Energy Tax Incentives Act of 2005
The Energy Tax Incentives Act of 2005 contains $14.5 billion in tax cuts to promote domestic energy production and conservation. Businesses and individuals are eligible for new credits, deductions and incentives. A few of the highlights are listed below.
Energy-efficient improvements. Although the main thrust of the Energy Tax Incentives Act of 2005 is on energy producers and related industries, individuals were not forgotten. Owners of existing homes will be entitled to a lifetime credit of up to $500 for energy- efficient improvements to their homes made in 2006 and 2007. In general, the credit will be 10% of the cost of an air circulating fan, certain furnaces and hot water heaters, and some pumps and air conditioners. The energy-efficient improvements must be expected to remain in use for at least five years. In addition, the credit only applies to installations in your principal residence. Second homes don’t qualify for the credit.
There also is a 30% credit for the installation of solar hot water heaters and photovoltaic or fuel cell property, up to $2,000 per category per year.
Note: Energy-efficient improvements made or residential energy property installed before January 1, 2006, do not qualify for the credit.
New credits on purchase or lease of alternative vehicles. The Act also did not overlook a growing segment of the American driving public consisting of purchasers of vehicles that are powered by other than a traditional gasoline engine. Such vehicles, which include pure electrics and hybrids, as well as those that run on natural gas, liquefied petroleum, or 85-percent methanol, have been growing in popularity as gasoline prices continue to increase. Hybrid cars, such as the Toyota Prius and Honda Insight, as well as more recent luxury entries like the Lexus RX 400h, have been garnering the bulk of the publicity.
The Energy Act effectively terminates the current law deduction for clean fuel vehicles and replaces it with a series of credits for hybrids and alternative fuel vehicles under the overall title of the “Alternative Motor Vehicle Credit.”
Because a tax credit is worth more than a deduction, the new law provides a much greater incentive to purchase a hybrid car or other alternative fuel vehicle. You might consider delaying a planned purchase in 2005 until 2006.
Katrina Emergency Tax Relief Act of 2005
The Katrina Emergency Tax Relief Act of 2005 contains tax breaks not only for victims of the disaster but also for individuals and businesses helping in the recovery.
Giving shelter to evacuees. Americans have opened their homes in unprecedented numbers to give shelter to evacuees. The new law rewards those generous homeowners (and renters) with a special tax deduction for tax years beginning in 2005 or 2006. Individuals who use their principal residence to provide housing free of charge to evacuees (referred to as Hurricane Katrina displaced individuals) for at least 60 consecutive days may claim a special $500 deduction from taxable income for each evacuee residing in the taxpayer’s home. The deduction is capped at $2,000 but may be taken whether or not you itemize your deductions. In order to qualify, the evacuee’s principal place of abode must have been in the Hurricane Katrina disaster area on August 28, 2005.
Note: A Hurricane Katrina displaced individual for purposes of the deduction does not include your spouse or any of your dependents. A nondependent cousin, aunt, or other relative, however, can qualify. The evacuee’s taxpayer identification number must be included on your return if you are claiming this deduction.
Charitable Contributions. Generally, for individuals, contributions to taxexempt charitable organizations are limited to 50 percent of the taxpayer’s contribution base (adjusted gross income) for the tax year. Any excess amount may be carried over for a period of up to five years. The new law increases the deduction to 100% of the contribution base for all cash donations to a qualified “public charity” for the period beginning on August 28, 2005, and ending on December 31, 2005.
Procedurally, an individual’s charitable deduction is allowed up to the amount by which the taxpayer’s contribution base exceeds the deduction for other charitable contributions. The provision also exempts these special qualifying contributions from the application of the phase-out of itemized deductions for high-AGI taxpayers. A taxpayer must elect to have contributions treated as qualified contributions under these provisions.
Note: This provision is one of the few that does not require a connection with Hurricane Katrina. Any and all cash contributions made by an individual taxpayer made after August 27th through the end of the year qualify for exemption from the contribution base rule.
New Retirement Saving Option: Roth 401(k)
Effective for post-2005 tax years, the Roth 401(k) is designed to allow 401(k) plan participants to make their contributions to the plan on an aftertax basis, and for these contributions to grow with tax-free earnings and to be distributed at retirement without any future income tax liability.
Under present law, high income employees do not have the right to use Roth IRAs because of the Roth IRA income limits. However, by participating in Roth 401(k) plans, these employees will be able to save up to $15,000 per year (in 2006) without future income tax liability on the earnings on these Roth 401(k) contributions.
But keep in mind that amounts contributed to the Roth 401(k) reduce an employee’s right to make regular 401(k) contributions; and regular 401(k) contributions are not taxed to the employee until actual distribution. So the choice is between deferring tax on the contributions until after retirement (regular 401(k)) or paying income tax right away but no taxes thereafter (Roth 401(k)).
The Roth 401(k) rules will also apply to employee contributions to tax-sheltered annuity Code Sec. 403(b) plans. However, plan sponsors will have to take several steps to implement Roth 401(k) programs in their defined contribution plans, so check with your employer to see if this provision applies to your retirement plan.
Standard Mileage Rate
Taxpayers can use the standard mileage rate in lieu of actual expenses in computing the deductible costs of operating automobiles (including vans, pickups or panel trucks) owned or leased by them for business purposes. This rate is also used as a benchmark by the federal government and many businesses to reimburse their employees for business travel.
