Jacob M. Leon, CPA/PFS CFP^®

Along with the numerous indexing changes that go into effect in 2006, many other important tax changes also go into effect in 2006. These non-indexing changes are primarily the result of the Gulf Opportunity Zone Act of 2005 (GO Zone Act), the Katrina Emergency Tax Relief Act of 2005 (KETRA), and the Energy Tax Incentives Act of 2005 (Energy Act). However, they are also the result of earlier legislation with phased-in changes, such as the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and IRS guidance. This article carries an overview of the non-indexing changes for businesses for 2006. 

Broad-based Tax Changes for Businesses

Electronic filing of returns. Corporations that have assets of $50 million or more and file at least 250 returns annually must electronically file their income tax returns (Form 1120, U.S. Corporation Income Tax Return, or Form 1120S, U.S. Income Tax Return for an S Corporation) for tax years ending on or after December 31, 2005. (Beginning with tax year 2006 returns, e-filing is mandatory for corporations, including electing small business corporations, that have $10 million or more in assets and file at least 250 returns annually.)  The 250 annual returns includes individual W-2's, Form 1099's and the Form 1120 or 1120S.

Taxes paid by credit card. Beginning January 1, 2006, businesses filing Form 940, Employer's Federal Unemployment Tax Return, and Form 941, Employer's Quarterly Federal Tax Return, can pay any balance due using a credit card over the phone or Internet. Credit card payments—which can be made through either of two authorized service providers who are permitted to charge a fee based on the amount of the payment—can be made for the balance due on the current return. In addition, Form 941 filers can make credit card payments for up to three prior quarters. The service providers give a confirmation number as proof of payment, and payments are effective on the date the charge is authorized. However, tax deposits cannot be paid by credit card. 

Employers' Annual Federal Tax Program. Under new temporary regs that are effective on January 1, 2006, employers who receive written notification from IRS of their qualification for the new Employers' Annual Federal Tax Program generally file a Form 944, Employer's Annual Federal Tax Return, rather than Form 941, Employer's Quarterly Federal Tax Return. IRS says that the new Form 944 Program will significantly reduce tax filing burdens for nearly 950,000 small business owners because they will only have to file the new Form 944 once a year rather than filing Form 941 four times a year, see New Form 944.

Withholding on nonresident alien employees. For wages paid on or after January 1, 2006, employers must calculate income tax withholding on wages of nonresident alien employees (except for students and business apprentices from India) by adding an amount to their wages solely for purposes of calculating their income tax withholding for each payroll period. The specific amount depends on the payroll period. Employers determine income tax withheld by applying the Publication 15 tables to the sum of the wages paid for the payroll period plus the additional amount.

Six-month automatic extension for most 2005 returns. IRS has issued new temporary regs that allow most businesses to request a six-month automatic filing extension on a single form, without a reason or even a signature, for a tax year which ends on or after December 31, 2005. The regs are generally helpful, in many cases eliminating the time and expense of filing a second extension, but may operate to increase filing burdens for partners (who need Schedules K-1 from their partnerships) because now partners and partnerships may both apply for a six-month automatic extension. While the regs don't change the rules regarding filing extensions for corporations, taxpayers filing the following returns will also use Form 7004 to request an automatic six-month extension of time to file: Form 2758, Application for Extension of Time To File Certain Excise, Income, Information, and Other Returns; Form 8736, Application for Automatic Extension of Time To File U.S. Return for a Partnership, REMIC, or for Certain Trusts; and Form 8800, Application for Additional Extension of Time To File U.S. Return for a Partnership, REMIC, or for Certain Trusts. 

Tax Changes for Businesses Due to Expired Tax Provisions

A number of tax provisions affecting businesses expired at the end of 2005. While many expired provisions may eventually be revived and extended under proposed legislation, there is now no way to know for sure, which, if any, of the following provisions will be extended, and whether they'll be extended retroactively (i.e., as if they never expired):

Investment and employment provisions:

• The research and experimentation tax credit has terminated for amounts paid or incurred after 2005. 

• The work opportunity tax credit (WOTC) is not available for any amount paid to an employee who begins work for the employer after December 31, 2005. However, this termination date doesn't apply to Hurricane Katrina employees, who are treated as member of a targeted group for purposes of the WOTC.

• The welfare-to-work tax credit does not apply to individuals who begin work for the employer after December 31, 2005. 

• The Indian employment tax credit does not apply for tax years beginning after 2005. 

• Accelerated depreciation for business property on an Indian reservation does not apply for property placed in service after December 31, 2005. 

• 15-year straight-line cost recovery for qualified leasehold improvements and qualified restaurant improvements are not available for property placed in service after December 31, 2005.

