresident
shareholder, the S corporation must multiply each nonresident
shareholder’s pro rata share of the S corporation’s
separately and nonseparately computed income derived from
or connected with Connecticut sources, whose expected tax
liability is expected to equal or exceed $1,000, by 5%.
Form CT-1065/CT-1120SI is due on or before the 15th day
of the fourth month following the end of the S corporation’s
taxable year (April 15th for calendar-year filers.) Similar
rules apply to partnerships.
tax. Under prior law, employers had to remit
withholding tax at the same time as required by federal
law. The statute was amended to break from federal withholding
due dates and establish state withholding due dates beginning
January 1, 2005. The state of Connecticut determines that
the tax be deducted and withheld using the look-back method,
based on the prior year’s liability.
remittances are required if the tax withheld in the prior
year was $10,000. The tax must be remitted on or before
the Wednesday next succeeding the weekly period, which runs
from Saturday to Friday. Monthly remittances are required
if the tax withheld in the prior year was more than $2,000
but less than $10,000. The tax must be remitted by the 15th
of the following month. Quarterly remittances are required
if the tax withheld in the prior year was $2,000 or less.
The tax must be remitted by the last day of the month of
the month succeeding the end of the quarter. Household employers
must pay the tax withheld on or before April 15th next succeeding
the calendar year.
business entity tax for taxable years beginning January
1, 2004, is $250. The business entity tax applies to S corporations,
limited liability partnerships, limited liability companies,
and limited partnerships if they are required to file an
annual report with the Connecticut Secretary of State.
tax is required to be filed on Form OP-424 and paid by the
15th day of the fourth month following the close of the
entity’s tax year.
Berger, CPA, is a tax principal at Weinick Sanders
Leventhal & Co. LLP, New York, N.Y.
Ben J. Bogdanowicz, CPA, own account, is based in
New York, N.Y.