Tax Law Changes : Tax-Year 2005 Individuals
Pick a topic from the list below to learn about the tax changes:
- Uniform Definition of a Qualifying Child
- Section 1202 Exclusion Increased for Gain from Empowerment Zone Business Stock
- Charitable Contributions of Cars, Boats, and Aircraft
- Exemption Amount Increases
- Standard Deduction Amount Increases
- Earned Income Credit (EIC) Amounts Increase
- Standard Mileage Rate
- Social Security and Medicare Taxes
Beginning in 2005, one definition of a “qualifying child” will apply for each of the following tax benefits.
- Dependency exemption.
Head of household filing status.
Earned income credit (EIC).
Child tax credit.
Credit for child and dependent care expenses.
Tests To Meet
In general, all four of the following tests must be met to claim someone as a qualifying child.
The child must be your child (including an adopted child, stepchild, or eligible foster child), brother, sister, stepbrother, stepsister, or a descendent of one of these relatives.
An adopted child includes a child lawfully placed with you for legal adoption even if the adoption is not final.
An eligible foster child is any child who is placed with you by an authorized placement agency or by judgment, decree, of competent jurisdiction.
The child must live with you for more than half of the year. Temporary absences for special circumstances, such as for school, vacation, medical care, military service, or detention in a juvenile facility count as time lived at home. A child who was born or died during the year is considered to have lived with you for the entire year if your home was the child's home for the entire time he or she was alive during the year. Also, exceptions apply, in certain cases, for children of divorced or separated parents and parents of kidnapped children. For more information, see Publication 501, Exemptions, Standard Deduction, and Filing Information.
The child must be under a certain age (depending on the tax benefit) to be your qualifying child.
Dependency exemption, head of household filing status, and EIC. For purposes of these tax benefits, a child must be under age 19 at the end of the year, or under age 24 at the end of 2005 if a student, or any age if permanently and totally disabled.
A student is any child who, during any 5 months of the year:
- Was enrolled as a full-time student at a school, or
- Took a full-time, on-farm training course given by a school or a state, county, or local government agency.
A school includes a technical, trade, or mechanical school. It does not include an on-the-job training course, correspondence school, or night school.
Child tax credit. For purposes of the child tax credit, a child must be under the age of 17.
Credit for child and dependent care expenses. For purposes of the credit for child and dependent care expenses, a child must be under the age of 13 or any age if permanently and totally disabled.
The child cannot have provided over half of his or her own support during the year. For the definition of support, see Support Test, in Publication 501.
Exception. For purposes of the EIC only, the support test does not apply.
Qualifying Child of More Than One Person
Sometimes a child meets the tests to be a qualifying child of more than one person. However, only one person can treat that child as a qualifying child. If you and someone else (other than your spouse if filing jointly) have the same qualifying child, you and the other person(s) can decide who will claim the child. If you cannot agree on who will claim the child and more than one person files a return using the same child, the IRS may disallow one or more of the claims using the tie-breaker rule explained in Table 1, below.
|Table 1. When More Than One Person Files a Return Claiming the Same Qualifying Child (Tie-Breaker Rule)|
|IF . . .||THEN the child will be treated as the qualifying child of the. . .|
|only one of the persons is the child's parent,||parent.|
|both persons are the child's parent,||parent with whom the child lived for the longer period of time. If the child lived with each parent for the same amount of time, then the child will be treated as the qualifying child of the parent with the highest adjusted gross income (AGI).|
|none of the persons are the child's parent,||person with the highest AGI.|
To claim the dependency exemption for a qualifying child, all four tests listed earlier under Tests To Meet must be met. The child generally must also be a U.S. citizen, U.S. national, or a resident of the United States, Canada, or Mexico. An exception applies for certain adopted children. If married, the child cannot file a joint return unless the return is filed only as a claim for refund and no tax liability would exist for either spouse if they had filed separate returns.
