Tax Changes for Individuals

Deduction of state and local general sales taxes. For the 2005 tax year a new law allows taxpayers to elect to take state and local general sales and use taxes as an itemized deduction instead of taking an itemized deduction for state and local income taxes. This change 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). Previously, only state and local income tax payments were deductible. Taxpayers who itemize may deduct their actual sales taxes or use IRS-published tables plus sales tax paid for motor vehicles, boats, aircraft, homes and home building materials.

Deduction for charitable donations of cars, boats and planes. A new law generally limits the deduction for motor vehicles, boats and airplanes contributed to charity after 2004, for which the claimed value exceeds $500, by making it dependent upon the charity’s use of the vehicles and imposing higher substantiation requirements. If the charity sells the vehicle without any “significant intervening use” or “material improvement”, the donor’s charitable deduction can’t exceed the gross proceeds from the sale.

Education credits. For 2006, the Hope and Lifetime credits phase out ratably for taxpayers with modified AGI of $45,000 to $55,000 ($90,000 to $110,000 for joint filers). In 2005, these figures were $43,000 to $53,000 ($87,000 to $107,000 for joint filers).

Interest exclusion for higher education. The interest on U.S. savings bonds redeemed to pay qualified higher education expenses may be tax-free. The exclusion is phased-out for certain higher income individuals. The phase-out for 2005 will begin at modified adjusted gross income above $61,200 ($91,850 on a joint return). For 2006, the corresponding figures are $63,100 and $94,700.

Student loan interest deduction. For 2005 and 2006, the deduction phases out ratably for taxpayers other than joint filers with modified AGI between $50,000 and $65,000. For 2005 and 2006, the corresponding figures for joint filers are $105,000 and $135,000.

Qualified transportation fringe benefits. For 2006, an employee will be able to exclude up to $250 (up from $200 in 2005) a month for qualified parking expenses and up to $105 a month (same as 2005) of the combined value of transit passes and transportation in a commuter highway vehicle.

Adoption credit. An individual is allowed a credit against income tax (and AMT) for qualified adoption expenses. The total expenses that may be taken as a credit for all tax years with respect to the adoption of a child by the taxpayer will be limited to $10,960 for 2006 (up from $10,630 in 2005). For 2006, the credit for the adoption of a special-needs child will be $10,960, regardless of the extent to which the taxpayer has qualified adoption expenses (up from $10,630 in 2005). The credit will begin to phase out at AGI of $164,410 (up from $159,450 in 2005). The phase-out will be complete at $40,000 above the threshold.

Adoption exclusion. Individuals are allowed the exclusion for employer-provided adoption assistance. The total amount excludable per child (whether or not he has special needs) will be limited to $10,960 in 2006 (up from $10,630 in 2005). Note that the exclusion for the adoption of a child with special needs applies regardless of whether the employee has qualified adoption expenses.

Tax Changes for Businesses

Expensing. The amount that may be expensed under Code Sec. 179 in 2006 will be $108,000 (up from $105,000 in 2005). For 2006, the expensing limit will be reduced when more than $430,000 of property is placed in service (up from $420,000 in 2005).

Limit on expensing sport utility vehicles. For property placed in service after October 22, 2004, a new law limits the ability of taxpayers to claim deductions under Code Sec. 179 for certain vehicles to $25,000. The change applies to sport utility vehicles that are not subject to the luxury auto rules (i.e., because they have a GVWR of more that 6,000 pounds), and are rated at 14,000 pounds gross vehicle weight or less (in place of the pre-Act law 6,000 pound rating).

New limit on company deductions for entertainment, etc. provided to officers and directors. For expenses incurred after October 22, 2004, the Jobs Act limits a company’s trade or business deduction for costs of entertainment, amusement, or recreation-related goods, service or facilities it provides to officers, directors, and 10%-or-more owners. The costs are deductible only to the extent that they don’t exceed the amount of expenses treated by the company as compensation income to the recipient as a result of receiving those goods, services, or facilities. The Act overturns a court decision holding that a company could deduct the entire cost of providing entertainment, amusement, or recreation-related goods, services or facilities, regardless of whether that cost was greater or less than the amount that the recipient had to treat as income.

Tax Changes for Retirement Planning

Roth 401(k)s. Effective January 1, 2006, for 401(k) plans that have been amended to allow such contributions, plan participants can designate part or all of their plan contributions as Roth 401(k) contributions. The employee must irrevocably designate amounts as Roth 401(k) contributions and can change only future deferrals.

Elective Deferrals. An employee may elect to defer a maximum of $14,000 on a pre-tax basis under a 401(k) plan, SEP, or Code Sec. 403(b) tax-sheltered annuity for 2005. The maximum deferral amount will be $15,000 in 2006, (indexed in later years). Individuals who attain age 50 by the end of the plan year may make (if their plan permits) additional pre-tax “catch up” contributions of up to $4,000 for 2005, $5,000 for 2006, with inflation adjustments in later years.

Traditional IRA Contributions. An individual who isn’t an active participant in certain employer-sponsored retirement plans and whose spouse isn’t an active participant, can deduct, for each tax year, cash contributions to an IRA for that year, up to the lesser of: 1) $4,000 for 2005 and $4,000 for 2006 ($4,500 in 2005 and $5,000 in 2006 for those 50 and over), or 2) 100% of the compensation that’s includible in his gross income for that year. If the individual is an active participant in an employer retirement plan, the phase out rules of $50,000 - $60,000 (single and head of household) and $70,000 - $80,000 (married filing joint) of adjusted gross income (AGI) are applied to any contribution. A nonworking spouses IRA is phased out when the AGI is between $150,000 - $160,000.

Roth IRA Contributions. An individual can make annual nondeductible contributions to a Roth IRA in amounts up to $4,000 for 2005 ($4,500 for those 50 and over in 2005) and $4,000 for 2006 ($5,000 for those 50 and over in 2006) or 100% of compensation, if less, reduced by the amount of contributions for the tax year made to all other IRAs but not reduced by contributions to a SEP or SIMPLE Plan. The allowable contribution phases out ratably (in $10 increments) over the following levels of AGI: $150,000 to $160,000 for joint filers; $0 to $10,000 for married couples filing separately; $95,000 to $110,000 for others.

Non-deductible IRA contributions. An active participant in a qualified plan who may not be eligible to make deductible contributions either in whole or in part to an IRA, can make designated nondeductible contributions (DNCs) to an IRA for a tax year up to the due date (without extensions) for the taxpayer’s income tax return for that year. A nondeductible contribution produces no initial tax savings, but the earnings generated by the contribution compound tax-deferred until distributed. Roth IRA contributions are also nondeductible and compound tax-deferred, but distributions may be tax-free when distributed. Thus, nondeductible contributions to non-Roth IRA’s generally would be made only by those with incomes above the Roth IRA contribution threshold.

The amount of any DNCs made in any tax year on behalf of an individual is limited to the excess of: 1) the lesser of $4,000 for 2005 ($4,000 for 2006) or $4,500 for those 50 and over ($5,000 for those 50 and over in 2006) or 100% of compensation (including the higher-earning spouse’s compensation), or 2) the amount allowable as a deduction for IRA contributions by active participants.

Please note, the preceding only provides summarized, general information. Please consult us prior to any action on your part, based on this information.