As you and your clients prepare to file their 2004 tax returns, you may want to start thinking if there is a better way of getting organized for 2006. Are there any tax law changes that impact the tax returns? Can your clients make larger retirement plan contributions? Did they serve on active duty? What documents do you or your clients need to help in preparing the tax returns?
Last fall, we saw two federal income tax law changes—the Working Families Tax Relief Act of 2004 (WFTRA) and the American Jobs Creation Act of 2004 (AJC).
WFTRA extended many provisions of the Economic Growth and Tax Relief Act of 2001 (EGTRRA 01). WFTRA did not change or extend the capital gains rates of 5 percent and 15 percent. Nor did it modify the 2008 rate of 0 percent for the gains currently in the 5 percent bracket. These lower rates are scheduled to expire at the end of 2008.
RETIREMENT-CONTRIBUTION LIMITS HAVE INCREASED FOR 2005.
One of the taxes that hit many clients unexpectedly was the alternative minimum tax (AMT), originally designed to affect high-income earners so they would have to pay some tax. Unfortunately, this alternative tax system has not been adjusted for inflation and is affecting more of your clients than ever before. For 2005, the AMT exemption has been increased to $58,000 for couples filing jointly and $40,250 for single filers. This is a one-year extension, and unless further legislation occurs in 2005 or 2006, many people will pay this tax under the best of circumstances.
Whom does this tax affect? A good example is the group of taxpayers with large itemized deductions, such as medical expenses and state and local tax bills. Many more people are paying their medical insurance premiums personally. Some of these premiums can exceed $1,400 a month, depending upon the age of your clients and the community in which they live. If your clients are paying huge medical bills, they should check with their tax advisor to see if the AMT applies to them.
The AJC allows active-duty personnel to take distributions from their IRAs and qualified employer retirement accounts penalty-free as long as their tour of active duty exceeds 179 days or is for an indefinite period. This provision applies to individuals called to active duty after Sept. 11, 2001, and before Sept. 12, 2005.
Also, the AJC allows victims of federally declared disasters, such as the Florida hurricanes, to withdraw penalty-free a “qualified disaster-relief distribution.” The distribution must be made within one year beginning on the date such declaration is made and cannot exceed the taxpayer’s unreimbursed loss incurred as a result of the disaster.
Retirement-contribution limits have increased for 2005. Simple contributions go up to $10,000, 401(k) deferrals have increased to $14,000, catch-up provisions for individuals over age 50 for 401(k) plans are $4,000, while simple, catch-up provisions are $2,000. People in defined-contribution plans can contribute $42,000, up from $41,000. The additional $1,000 for simple and 401(k) contributions saves an individual in the 25-percent tax bracket $250.
More tax reform
The Bush administration is discussing additional tax reform during Bush’s second term. Emphasis appears to be on increasing savings and simplifying the various regulations. During the second half of 2005, experts believe some type of tax reform bill will be introduced in Washington, D.C. Social Security reform, allowing individuals to direct some portion of their Social Security contributions to the equities market, is also on the table. You and your clients need to stay abreast of the latest developments.
IF YOUR CLIENTS ARE PAYING HUGE MEDICAL BILLS, THEY SHOULD CHECK TO SEE IF THE AMT APPLIES TO THEM.
Aside from paying attention to what finally gets passed in Washington, organizing the information you and your client need to prepare tax returns will reduce the cost of preparation and help prevent frantic telephone calls from tax preparers and their clients, especially as deadlines loom.
When a client sells a stock, determining the basis of the stock can be challenging at best. I recommend that all clients keep a file on the stock, put the transactions on Quicken, Microsoft Money or an Excel spreadsheet so that this information is available quickly and accurately. Nothing is worse or more expensive to the client than when the preparer spends hours reconstructing the stock purchases, the reinvested dividends and the spin-offs.
It pays to file
One way for your clients to organize their tax information—from retirement plans to medical bills—is to have a file where the pertinent information is placed all year long. When stock inherited from a relative is sold, the appropriate paperwork goes into this file. When a car is donated to a charity and a receipt is received from the charity, the receipt is also placed in this file.
The type of information that is needed for your client’s tax return is determined in part by the tax law changes. Staying informed and getting organized will make the tax-preparation process easier and more efficient—for you and your client.
Pam Feely, CPA, has 26 years of experience as a tax practitioner. She is the publisher of The Feely Files, Commentary on Colorado Tax and Business Issues. You can reach her at www.feelyfiles.com.