New Tax Laws That Could
Affect Your 2004 Return

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By Kay Bell • Bankrate.com

Another filing season has arrived, bringing with it the perennial tax-law changes.

Some of the changes are provisions from legislation passed years earlier that finally took effect in 2004. You can thank Internal Revenue Service rulings for a few. And two new laws enacted in October bring both good and bad news this filing season, depending on your tax specifics.

If you're a parent, a student or resident of a state with a high sales tax rate but no income tax, you'll probably find something to like on your current return. On the other hand, if you plan to write off an SUV purchase or donate a car this year, you could be out of tax luck.

Here are 10 tax changes you should know about. Most of them will affect your return due this April. A couple won't matter this filing season, but you need to know about them now so that you won't run into tax trouble when you file next year.

1. Sales tax break
The big tax news, at least for people in Texas, Florida and the other states without an income tax, is that state sales taxes are now deductible on federal returns.

To claim this tax break you'll have to itemize and then determine which tax amount, sales or income, provides you with the biggest deduction. You can count all the sales taxes you paid in 2004, but since this deduction was created last October as part of the American Jobs Creation Bill, most people probably don't have sales receipts for the whole year. So the IRS created state tables providing an average sales tax deduction amount based on income levels that you can claim. Local levies also can be counted (you'll have to fill out a worksheet to determine how much more you can deduct), as can sales taxes you paid on the purchase of an auto, boat, other vehicles and home building supplies.

2. Charitable considerations
The tax code has long provided rewards for generous filers, and this tax season is no different. In fact, a special law change was made early this year to allow some 2005 donations to count against 2004 taxes. Contributions made by Jan. 31 to tsunami relief funds can be deducted on your current return rather than being delayed until you file 2005 taxes next year. If, however, you'll get more of a tax benefit by waiting, you can decide to wait to deduct your charitable gift to tidal wave victims. A couple of things to remember here: You must itemize to deduct any contributions, and in addition to being made by the end of January, your tsunami donations must be in the form of cash, check or credit card.

But what the tax code gives, it also takes. If you donate a vehicle to your favorite nonprofit in 2005, you might not get as big a tax break on next year's returns as you expect. Previously, you could deduct the fair market value of the vehicle (usually the Blue Book amount). But a new law has scrapped that option. For any donations made this year, exactly how much you can claim on your 2005 taxes will depend on how the charity uses the vehicle and, if they sell it, how much they actually get for it.

This vehicle contribution change took effect Jan. 1, so if you donated a car in 2004, you can still use the earlier, more lenient valuation guidelines on your current taxes.

3. Easier forms for more filers
If you don't need to itemize to claim the sales tax, charitable donation or any other allowable deductions, you'll probably file one of the easier 1040 incarnations: the 1040A or the 1040EZ. This filing season, even more taxpayers are eligible for these two forms because the income limit has been raised. Previously, you could only use these two if your taxable income was less than $50,000. This year, you can make up to $100,000 and file a 1040A or 1040EZ.

Self-employed taxpayers, both those who run a full-time business and those who operate one on the side to supplement a wage-paying job, get some tax-form help, too. If the expenses you claim against self-employment income are $5,000 or less, you can file the less-complicated Schedule C-EZ instead of Schedule C. Last year, the expense limit was $2,500. The IRS says the threshold change means approximately 500,000 more small businesses, a 15 percent increase, will be able to file C-EZ, saving themselves a combined 5 million hours of paperwork.

4. Educator tax break revived
When 2004 began, this tax break was dead, but lawmakers resuscitated it as part of the Working Families Tax Relief Act so teachers can continue to deduct $250 of their classroom expenses. You don't have to itemize to claim this deduction; it's claimed directly on Form 1040 or 1040A. And it isn't limited to teachers. Principals, instructors, counselors and aides who work at least 900 hours during the school year in a public or private school, kindergarten through grade 12, also can claim it. The educator expenses deduction will continue through 2005, but is scheduled to expire, again, at the end of this year.

5. Larger tuition and fees deduction
The amount of qualified education expenses you can take into account in figuring this tax break is now $4,000. This is up a grand from last year. You'll find this deduction directly on Form 1040 and Form 1040A, meaning you don't have to itemize to take advantage of it. Just remember, this easy-to-claim deduction has an income limit. Single filers can take it as long as their total income is less than $65,000; the income cap is twice that for married couples filing jointly. If you make more than that, all might not be lost. As long as you made $80,000 or less ($160,000 or less for married filers), you can still can claim up to $2,000 in tuition and fees.