A person who used to qualify as your dependent but who is not your “qualifying child” may still qualify as your dependent as a “qualifying relative.” To claim the dependency exemption for a qualifying relative, the person cannot be the qualifying child of any other person and all five dependency tests discussed under Dependency Tests in Publication 501 must be met.
|If you are a dependent of another person, you cannot claim any dependents on your return.|
Head of Household Filing Status
In general, you can use head of household filing status only if, as of the end of the year, you were unmarried or “considered unmarried” and you paid over half the cost of keeping up a home:
- That was the main home for the entire year of your parent whom you can claim as a dependent (your parent did not have to live with you), or
In which you lived for more than half of the year with either of the following:
- Your qualifying child (defined earlier, but without regard to the exception for children of divorced or separated parents). But, if your qualifying child is married at the end of the year, see Married child, later.
- Any other person whom you can claim as a dependent.
But you cannot use head of household filing status for a person who is your dependent only because:
- He or she lived with you for the entire year, or
- You are entitled to claim him or her as a dependent under a multiple support agreement.
Married child. If your qualifying child is married at the end of the year, both of the following must apply for the child to be your qualifying child for purposes of head of household filing status.
- The child cannot file a joint return unless the return is filed only as a claim for refund and no tax liability would exist for either spouse if they had filed separate returns.
- The child must be a U.S. citizen, U.S. national, or a resident of the United States, Canada, or Mexico. An exception applies for certain adopted children.
Earned Income Credit (EIC)
For purposes of the EIC, a qualifying child must meet the Relationship test, Residency test (without regard to the exception for children of divorced or separated parents), and Age test, discussed earlier. A qualifying child does not have to meet the Support test for purposes of the EIC. But, if your qualifying child is married at the end of the year, see Married child, below. For additional rules that you must meet to claim the EIC, see Publication 596, Earned Income Credit.
Married child. A child who is married at the end of the year is a qualifying child for purposes of the EIC only if you can claim him or her as your dependent (see Dependency Exemption, earlier) or this child's other parent claims him or her as a dependent under the rules for children of divorced or separated parents in Publication 501.
Child Tax Credit
You may be able to take the child tax credit if you have a qualifying child who meets all four of the tests listed earlier under Tests To Meet. For additional rules that you must meet, see Publication 972, Child Tax Credit.
Credit for Child and Dependent Care Expenses
Generally, a qualifying person for purposes of the credit for child and dependent care expenses is:
- Your qualifying child (defined earlier, but without regard to the exception for parents of kidnapped children), or
- Your dependent or spouse who is physically or mentally incapable of caring for himself or herself and who lived with you for more than half of the year.
For purposes of the credit for child and dependent care expenses, a qualifying child and dependent are determined without regard to the exception for children of divorced or separated parents and the child is treated as a qualifying person only for the custodial parent.
For additional rules that you must meet, see Publication 503, Child and Dependent Care Expenses. However, for 2005, you no longer need to meet the Keeping Up a Home Test discussed in Publication 503.
You generally can exclude up to 50% of your gain on the sale or trade of qualified small business stock held by you for more than 5 years. This is called the section 1202 exclusion. Beginning in 2005, you generally can exclude up to 60% of your gain if you meet the following additional requirements.
- You sell or trade stock in a corporation that qualifies as an empowerment zone business during substantially all of the time you held the stock.
- You acquired the stock after December 21, 2000.
Item (1) will still be met if the corporation ceased to qualify after the 5-year period that begins on the date you acquired the stock. However, the gain that qualifies for the 60% exclusion cannot be more than the gain you would have had if you had sold the stock on the date the corporation ceased to qualify.
The part of the gain that is included in income is 28% rate gain. See Capital Gain Tax Rates in chapter 4 of Publication 550.
For more information about the section 1202 exclusion, see Section 1202 Exclusion in chapter 4 of Publication 550. For more information about empowerment zone businesses, see Publication 954, Tax Incentives for Distressed Communities.
If you donate a car to a qualified organization after December 31, 2004, your deduction is limited to the gross proceeds from its sale by the organization. This rule applies if the claimed value of the donated vehicle is more than $500. However, if the organization makes significant intervening use of or materially improves the car, you generally can deduct its fair market value.
