By Richard R. Hammar, J.D., LL.M., CPA
© Copyright 2004 by Church Law & Tax Report. All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Church Law & Tax Report, PO Box 1098, Matthews, NC 28106. Reference Code: m69 m94 c0104
Congress enacted a number of tax law changes that will impact the preparation of 2003 tax returns by ministers and lay church employees in 2003, and tax reporting by churches. In addition, a number of court decisions and IRS rulings provided clarification on a number of important tax issues. Nearly 70 of the most important changes and clarifications are summarized in this library.
Congress enacted major tax bills in 2001 and 2003 containing several provisions that will affect tax reporting by both churches and ministers for 2003 and future years.
Key point. An unprecedented feature of EGTRRA is a "sunset" provision that revokes all of the hundreds of tax law changes at the end of 2010 unless Congress votes to extend them. If Congress fails to take action, then the tax law in effect in 2001 will be reinstated. Because many taxpayers, in all income brackets, will increasingly rely on many of the tax law changes in the new law, it is inconceivable that Congress will allow all of the changes to expire at the end of 2010. It is reasonable to assume that many of the changes will be permanently adopted by Congress, but not necessarily all of them.
Tax Law Changes Made by Congress
Miscellaneous changes
11. Backup withholding. Employers are required to engage in "backup withholding" for payments made to self-employed workers who do not disclose their Social Security number. EGTRRA decreases the backup withholding rate to 30% in 2002 and 2003, 29% for 2004-2005, and 28% for 2006 and subsequent years. Table 8 summarizes the backup withholding rates.
Table 8: Backup Withholding Rates
|
Year
|
Backup withholding rate
|
| 2002-2003 |
30%
|
| 2004-2005 |
29%
|
| 2006 and thereafter |
28%
|
JGTRRA provides taxpayers with an additional first year depreciation allowance in order to stimulate the economy by encouraging the purchase of goods and equipment. The first year depreciation deduction is equal to 50% of the adjusted basis of qualified property. Qualified property is defined as any property to which MACRS applies with an applicable recovery period of 20 years or less. In addition, the property must be acquired after May 5, 2003 and before January 1, 2005, and no binding written contract for the acquisition is in effect before May 6, 2003.
13. Increase in first year depreciation limit for automobiles used in business. Ministers and lay church employees who use the “actual expense” method of computing their car expenses can claim a deduction for depreciation. There are limits on the amount of depreciation that you can claim in any given year. These limits are known as the “luxury car” limits. The pre-JGTRRA limits are summarized in the Table 9.
Table 9: Pre-JGTRRA “Luxury car” depreciation limits (2003)
|
tax year
|
maximum depreciation deduction for cars first placed in service in 2003
|
| first |
$3,060
|
| second |
$4,900
|
| third |
$2,950
|
| each succeeding year |
$1,775
|
JGTRRA increases the limitation on the amount of depreciation deductions allowed with respect to passenger automobiles in the first year by $7,650 for automobiles that qualify (and do not elect out of the increased first year deduction). The $7,650 increase is not indexed for inflation. This means that the total depreciation that can be claimed for the purchase of an automobile used in one's trade or business increases to $10,710 for 2003 and 2004 (the pre-JGTRRA limit of $3,060 plus the bonus amount of $7,650).
14. Increase in section 179 expensing. Current law provides that, in lieu of depreciation, a taxpayer may elect to deduct up to $25,000 (for taxable years beginning in 2003 and thereafter) of the cost of qualifying property placed in service for the taxable year (the "section 179 deduction"). In general, qualifying property is defined as depreciable tangible personal property that is purchased for use in the active conduct of a trade or business. The $25,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $200,000. An election to expense these items generally is made on the taxpayer's original return for the taxable year to which the election relates.
JGTRRA increases the maximum dollar amount that may be deducted under section 179 to $100,000 for property placed in service in taxable years beginning in 2003, 2004, and 2005. In addition, the $200,000 amount is increased to $400,000 for property placed in service in taxable years beginning in 2003, 2004, and 2005. The dollar limitations are indexed annually for inflation for taxable years beginning after 2002 and before 2006. This provision is effective for taxable years beginning after 2002.
15. Reduction in capital gains rates. In general, gain or loss reflected in the value of an asset is not recognized for income tax purposes until a taxpayer disposes of the asset. On the sale or exchange of a capital asset, any gain generally is included in income. Any net capital gain of an individual is taxed at rates lower than the ordinary income tax rates. Net capital gain is the excess of the net long-term capital gain for the taxable year over the net short-term capital loss for the year. Gain or loss is treated as long-term if the asset is held for more than one year.