Miscellaneous provisions:

• The deduction for corporate donations of computer technology doesn't apply for contributions made during any tax year beginning after December 31, 2005.

• Incentives for investment in the District of Columbia: designation of enterprise zone (expired after December 31, 2005), tax-exempt economic development bonds (doesn't apply to bonds issued after Dec, 31, 2005), and zero percent capital gains rate (doesn't apply for DC business zone stock, partnership interests, or business property acquired after December 31, 2005).

Energy Act Changes for Businesses

New deduction for energy efficient commercial buildings. For property placed in service after December 31, 2005, and before January 1, 2008, taxpayers can claim a deduction for expenses incurred for energy-efficient commercial buildings that meet a 50% energy reduction standard. The deduction is a major incentive for current building owners to upgrade their systems and for those building new structures to design them in an energy-efficient manner. The maximum energy efficient commercial building deduction is equal to $1.80 per building square foot (60¢ per building square foot, for certain separate building systems), less the aggregate amount of these deductions allowed for the building for prior years. Among other requirements, the property must be depreciable or amortizable; installed on or in any building located in the U.S. as part of (a) the interior lighting systems, (b) the heating, cooling, ventilation, and hot water systems, or (c) the building envelope; and be certified as being installed as part of a plan designed to reduce the total annual energy and power costs with respect to the interior lighting systems, heating, cooling, ventilation, and hot water systems of the building by 50% or more. 

New business tax credit for contractors building new energy efficient homes. An eligible contractor can claim either a $2,000 or $1,000 credit (depending on the type of home and the energy reduction standard it meets) for each qualified new energy efficient home that the contractor builds and which is acquired by a person from the contractor for use as a residence. The credit applies to homes which are purchased after December 31, 2005 and before January 1, 2008. For a structure to qualify for the credit:

• It must be located in the U.S.;

• Its construction (which includes substantial reconstruction and rehabilitation) must be substantially completed after Aug. 8, 2005;

• It must meet specific energy saving requirements;

• It must be built by the eligible contractor (the person who constructed the home, or the manufacturer, if the structure is a manufactured home); and

• It must be acquired (which includes purchases) by a person from the eligible contractor for use as a residence during the tax year.

Observation: There is no requirement that the property used as a residence be the person's principal residence. Thus, assuming the other requirements are met, an eligible contractor may claim the credit for vacation homes that it constructs and that are acquired by other persons for use as second homes.

New manufacturers' tax credit for energy efficient dishwashers, clothes washers, and refrigerators manufactured in 2006 and 2007. In general, the new tax credit (which is part of the general business credit) depends on the type of appliance and how much energy it saves. The maximum tax credit is $100 per dishwasher or clothes washer, and $175 per refrigerator.

New alternative motor vehicle credit. A taxpayer may be able to claim a credit for buying a hybrid or lean burn vehicle in 2006. The tax credit may be as much as $3,400 for those who buy the most fuel-efficient vehicles. The full amount of the allowable credit is available only up to the end of the first calendar quarter after the quarter in which the manufacturer records its sale of the 60,000th hybrid and advanced lean-burn technology motor vehicle. The credit is allowed to the vehicle owner, including the lessor of a vehicle subject to a lease. See Alternative Power Vehicles.  There's also a new credit for 30% of the cost of alternative fuel vehicle refueling property. The credit can't exceed $30,000 for depreciable property and $1,000 for other property. Both these credits can also be personal credits. The portion of the credit attributable to property of a character subject to depreciation is treated as a part of the general business credit; the remainder is a personal credit. The new credits replace the deduction for certain clean fuel vehicles and clean fuel property that was available for property placed in service before 2006. 

Nonconventional fuel credit. For tax years ending after December 31, 2005, the tax credit for fuel produced from nonconventional sources is, at the taxpayer's election, included in the general business credit, resulting in a 1-year carryback, 20-year carryforward for unused credits. In addition, for fuel produced and sold after 2005, this credit is extended to coke and coke gas from qualified facilities placed in service before January 1, 1993, or after June 30, 1998, and before January 1, 2010.

Renewable diesel fuel. For fuel sold or used after December 31, 2005 and before January 1, 2009, producers of “renewable diesel” may claim income and excise tax credits at the $1.00 rate applicable to agri-biodiesel.

    For more information on how these changes may affect your tax situation

call me at 713-333-7477

or email me at jacob@thefinancialfirm.com

Any discussion pertaining to taxes in our web site (www.thefinancialfirm.com) may be part of a promotion or marketing effort. As provided for in circular 230 of the IRS, advice related to federal taxes that is contained in this communication is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue code. Individuals should seek advice based on their own particular circumstances from an independent tax advisor.

Posted 7/5/06