Tax Rules Change for Small Businesses in 2005
On October 22, 2004, President Bush signed into law
the American Jobs Creation Act of 2004, which made
numerous changes in the tax laws affecting small
businesses. These are summarized below. Except where
otherwise noted below, the changes went into effect
on Jan. 1, 2005. Start-up expenses.
Start-up expenses cannot automatically be deducted
in the first year you start your business. Under
prior law, business owners were required to deduct
such expenses over the first five years they were in
business. Tax law now allows business owners to
deduct up to $5,000 in start-up expenses the first
year they are in business, and then deduct the
remainder, if any, in equal amounts over the next 15
years. (IRC Sec. 195.) If your business began before
October 22, 2004, the date the law took effect, the
old rule applies to you.
Long-term asset expenses. The cost of
long-term assets you use in your business -- assets
that last more than one year -- must be depreciated
over several years, or deducted in a single year
under IRS Section 179 -- a process called expensing.
There were major changes in this area, some good for
small businesses, some not so good.
 | Bonus depreciation. The bad news
first: First-year bonus depreciation (whereby
businesses were able to depreciate up to 50% of
the cost of long-term assets in a single year)
ended on Dec. 31, 2004. It may not be taken for
property placed in service after that date.
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| Section 179 expensing limit. The good
news is that the $100,000+ limit for Section 179
expensing has been extended through 2007.
Businesses can deduct up to $105,000 of
qualifying property in 2005. In the years 2006
and 2007, the $105,000 limit will be increased
by inflation adjustments.
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| SUV deduction loophole closed. Until
Congress closed the loophole, business owners
who purchased “heavy” SUVs with gross vehicle
weight ratings of more than 6,000 pounds could
expense the cost under Section 179. This meant
that over $100,000 could be deducted in a single
year. Effective October 22, 2004, there is now a
lower $25,000 limit on Section 179 deductions
for SUVs. (The restriction does not apply to
pick-up trucks with a gross vehicle weight
rating over 6,000 pounds.)
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| Leasehold improvements. A leasehold
improvement is an improvement to the interior of
a commercially leased building -- for example,
installing new flooring, walls, or elevators.
Qualified leasehold improvements placed in
service between October 22, 2004 and January 1,
2006 may be depreciated over 15 years (using the
straight-line method), instead of over 39 years.
To qualify, the improvement may be made by the
landlord or the commercial tenant, but must have
been done more than three years after the
building was placed in service. A similar
provision applies to improvements to buildings
used as restaurants.
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Inflation adjustments. The dollar amounts
of several important tax deductions were adjusted
for inflation for 2005, including:
| The standard mileage deduction for business
use of an automobile was increased to 40.5 cents
per mile (from 37.5 cents).
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| The personal exemption was increased to
$3,200.
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| The standard deduction was increased to
$5,000 for singles and $10,000 for married
taxpayers. Singles over 65 get a $6,500
deduction.
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| The Social Security wage base was increased
to $90,000 (the 12.1% Social Security tax must
be paid on this amount of net self-employment
income).
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| The caps for annual contributions to
retirement accounts were increased: $14,000 may
be contributed to a 401(k) plan and $4,000 to an
IRA ($4,500 for people born before 1956).
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| The annual limit on deductible contributions
to a health savings account (HSA) was increased
to $5,250 for families and $2,650 for
individuals. The ceiling on out-of-pocket costs
increased to $10,200 for families and $5,100 for
individuals. |
New tax rates. New tax rates went into
effect in 2005, retaining the 10% bracket that had
been scheduled to expire:
|
Tax Bracket |
Income If Single |
Income if Married Filing Jointly |
Income Tax Saving for Each Dollar In
Deductions |
| 10% |
Up to $7,300 |
Up to $14,600 |
10˘ |
| 15% |
From $7,301 to
$29,700 |
$14,601 to
$53,450 |
15˘ |
| 25% |
$29,701 to
$71,950 |
$53,451 to
$119,950 |
25˘ |
| 28% |
$71,951 to
$150,150 |
$119,951 to
$182,800 |
28˘ |
| 33% |
$150,151 to
$326,450 |
$182,801 to
$326,450 |
33˘ |
| 35% |
All over
$326,450 |
All over
$326,450 |
35˘ |
S corporation rules. The maximum number of
S corporation shareholders was increased from 75 to
100, with family members counted as one shareholder.
Manufacturing deduction. Congress enacted
a complex provision permitting businesses to deduct,
in 2005, 3% of the net income they earn from
production activities conducted within the United
States. “Production activities” are broadly defined
to include manufacturing; construction (not
painting); energy production; producing films,
videotapes, or computer software; farming; mining;
and engineering services. Any business can claim the
deduction, but the deduction may not exceed its
taxable income and is further limited to 50% of the
total wages the business pays its employees. In
2007, the deduction percentage will rise to 6% and
will top out at 9% in 2009 and later. |
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