Congress Extends Individual and Business Tax Cuts; Adds New Tax Relief

Congress has acted to extend the life of popular tax reductions that were due to expire at the end of this year, averting a tax "increase" for virtually all taxpayers. The measure also gives a reprieve to expiring business and special-interest tax breaks, tidies up the tax code, and offers a further one-year "fix" on the alternative minimum tax.

The Working Families Tax Relief Act of 2004 extends the life of four popular "middle class" tax breaks. The child tax credit is extended at its current $1,000 per child level, the 10-percent income tax bracket will stay at its current level (adjusted for inflation) and two "marriage tax penalty relief" measures will not decrease next year.

"In effect, the Act smoothes out ups and downs in these tax benefits to keep them in effect at basically their current level through 2010," said CCH Principal Federal Tax Analyst Mark Luscombe, J.D., C.P.A.

Without the Act, the child credit was scheduled to decrease to $700 in 2005. The 10-percent bracket was scheduled to shrink to $12,000 for married couples filing jointly and $6,000 for single filers. Instead, the top of the brackets will stay at $14,000 and $7,000 respectively, adjusted for inflation since 2003, so taxpayers can expect the brackets to top out at $14,600 and $7,300, respectively, next year.

Married couples filing jointly would have taken two additional tax hits in 2005 if the legislation hadn't passed. Their standard deduction would have been $8,700 next year, instead of the $10,000 they can expect due to inflation adjustment of their current $9,700 standard deduction. In addition, under prior law their 15-percent tax bracket would top out at $53,450 in 2005, rather than $59,400. That would have subjected nearly $6,000 more of their income to taxation at 25 percent rather than 15 percent.

Alternative Minimum Tax Relief Is Costly

The bill contains a one-year extension for individual alternative minimum tax (AMT) relief in the form of an expanded exemption and extends the ability to apply non-refundable personal credits against the alternative tax for 2004 and 2005. Many taxpayers would not have reaped the full benefits of the tax cuts that began in 2001 if it were not for a series of temporary "fixes" to the AMT. Because the AMT is not indexed for inflation, more and more taxpayers tend to become subject to its arduous provisions every year.

By raising the exemption used in calculating liability for the AMT, Congress has spared many taxpayers from having to pay the alternative tax and thus preserves for many people the full benefit of the tax reductions enacted in 2001 and 2003. What's more, by raising the exemption for only a year or two at a time, Congress has kept to a minimum the cost of these fixes that must be taken into account for budget purposes.

"As much as many legislators would love to do away with the AMT entirely, the cost of doing that--measured in terms of lost revenue--is enormous," Luscombe said. "The single tax year of AMT relief in this bill will have a bigger impact in fiscal 2005 and 2006 than any other single provision."

Other Extensions

The measure also contains a one-year extension of many expiring tax credits affecting businesses and a select number of individuals, including:

• the research and development tax credit
• the welfare-to-work and work opportunity tax credits
• extension of Liberty Zone bonds for New York City
• tax incentives for investment in the District of Columbia

Extensions of provisions affecting a relatively small number of individuals include a credit for electric cars, deduction for clean-fuel vehicles and an above-the-line deduction for teacher classroom expenses.

Tidying Up

Congress also used the Working Families Tax Relief Act of 2004 to tidy up some messy bits of the tax code. One major effort was to arrive at a unified definition of a "qualified child" for the purposes of the dependency exemption, the child credit, the earned income credit, the dependent care credit and head of household filing status. Each of these provisions has defined "child" somewhat differently in the past. Different provisions--notably, the child credit--will continue to use different ages as cut-offs in their definition of a "qualified child," but in general tests involving residency and relationship to the taxpayer will be the same across the board.

Related items:

Congress Moves To Make Some Tax Cuts Permanent

Prepare Now for Next Year's Tax Season

Posted September 27, 2004.