6. Education credits earning limit increased
The Hope and Lifetime Learning tax credits are two other popular tax-saving ways to pay for college costs. This filing season, you can make up to $42,000 as a single filer and still claim these credits in full; married filing jointly taxpayers can make up to $85,000. These earning limits are $1,000 and $2,000 higher, respectively, than they were the previous tax year. If you make more than those amounts for your filing status, your credit claims will be reduced and possibly eliminated.

7. Environmentally friendly cars
If you purchased either a hybrid car or a fully electric auto last year, you'll continue to get the maximum tax breaks this year as a reward for your environmentally friendly driving. The deduction for hybrids and other alternative-fuel vehicles, as well as the credit for fully electric vehicles, had been scheduled to start phasing out last year, but the Working Families Tax Relief Act of 2004 postponed the reductions.

So hybrid drivers who bought their cars last year can still claim the full $2,000 deduction on their 2004 returns (as long as they file Form 1040, that is; the deduction can only be taken on line 35 of that form). And if you're going to buy an alternative-fuel auto this year, you'll also get the full deduction. In 2006, however, the deduction drops to $500 and it will disappear in 2007.
Similarly, the reduction of the tax credit for purchasers of fully electric autos is postponed until 2006. This larger tax break -- a $4,000 credit -- will remain in effect for electric cars bought in 2004 and 2005 before being phased out by 2007.

8. Expansion of child tax credits
On 2004 returns, this tax credit could cut a parent's tax bill by $1,000. Thanks to the Working Families Tax Relief Act that became law in October, this same savings-per-child amount will continue through 2010. This popular and easy-to-claim credit has one drawback: It's nonrefundable, meaning that if it's more than the tax you owe, the excess credit is wasted.

But its companion tax break, the additional child tax credit, could help some parents get a part of that excess back based on a percentage of their earned income. The same law that extended the child tax credit amount through the end of the decade also upped the allowable additional child credit percentage to 15 percent vs. the previous 10 percent limit. This increase should let eligible taxpayers get a bigger tax break.

9. SUV loophole closed
If you bought a large sport utility vehicle and started using it primarily for your business (either full- or part-time) before Oct. 23, 2004, you are going to be a happy filer this year. But if your heavy-duty ride went to work for you on that day or later, your tax write-off has dropped dramatically.

Previously, business filers could expense up to $100,000 of the cost of a 6,000-pound company vehicle. Many folks took advantage of this law to make Hummers and their heavy-duty brethren official business vehicles. But the American Jobs Creation Act of 2004 that was signed into law last autumn throws a major roadblock into the path of the SUV tax break.

The $100,000 deduction is still around for vehicles bought since the law took effect, but only if they weigh at least 14,000 pounds. A relatively smaller SUV placed in service on or after the law took effect will only get its owner a $25,000 write-off.

What if you purchased your high-dollar, but lighter-weight, SUV on Oct. 22, 2004, or earlier? You're in luck. You can claim the larger, prior-law amount on your 2004 returns.

Remember, regardless of which amount applies to your vehicle, the deduction can only be claimed on vehicles that are used at least 50 percent of the time for business, and then only up to the actual percentage of use that is business-related.

10. IRA deduction phase-out range is bigger
Many taxpayers continue to fund traditional IRAs, either because they do not meet Roth account guidelines or they want the tax deduction that comes with the original IRA account. That deduction, however, is phased out at certain income limits if you also are covered by a retirement plan at work.

For 2004 taxes, more traditional-IRA holders should be eligible for at least some deduction of their contributions because the adjusted gross income limit has been raised. Single and head-of-household filers covered by a company retirement plan can make up to $45,000 and still get a full IRA contribution deduction. They're allowed a partial deduction if their income falls between $45,000 and less than $55,000.

Married couples filing joint returns can make up to $65,000 modified adjusted gross income and get the full deduction; a partial deduction is available when income falls between $65,000 and up to $75,000. Your tax form instructions have worksheets to help you determine just how much of your contribution can be used to reduce your tax bill.