Boats, aircraft, and other vehicles. These rules also apply to donations of boats, aircraft, and any vehicle manufactured mainly for use on public streets, roads, and highways.
Acknowledgement required. If the claimed value of the car is more than $500, you must have a written acknowledgement of your donation from the organization and must attach it to your return. If you do not have an acknowledgement, you cannot deduct your contribution.
The acknowledgement must include the following information:
- Your name and taxpayer identification number.
- The vehicle identification number or similar number.
- A statement certifying the car was sold in an arm's length transaction between unrelated parties.
- The gross proceeds from the sale.
- A statement that your deduction may not be more than the gross proceeds from the sale.
- The date of the contribution.
However, if there was significant intervening use of or material improvement to the car by the organization, the acknowledgement does not have to include the information in items 3, 4, and 5 above. Instead, it must contain a certification of the intended use of or material improvement to the car and the intended duration of that use and a certification that the vehicle will not be transferred in exchange for money, other property, or services before completion of that use or improvement.
This acknowledgement must be provided within 30 days of the sale of the car or, if there is significant intervening use or material improvement of the car by the organization, within 30 days of the contribution.
The organization also must provide this information to the IRS.
Donations of inventory. These rules do not apply to donations of inventory. For example, these rules do not apply if you are a car dealer who donates a car you had been holding for sale to customers.
More information. The IRS expects to issue more guidance on these rules early in 2005. To find out if that guidance has been issued, check the Internal Revenue Bulletin or www.irs.gov.
The amount you can deduct for each exemption has increased from $3,100 in 2004 to $3,200 in 2005.
You lose all or part of the benefit of your exemptions if your adjusted gross income is above a certain amount. The amount at which the phaseout begins depends on your filing status. For 2005, the phaseout begins at:
- $109,475 for married persons filing separately,
- $145,950 for single individuals,
- $182,450 for heads of household, and
- $218,950 for married persons filing jointly or qualifying widow(er)s.
The standard deduction for people who do not itemize deductions on Schedule A of Form 1040 is, in most cases, higher for 2005 than it was for 2004. The amount depends on your filing status, whether you are 65 or older or blind, and whether an exemption can be claimed for you by another person. The 2005 Standard Deduction Tables are shown in Publication 505, Tax Withholding and Estimated Tax.
The following paragraphs explain the changes to the credit for 2005.
Earned income amount. The maximum income you can earn and still get the credit is higher for 2005 than it is for 2004. You may be able to take the credit for 2005 if:
- You have more than one qualifying child and you earn less than $35,263 ($37,263 if married filing jointly),
- You have one qualifying child and you earn less than $31,030 ($33,030 if married filing jointly), or
- You do not have a qualifying child and you earn less than $11,750 ($13,750 if married filing jointly).
The maximum adjusted gross income (AGI) you can have and still get the credit has also increased. You may be able to take the credit if your AGI is less than the amount in the above list that applies to you.
Investment income amount. The maximum investment income you can have in 2005 and still get the credit increases to $2,700.
Business-related mileage. For 2005, the standard mileage rate for the cost of operating your vehicle is increased from 37.5 cents a mile to 40.5 cents a mile for all business miles.
Car expenses and use of the standard mileage rate are explained in chapter 4 of Publication 463, Travel, Entertainment, Gift, and Car Expenses.
Medical and move-related mileage. For 2005, the standard mileage rate for the cost of operating your vehicle for medical reasons or as part of a deductible move is increased from 14 cents a mile to 15 cents a mile. See Transportation under What Medical Expenses Are Includable in Publication 502, Medical and Dental Expenses, or Travel by car under Deductible Moving Expenses in Publication 521, Moving Expenses.
For 2005, the employer and employee will continue to pay:
- 6.2% each for social security tax (old-age, survivors, and disability insurance), and
- 1.45% each for Medicare tax (hospital insurance).
Wage limits. For social security tax, the maximum 2005 wages subject to the tax increased to $90,000. For Medicare tax, all covered 2005 wages are subject to the tax. For information about these taxes, see Publication 15 (Circular E), Employer's Tax Guide.