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Tax changes largely favor taxpayers

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Should you buy that $80,000 Mercedes or a Hummer of comparable value? If you’re planning to use it for business, the Hummer has a clear advantage, at least when it comes to taxes.

Under a provision of this year’s tax laws, vehicles weighing more than 6,000 pounds can be fully expensed up to $100,000, and aren’t subject to luxury auto limits that apply to cars. Buy a luxury car under 6,000 pounds, and you can only expense $10,710 per year.

Changes in business depreciation provisions, as well as the reduction in the long-term capital gains tax rates are among the key differences taxpayers will notice when preparing their returns, said Paul Hayes, managing director for tax services at RSM McGladrey in Des Moines.

Overall, taxpayers will enjoy some automatic relief through the reduction in federal tax rates enacted earlier this year by Congress. The top rate has dropped to 35 percent, with the lower brackets now at 33, 28, 25, 15 and 10 percent.

In many cases, however, getting the most out of the third-largest tax cut in U.S. history will take some careful planning, particularly on the part of investors and business owners.

“Probably the biggest item that’s affecting business is the year-end expensing elections that are available,” Hayes said. For instance, purchases of up to $100,000 of equipment can be completely written off in the year it was purchased, up from $25,000 last year. The benefit isn’t available, however, if the business purchases more than $400,000 in equipment.

“For the vast majority of small businesses out there, and even for those that aren’t so small, it will provide a pretty significant current-year benefit in terms of tax reduction,” he said.

Bonus depreciation is also available to all businesses, allowing them to write off up to 50 percent of the purchase price of equipment, up from 30 percent last year. That benefit goes away after 2004.

“So between the $100,000 write-off, the 50 percent bonus depreciation and regular depreciation, a lot of businesses are basically in the position to be able to expense a substantial amount of equipment purchases during the year,” Hayes said.

However, businesses that expect to move into a higher tax bracket within the next few years might want to consider spreading the depreciation out over several years rather than taking it all at once, he said.

For investors, one of the most important changes this year is the drop of the top tax rate on dividend income to 15 percent. Previously, dividendes were taxed at the person’s prevailing tax bracket, which could be as high as 35 percent.

Another significant change is a reduction of the maximum tax on long-term capital gains, from 20 percent to 15 percent.

“So holding an asset for a year or more versus less than a year could make a pretty significant difference,” Hayes said. Investors need to look carefully at the proper matching of their capital gains and losses to ensure they get the maximum benefit, however.

With the reduction in capital gains rates, the new tax law also lowered the rate for taxpayers that are in the 10 or 15 percent brackets.

“At those lower brackets, long-term capital gains are only taxed at 5 percent.” Hayes said. “So you may want to take advantage of capital gains when you’re in a lower tax bracket. Or you may want to look at gifting appreciated assets to your children (14 or older) and just pay 5 percent tax on the gain.”

Looking ahead for next year, people who have a 401(k) investment plan at work will be able to contribute more. The limitation on total contributions will increase to $13,000 next year, up from $12,000 this year. The catch-up provision for people 50 or over will also bump up, from $2,000 this year to $3,000 next year.

“A lot of people overlook the fact that a lot of plans have matching provisions, and if you don’t contribute, you won’t get the match,” Hayes said. “Certainly if you’re going to be someplace for five years or so, you’re probably going to vest in most or all of that match. If not, you can just roll it over to an IRA.”

Despite an increase in the alternative minimum tax exemption this year from $49,000 to $58,000, lower overall tax rates and reductions in dividend and long-term capital gains rates may actually make it easier to fall into the AMT.

“The AMT continues to surprise people,” Hayes said. “That $9,000 change didn’t make a big difference.”

One of the biggest caveats concerning many of this year’s changes are that they apply for only a limited number of years, which makes planning more important than ever, Hayes said.

Other strategies from RSM McGladrey’s tax services experts:

– Avail yourself of the drop in overall tax rates. Consider lowering your paycheck’s withholding amount and using those extra dollars to invest in an IRA or 401(k).

– Make the most of moving. As often as every two years you can exclude up to $250,000 ($500,000 if you’re married filing jointly) of the gain you realize on the sale or exchange of your principal residence, as long as you meet certain tests.

– Consider filing separately. When both spouses have substantial income, and one has significant itemized deductions that are subject to a floor, filing separately may provide overall tax savings.   

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