The IRS normally updates the mileage rates once a year in the fall for the next calendar year. In recognition of recent gasoline price increases, however, the IRS made this special adjustment for the final months of 2005:
2005 Rates Jan-Aug Sept-Dec
Business $.405 $.485
Medical .15 .22
Moving .15 .22
Charitable .14 .14
If you are an employee you may deduct an amount computed using the standard mileage rate only as an itemized deduction, subject to the 2% floor on miscellaneous itemized deductions. If you are self-employed you may deduct an amount computed using the standard mileage rate in determining your net earnings for self-employment.
Remember, whether you are an employee or self-employed, the use of the standard mileage rate does not relieve you of the requirement to substantiate the amount of each business trip, or the time and business purpose of each use. You should keep a record of the time, place, business purpose and number of miles traveled for tax purposes.
Note: If you used a vehicle in providing donated services to a charity for relief related to Hurricane Katrina, you can compute the charitable mileage deduction using a standard mileage rate equal to 70% of the business mileage rate in effect on the date of the contribution.
Possible Grace Period for Sec. 125 Cafeteria Plans
Cafeteria plans (also known as flexible benefit plans or flexible benefit arrangements) allow employees to pay for qualified benefits with pre-tax dollars. Qualified benefits include employerprovided accident and health plans, group-term life insurance, dependent care assistance programs and adoption assistance programs. A cafeteria plan can’t operate in a way that enables participants to defer compensation by, for example, allowing participants to use contributions for one plan year to buy a benefit that will be provided in a subsequent plan year. This rule is commonly referred to as the “use-it-or-lose-it” rule, requiring that unused contributions at the end of the plan year be forfeited.
New for 2005. IRS Notice 2005-42 permits (but does not require) an employer to amend its cafeteria plan to give all participants a grace period lasting no longer than 2-1/2 months immediately following the end of each plan year. Expenses for qualified benefits incurred during the grace period could be paid or reimbursed from amounts remaining unused at the end of the immediately preceding plan year, as if the expenses had been incurred in the preceding plan year.
During the grace period, unused amounts may not be cashed-out or converted to any other taxable or nontaxable benefit. And unused amounts relating to a particular qualified benefit may only be used to pay or reimburse expenses incurred for that particular qualified benefit. For example, unused amounts in a health flexible spending arrangement couldn’t be used to pay or reimburse dependent care expenses incurred during the grace period.
Remember to check with your employer to see if this provision applies to your cafeteria plan.
Year-end Tax Planning Tips
You may also want to postpone income until 2006 and accelerate deductions into 2005 to lower your tax bill. This strategy may enable you to claim larger deductions, credits and other tax breaks for 2005 that are phased out over varying levels of adjusted gross income. These could affect Roth-IRA contributions, child credits, higher education tax credits and deductions for student loan interest.
You may want to consider converting part or all of your traditional IRA to a Roth IRA as part of your year-end tax planning. A conversion completed while the stock market is depressed may result in the reduction of the amount of income that must be recognized upon the conversion of a traditional IRA to a Roth IRA. Please note that in 2005, a single taxpayer must have less than $95,000 adjusted gross income to make this conversion, and a married taxpayer filing jointly must have less than $150,000 AGI to make this conversion.
For 2005, you can deduct state and local sales taxes in lieu of state and local income taxes. Unless the law is changed, for 2006 you won’t have this choice; you’ll only be able to deduct income taxes. So if you are deducting sales taxes this year and are planning to buy a car soon, you may want to push the purchase into 2005 to ensure a sales tax deduction for that item.
In addition, there are other tax law changes taking effect at the beginning of 2006 that you should take into account in your end-of-2005 planning. For example, a deduction for college tuition is scheduled to go off the books unless Congress extends it. You may want to prepay in 2005 tuition not due until early 2006 if that lets you increase your tax savings from the possibly expiring deduction.
Deduction bunching. Though this concept is not new, from time to time it bears repeating. For those taxpayers who itemize deductions on Schedule A, Form 1040, consider bunching your itemized deductions into every-other-year. In this way you would double-up the deductions for two years for much expenses as real estate taxes and charitable donations into the beginning and end of the same year. In the years in between, with no itemized deductions, you would utilize the “free” standard deduction. Since you can only deduct the greater of the standard deduction or your actual deductions in any one year, you may end up wasting the standard deduction every year. For example, a married couple with actual deductions of $15,000 each year would not be using the standard deduction the government gives them of $10,000. Thus, over two years they deduct a total of $30,000. However, if they had bunched two years worth of deductions into just one year, their total deductions for both years would be $40,000.
This is a rather simple, straightforward opportunity and it works in your favor to utilize the benefits provided to taxpayers under the law (just like it makes sense to be sure you are fully utilizing your estate and gift tax exemptions as well). Nonetheless, this won’t work for everyone. It is not possible to bunch your monthly mortgage payments, or Wisconsin income tax withheld from wages, so you may find your actual deductions necessarily exceed the standard deduction each year. Also, because some deductions, like taxes, are not deductible for alternative minimum tax (“AMT”) purposes, those who are subject to AMT may not benefit from bunching their deductions.
von Briesen & Roper Legal Update is a periodic publication of von Briesen & Roper, s.c. It is intended for general information purposes for the community and highlights recent changes and developments in the legal area. This publication does not constitute legal advice, and the reader should consult legal counsel to determine how this information applies to any specific situation.