Capital losses generally are deductible in full against capital gains. In addition, individual taxpayers may deduct capital losses against up to $3,000 of ordinary income in each year. Any remaining unused capital losses may be carried forward indefinitely to another taxable year.
A capital asset generally means any property, with certain exceptions (including depreciable business assets and business supplies).
Prior to JGTRRA, the maximum rate of tax on the adjusted net capital gain of an individual was 20%. In addition, any adjusted net capital gain that would be taxed at the 15% rate if it were ordinary income is taxed at a 10% rate. JGTRRA reduces the 10% and 20% rates on the adjusted net capital gain to 5% and 15%, respectively. The lower rates apply to assets held more than one year, and sold after May 5, 2003. The 5% tax rate is reduced to zero for taxable years beginning after December 31, 2007. In some cases, other tax rates may apply. See IRS Publication 544 for details.
16. Dividend income. Prior to JGTRRA, dividends received by an individual were included in gross income and taxed as ordinary income. JGTRRA taxes dividends received by an individual shareholder from a domestic corporation (and "qualified foreign corporations") at the same rates that apply to net capital gain. As a result, dividends will be taxed at rates of 5% and 15%.
Key point. If a shareholder does not hold a share of stock for more than 60 days during the 120-day period beginning 60 days before the ex-dividend date, dividends received on the stock are not eligible for the reduced rates.
Certain dividends from regulated investment companies (such as mutual funds), real estate investment trusts, and certain foreign corporations do not qualify for the reduced rates. The 2003 Form 1099-DIV will be reissued to add a box for the reporting of qualified dividends subject to the reduced rates.
17. Tax law changes rejected by Congress. A number of provisions in the Senate version of JGTRRA were not adopted by the conference committee and so did not make their way into the final law. Here are some of the rejected provisions that are of most interest to church leaders. It is possible that some or all of these proposals will be considered or enacted in future years.
(1) corporate CEO signs all tax forms
The Senate bill would have required the chief executive officer of a corporation to sign the corporation's income tax returns. This provision only applied to the corporate income tax return (IRS Form 1120), and not to payroll tax forms such as W-2s, 1099s, and 941s.
(2) increase criminal penalties
Section 7201 of the tax code imposes a criminal penalty on persons who willfully attempt to evade or defeat the payment of tax. The current penalty is a fine of up to $100,000 or imprisonment for not more than five years, or both. In the case of a corporation, the maximum penalty is $500,000. The Senate bill would have increased these penalties to $250,000 for individuals and $1 million for corporations, and extended the maximum prison sentence to ten years.
Section 7203 of the tax code imposes a criminal penalty on persons required to make estimated tax payments, pay taxes, keep records, or supply information who willfully fail to do so. The maximum penalty for a violation is a fine of up to $25,000 ($100,000 for a corporation) or imprisonment of not more than one year (a misdemeanor), or both. The Senate bill would have increased this penalty from a misdemeanor to a felony, and the term of imprisonment to ten years.
(3) rabbi trusts
Rabbi trusts are commonly used by secular corporations, and are increasingly being used by churches. A rabbi trust is a trust established by an employer to pay benefits to an employee upon retirement or some other event. The trust is generally irrevocable and does not permit the employer to use the assets for purposes other than payments to the employee. A rabbi trust is not taxable to the employee until the assets are distributed, so long as the trust is subject to a "substantial risk of forfeiture" which generally means that the trust is subject to the claims of the employer's general creditors. The Senate bill would not have eliminated the tax benefits of rabbi trusts, but would have made it much more difficult to qualify for these benefits.
(4) foreign earned income exclusion
U.S. citizens living abroad may be eligible to exclude from their income for U.S. tax purposes certain foreign earned income and foreign housing costs. In order to qualify for these exclusions, a U.S. citizen must be either: (1) a bona fide resident of a foreign country for an uninterrupted period that includes an entire taxable year; or (2) present overseas for 330 days out of any 12-consecutive month period. In addition, the taxpayer must have his or her tax home in a foreign country. The exclusion for foreign earned income generally applies to income earned from sources outside the United States as compensation for personal services actually rendered by the taxpayer. The maximum exclusion for foreign earned income for a taxable year is $80,000 (for 2002 and thereafter). For taxable years beginning after 2007, the maximum exclusion amount is indexed for inflation.