You can put up to $3,000 ($3,500 if you're 50 or older) in your IRA for the 2004 tax year. You have until April 15 to make the contribution, regardless of whether you deduct it.

See also: Old tax laws remain, but effective amounts change

How tax-friendly is your state?
Local and state taxes can have a big impact on your take-home pay.

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NEW YORK (CNN/Money) -- There are countless reasons why you choose to live where you live. The climate, the schools and the job opportunities are just a few. But state and local taxes can make a big difference.

The Tax Foundation, a policy research group, estimated the average taxpayer's total state and local tax burden for 2005 in each of the 50 states and the District of Columbia. That burden reflects what residents pay in state and local income taxes, property taxes, sales taxes, luxury taxes and fuel taxes, among others. States below are ranked from least to most tax friendly. (Read more about this table below.)

Tax-friendly places 2005

Top honors go to Alaska, New Hampshire and Delaware. Most unfriendly? Maine, New York, D.C.
By Jeanne Sahadi, CNN/Money senior writer, April 11, 2005

NEW YORK (CNN/Money) – When you travel from state to state, some differences are readily apparent: the landscape, people's accents, use of the word "dude," you name it.

But you can't know what it truly costs to live in a place until you get hit with the whole magilla of taxes.

Every year, the Tax Foundation -- a nonpartisan, nonprofit policy research group that advocates, among other things, tax simplification -- measures the total tax bill for each state.

Specifically, the Tax Foundation measures as a percentage of per capita income what residents pay in income, property, sales and other personal taxes levied at the state and local levels. It also factors in the portion of business taxes passed along to state residents through higher prices, lower wages or lower profits.

The result: A list of the most – and least – tax-friendly states in the country.

See the full list here. And see more state rankings based on income tax, sales tax, property tax and tax breaks for retirees.

The winners are ...
This year, Alaska again takes top honors as the most tax-friendly to residents. It has no state sales tax, no income tax and the government annually sends residents a refund because of the excess revenue it collects from companies extracting oil from the state.

New Hampshire comes in second. Although it has relatively high property taxes, like Alaska it doesn't impose a sales tax and it doesn't tax wages (although it does tax investment income).

Delaware takes third place, primarily for its lack of a sales tax, its low income taxes – the top rate is 5.95 percent – and the relatively light burden imposed on residents resulting from the state's corporate tax.

Topping the list of least tax-friendly places is Maine. Its No. 1 ranking results from the great disparity between the fact that it is one of the lowest income states in the country yet has one of the highest rankings in terms of tax collection, said Curtis Dubay, an economist with the Tax Foundation.

Property taxes account for about 40 percent of the overall tax revenue Maine collects, and it has relatively high income tax rates – a top rate of 8.5 percent for all income above $16,950.

The District of Columbia comes in second, due in part to a high individual income tax – the top rate is 9.3 percent for income above $30,000.

New York, meanwhile, maintains its usual high ranking thanks to an average sales tax of about 8 percent when average state and local rates are combined, plus the option to levy a local income tax, which is one of the reasons New York City is among the least tax-friendly cities in the country.

In fact, the revenue generated by local taxes levied across New York account for about half of all tax revenue collected in the state, Dubay said.

It's not just about the averages
Of course, how tax friendly a state is to you depends on several factors. For instance:

How you make your money. Two states, Tennessee and New Hampshire, don't tax wage income but tax investment income. So if you're living off your investments, you'll pay for the privilege.

Where in a state you live. Big cities tend to have bigger tax bites than many suburban and rural areas in a state. (For a look at the rankings of the tax burden in the largest cities in the country, click here.)

Whether you own a home. A state may have modest taxes in many areas but rank high when it comes to property taxes. New Hampshire, for example, is a tax-friendly state overall, but has relatively high property taxes. Also, owning a home in a desirable neighborhood in any state is likely to increase your property tax bill.

Whether you're retired. Some states, even high-tax ones like Hawaii and New York, offer retirees income-tax breaks.

Whether you smoke or drink. Cigarette and liquor taxes can add up when you're feeding a habit. Ditto if you drive a gas guzzler in a state with high fuel taxes.

Tax lists:

State by state rankings

Big city rankings

Tax Survey 2005

The Tax Foundation

"The Jock" Tax

Bankrate.com