Highlights of the Working Families Tax Relief Act of 2004

The new law primarily affects individual taxpayers, particularly families. Also, it contains several short-term extensions of business or investment tax benefits, plus 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. And for at least some businesses, the new law may provide tax-saving 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.

bulletTen Percent Tax Bracket Increase Extended Through 2010 - 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.
bulletIndividual 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; $58,000 for joint filers and surviving spouses; $29,000 for married filing separately.
bulletAll nonrefundable personal credits can 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.
bulletMarriage 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).
bullet$1,000 Per Child Tax Credit Retained -The child tax credit for 2004 is $1,000 per qualifying child 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. 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.
bulletTeachers’ 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 [a whopping] $250 for certain unreimbursed classroom expenses. The new law extends this provision through 2005.
bulletQualified 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. The new law did not change the 75% reduction scheduled for 2006, or the termination of these special incentives thereafter.

Uniform Definition of Child

bulletThe 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 next April.
bulletIn most cases, the new rules will produce the same or greater tax benefits than the pre-2005 rules. But 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.
bulletA 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

bulletThe 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.
bulletThe most notable superficial 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.
bulletThese 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, in effect permits the custodial parent to release the claim to the exemption in favor of the noncustodial parent.
bulletTie breaker rules: The new law provides rules for any taxable year in which an individual could be a qualifying child with respect to two or more taxpayers - 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.
bulletIf 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.
bulletThe 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. 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

bulletthe 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,”;
bulleteliminates the requirement that a taxpayer provide more than one-half of the cost of maintaining  household in order to claim the credit; and
bulletadds a requirement that, for a spouse or a dependent (other than an 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.

Child Credit and Earned Income Credit

bulletThe new law generally retains the current law rules for determining the child credit and earned income credit.  However, the new law eliminates the requirement that foster children and certain other children be cared for “as the taxpayer’s own” children.

Head of Household Status

bulletThe new law generally retains the current law rules for determining head of household status.

Extensions of Business or Investment Tax Benefits - The new law extended several business or investment incentives through 2005.

bulletResearch Credit is extended through 2005, retroactive to July 1, 2004.
bulletWork Opportunity and Welfare-to-Work Credit is extended through 2005, retroactive to January 1, 2004.
bulletEnhanced Deduction for Corporate Donations of Computer Technology and Equipment is extended through 2005, retroactive to January 1, 2004.
bulletExpensing of Brownfields Environmental Remediation Costs is extended through 2005, retroactive to January 1, 2004.
bulletCredit for Electricity Produced from Certain Renewable Resources is extended through 2005, retroactive to January 1, 2004.
bulletSuspension of Taxable Income Limit on Percentage Depletion from Oil and Natural Gas Produced from Marginal Properties is extended through 2005, retroactive to January 1, 2004.

Other provisions include:

bulletextended the authority to issue “qualified New York Liberty Bonds” through 2009;
bulletextended additional refunding authority through 2005 and made bonds of the Municipal Assistance Corporation eligible for refunding.
bulletArcher Medical Savings Accounts;
bulletQualified Zone Academy Bonds;
bulletTax Incentives for Investment in the District of Columbia;
bulletIndian Employment Tax Credit;
bulletAccelerated Depreciation for Business Property on Indian Reservations.

More detailed information on this new law is available to clients in our forum. Access here.