The exclusion for housing costs applies to reasonable expenses, other than deductible interest and taxes, paid or incurred by or on behalf of the taxpayer for housing for the taxpayer and his or her spouse and dependents in a foreign country. The exclusion amount for housing costs for a taxable year is equal to the excess of such housing costs for the taxable year over an amount computed pursuant to a specified formula. In the case of housing costs that are not paid or reimbursed by the taxpayer’s employer, the amount that would be excludable is treated instead as a deduction.
The foreign earned income exclusion is a significant tax benefit to foreign missionaries. The Senate bill would have eliminated this provision, but this proposal was not adopted by the conference committee.
(5) civil rights tax deduction
Under current law, taxable income generally does not include the amount of any damages (other than punitive damages) received on account of personal injuries. However, expenses incurred in recovering such damages are generally not deductible.
The Senate bill would have provided an "above-the-line deduction" (available whether or not a taxpayer can itemize deductions on Schedule A) for attorneys’ fees and costs paid by a taxpayer in connection with any lawsuit involving a claim of unlawful discrimination. "Unlawful discrimination" was defined in the Senate bill to mean any act that is unlawful under any one or more of several laws, including the Fair Labor Standards Act (overtime and minimum wage), the Age Discrimination in Employment Act, the Employee Polygraph Protection Act, the Family and Medical Leave Act, the Civil Rights Act of 1964, the Americans with Disabilities Act, and similar state laws.
(6) repealing the 1993 tax increase on Social Security benefits
Under current law there is a two-tier system of taxation of Social Security benefits. Under this system, up to either 50% or 85% of Social Security benefits are includible in gross income, depending on the taxpayer’s income. The 85–percent tax was enacted in 1993.
The Senate bill included a "sense of the Senate" that the taxation of Social Security benefits should be repealed. The conference committee did not include this provision in the final text of JGTRRA.
(7) spouses' travel expenses
Under current law no tax deduction generally is allowed for the travel expenses of a spouse, dependent, or other individual accompanying a taxpayer on business travel. The Senate bill contained a provision repealing the prohibition of a deduction for the travel expenses of a spouse, dependent, or other person accompanying a taxpayer. The conference committee did not include this provision in the final text of JGTRRA.
(8) Archer medical savings accounts
Within limits, contributions to an Archer MSA are deductible in determining adjusted gross income if made by an eligible individual and are excludable from gross income and wages for employment tax purposes if made by the employer of an eligible individual. Earnings on amounts in an Archer MSA are not currently taxable. Distributions from an Archer MSA for medical expenses are not includible in gross income. Distributions not used for medical expenses are includible in gross income. In addition, distributions not used for medical expenses are subject to an additional 15% tax unless the distribution is made after age 65, death, or disability.
Archer MSAs are available to employees covered under an employer-sponsored high deductible plan of a small employer and self-employed individuals covered under a high deductible health plan. An employer is a small employer if it employed, on average, no more than 50 employees on business days during either the preceding or the second preceding year. An individual is not eligible for an Archer MSA if he or she is covered under any other health plan in addition to the high deductible plan.
The maximum annual contribution that can be made to an Archer MSA for a year is 65% of the deductible under the high deductible plan in the case of individual coverage and 75% of the deductible in the case of family coverage.
A high deductible plan is a health plan with an annual deductible of at least $1,700 and no more than $2,500 in the case of individual coverage and at least $3,350 and no more than $5,050 in the case of family coverage. In addition, the maximum out-of-pocket expenses with respect to allowed costs (including the deductible) must be no more than $3,350 in the case of individual coverage and no more than $6,150 in the case of family coverage. A plan does not fail to qualify as a high deductible plan merely because it does not have a deductible for preventive care as required by state law. A plan does not qualify as a high deductible health plan if substantially all of the coverage under the plan is for permitted coverage (as described above). In the case of a self-insured plan, the plan must in fact be insurance (e.g., there must be appropriate risk shifting) and not merely a reimbursement arrangement.
The number of taxpayers benefiting annually from an Archer MSA contribution is limited to a threshold level (generally 750,000 taxpayers). The number of Archer MSAs established has not exceeded the threshold level. After 2003, no new contributions may be made to Archer MSAs except by or on behalf of individuals who previously had Archer MSA contributions and employees who are employed by a participating employer.
The Senate bill contained a provision extending Archer MSAs through December 31, 2004. The conference committee did not include this provision in the final text of JGTRRA.