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  What's New      
Taxes: What's New For 2005?

Each new year brings change, and the IRS is no exception. Even when there are no big changes to the tax rules—like those we saw in 2001 and 2003—annual inflation and previously scheduled adjustments trigger a number of small changes, including:

  • How much you can contribute to retirement accounts.
  • Eligibility limits based on adjusted gross income (AGI).¹
  • Income levels that determine which marginal income tax bracket you fall into.

Here, we'll look at a few of the tax highlights—is that an oxymoron?—for 2005. But first, let's review some legislative action Congress took in 2004.

  • Tax breaks. Late last year, Congress extended the following provisions of the 2003 tax act:
    • Expanded 10% bracket extended through 2010.
    • Marriage penalty relief extended through 2010.
    • Expanded Child Tax Credit extended through 2010.
    • AMT relief extended through 2005.

    This is good news for virtually all taxpayers. It should result in a lower overall tax in 2005 than would have been the case if these tax breaks had been allowed to expire.
     

  • Sales tax deduction. As part of its corporate tax relief package late last year, Congress also reinstituted an itemized deduction for state and local sales taxes. Before 1986, taxpayers could deduct both income tax and sales tax imposed at the state and local level. Under this new law, you have to choose one or the other.

    Taxpayers who itemize and reside in states that have sales tax but no income tax should welcome the change. Such states include Florida, Nevada, South Dakota, Tennessee, Texas, Washington and Wyoming (Alaska and New Hampshire aren't included because they don't have a state sales tax, though Alaska does have some local sales taxes).

    Taking the sales tax deduction instead of the state income tax deduction might also be worth a look if you live in a state with a low income tax, depending on your circumstances. The provision, however, is only effective through 2005.
     
  • Small businesses. Bonus depreciation expired at the end of 2004, but Congress extended through 2007 the increased Section 179 limitation which allows immediate expensing of equipment (up to $105,000 for 2005) that would otherwise have to be depreciated over a period of years.

Income tax brackets
Here are the new federal tables for single filers and married filing jointly. Check out the IRS Web site for additional information on tax brackets, personal exemption and standard deduction amounts, and more.

2005 federal income tax brackets

Rate Single Married filing jointly
10% $7,300 or less $14,600 or less
15% Over $7,300 but not over $29,700 Over $14,600 but not over $59,400
25% Over $29,700 but not over $71,950 Over $59,400 but not over $119,950
28% Over $71,950 but not over $150,150 Over $119,950 but not over $182,800
33% Over $150,150 but not over $326,450 Over $182,800 but not over $326,450
35% Over $326,450 Over $326,450


Long-term capital gains and qualified stock dividends are still taxed at 15% (5% for people in the 15% bracket or less), at least through the end of 2008—the 5% rate goes to zero in 2008 only.

Under current law, in 2009 we go back to the old rate structure: 20% for long-term capital gains and ordinary treatment for dividends. Keep that in mind if you're planning any future sales, particularly if you're selling a small business and you're thinking about structuring an installment sale over time.

One more note on income taxes: The limit on the so-called kiddie tax remains at $800 for 2005. This means children under age 14 will pay no income tax on the first $800 of unearned income, such as capital gains or interest from a savings account, and will be taxed at their own rate (most likely 10%) on the next $800 (5% for long-term capital gains). Anything over that amount is taxed at the parents' rate. Children 14 and older continue to pay tax at their own rate. If they're in the 15% ordinary bracket or below, that means only 5% on long-term capital gains and qualified dividends (0% in 2008 only).

Retirement
Here are the maximum amounts you can contribute to various retirement accounts for 2005, plus the catch-up contribution available to people 50 and older.

2005 federal limits for retirement accounts
 

Account Contribution limit Catch-up contribution
  $14,000 $4,000
  $10,000 $2,000
  20% of net self-employment income, up to $42,000 None
  20% of net self-employment income plus $14,000, up to $42,000 $4,000
  $4,000 $500


Money you put in a traditional IRA is generally tax deductible—unless you're an active participant in a qualified employer plan such as a 401(k) or 403(b). In that case, for 2005, your traditional IRA contribution is fully deductible if your AGI is $50,000 or below (partially deductible between $50,000-$60,000 for singles). The phase-out range for deductibility² is $70,000-$80,000 for married filing jointly ($150,000 limit for the non-participant spouse of an active participant, when filing jointly).

The AGI phase-out range for Roth IRA eligibility remains unchanged at $95,000-$110,000 for singles and $150,000-$160,000 for married filing jointly.

Finally, a new rule takes effect in 2005 for those taking required minimum distributions from their retirement accounts: You no longer need to include your RMD for the purpose of calculating the $100,000 modified adjusted gross income (MAGI) limitation on the conversion of a traditional IRA to a Roth IRA.

Education

  • The maximum contribution of $2,000 per year remains unchanged, as do the AGI phase-out ranges of $95,000-$110,000 for singles and $190,000-$220,000 for married filing jointly.
  • For ,³ there's still no limit to how much you can contribute each year—each state's plan has its own lifetime limit, typically over $200,000. You can still treat a 529 contribution as being made over five years for gift tax purposes. So, a married couple could contribute as much as $110,000 per child up front without using any of their lifetime gift tax credit (see below).
  • The AGI phase-out limits for the Hope and Lifetime Learning tax credits go to $43,000-$53,000 for singles and $87,000-$107,000 for married filing jointly.
  • The AGI phase-out for eligibility to deduct student loan interest remains at $50,000-$65,000 for singles but is increased to $105,000-$135,000 for married filing jointly.

The changes implemented in 2001 are still set to expire after 2010. In the meantime, here are the 2005 limits:

  • Gift tax. The $1 million lifetime gift tax exemption and $11,000 annual exclusion remain unchanged, but the top gift tax rate drops to 47%.
  • Estate tax. The lifetime exemption amount remains at $1.5 million ($555,800 equivalent credit), but the top estate tax rate drops to 47%.

FICA
The wage base limit for Social Security (OASDI) withholding goes to $90,000 (maximum of $5,580 withholding at 6.2%), while the wage base for Medicare withholding remains unlimited (tax rate of 1.45%).

For more information on these and other 2005 changes, visit the IRS Web site and see the official Inflation-Adjusted Tax Items for Tax Year 2005.


 
 
 
 
 
 
 
 
 
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