If you claimed the credit for child and dependent care expenses in 2002 or 2003, you may be entitled to a larger credit. The definition of earned income in the 2002 and 2003 instructions for Form 2441 and Schedule 2 (Form 1040A) and Publication 503 incorrectly omitted nontaxable earned income. See the 2004 versions of the instructions for Form 2441 and Schedule 2 (Form 1040A) and Publication 503 for the correct definition of earned income.

If you are entitled to a larger credit because you had nontaxable earned income in 2002 or 2003, you must file Form 1040X, Amended U.S. Individual Income Tax Return. Generally, you must file Form 1040X within 3 years after the date you filed your original return or within 2 years after you paid the tax, whichever is later. See Form 1040X and its separate instructions.

Beginning with the 2004 return, the income limit for using Form 1040A, Form 1040EZ, and TeleFile increases to taxable income of less than $100,000. Previously, the limit was taxable income of less than $50,000. See the instructions for other requirements to use these forms.

Beginning in 2004, the amount of qualified education expenses you can take into account in figuring your tuition and fees deduction increases from $3,000 to $4,000 if your modified adjusted gross income (MAGI) is not more than $65,000 ($130,000 if you are married filing jointly). If your MAGI is more than $65,000, but not more than $80,000 (more than $130,000, but not more than $160,000 if you are married filing jointly), your maximum tuition and fees deduction is $2,000. No tuition and fees deduction is allowed if your MAGI is more than $80,000 ($160,000 if you are married filing jointly). See chapter 6 of Publication 970, Tax Benefits for Education, for more information.

Beginning in 2004, if you receive a distribution from a QTP established and maintained by an eligible educational institution (generally private colleges and universities), you can exclude it from income to the extent of qualified education expenses. For more information on tax-free QTP distributions, see chapter 8 in Publication 970, Tax Benefits for Education.

For 2004, the amount of your Hope or lifetime learning credit is phased out (gradually reduced) if your modified adjusted gross income (MAGI) is between $42,000 and $52,000 ($85,000 and $105,000 if you file a joint return). You cannot claim an education credit if your MAGI is $52,000 or more ($105,000 or more if you file a joint return). This is an increase from the 2003 limits of $41,000 and $51,000 ($83,000 and $103,000 if filing a joint return). For more complete information, see chapters 2 and 3 in Publication 970, Tax Benefits for Education.

For 2004, the amount of your interest exclusion will be phased out (gradually reduced) if your filing status is married filing jointly or qualifying widow(er) and your modified adjusted gross income (MAGI) is between $89,750 and $119,750. You cannot take the deduction if your MAGI is $119,750 or more. For 2003, the limits that applied to you were $87,750 and $117,750.

For all other filing statuses, your interest exclusion is phased out if your MAGI is between $59,850 and $74,850. You cannot take a deduction if your MAGI is $74,850 or more. For 2003, the limits that applied to you were $58,500 and $73,500. For more complete information, see chapter 10 in Publication 970, Tax Benefits for Education.

Final regulations changed the following rules for deducting student loan interest. These changes apply to interest due and paid after December 31, 1997, on qualified student loans. For more complete information, see chapter 4 in Publication 970, Tax Benefits for Education.

Beginning in 2004, student loan repayments provided to you under certain federal and state repayment programs are tax free. For more information, see chapter 5 in Publication 970, Tax Benefits for Education.

If you were an eligible educator in 2004, you can deduct as an adjustment to income up to $250 of qualified expenses you paid in 2004. This provision was scheduled to expire at the end of 2003. However, it was extended through 2005. For more information on the deduction, see Publication 529, Miscellaneous Deductions.

A health savings account (HSA) is a tax-exempt trust or custodial account that you set up with a qualified HSA trustee to pay or reimburse certain medical expenses you incur. You must be an eligible individual to have contributions made to your HSA. For 2004, you can deduct contributions made on or before April 15, 2005, to your 2004 HSA. For more information on HSAs, see Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans.

The period for opening a new Archer MSA has been extended until December 31, 2005. Previously, this period was scheduled to expire at the end of 2003. Archer MSAs are explained in Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans.

You may be able to deduct as an adjustment to income attorney fees and court costs paid after October 22, 2004, for actions settled or decided after that date involving a claim of unlawful discrimination, a claim against the United States Government, or a claim made under section 1862(b)(3)(A) of the Social Security Act. However, you cannot deduct more than the amount you received from the claim that was included in gross income for the tax year. For more information, see Publication 525, Taxable and Nontaxable Income.

Generally, you can exclude from income a gain from selling property you used as your main home for at least 2 years during the 5-year period ending on the date of sale. However, you cannot exclude a gain from selling your home after October 22, 2004, if you acquired the property in a like-kind exchange and sold it during the 5-year period beginning on the date you acquired it. For more information, see Publication 523, Selling Your Home.

For 2004 and 2005, you can elect to deduct state and local general sales taxes instead of state and local income taxes as an itemized deduction on Schedule A (Form 1040). You cannot deduct both. Generally, to figure your state and local sales tax deduction, you can use either your actual expenses or the tables contained in Publication 600, Optional State Sales Tax Tables.

If you use the tables to figure your deduction, you may be able to add the following items to the table amount.

See the Instructions for Schedule A (Form 1040) and Publication 600 for details.

You can treat cash contributions made in January 2005 for the relief of victims in areas affected by the December 26, 2004, Indian Ocean tsunami as if you had made them on December 31, 2004. These contributions must otherwise qualify as deductible contributions. Contributions you deduct on your 2004 tax return cannot be deducted on your 2005 tax return.

If you donate a patent or other intellectual property to a qualified organization after June 3, 2004, your deduction is limited to the basis of the property or the fair market value of the property, whichever is less. Intellectual property means any of the following:

The additional deductions cannot be taken for patents or other intellectual property donated to certain private foundations.

If you claim a deduction of more than $500,000 for a contribution of property made after June 3, 2004, you must attach a qualified appraisal of the property to your return. This does not apply to contributions of cash, inventory, publicly traded stock, or intellectual property. Previously, the appraisal was required for your records but did not have to be attached to your return.

If you do not attach the appraisal, you cannot deduct your contribution, unless your failure to attach the appraisal is due to reasonable cause and not to willful neglect.

The amount you can deduct for each exemption has increased from $3,050 in 2003 to $3,100 in 2004.

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 2004, the phaseout begins at:

If your adjusted gross income is above the amount for your filing status, use the Deduction for Exemptions Worksheet in the Form 1040 or Form 1040A instructions to figure the amount you can deduct for exemptions.

The standard deduction for people who do not itemize deductions on Schedule A of Form 1040 is, in most cases, higher for 2004 than it was for 2003. 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 2004 Standard Deduction Tables are shown in Publication 501, Exemptions, Standard Deduction, and Filing Information.

If your adjusted gross income is above a certain amount, you lose all or part of your itemized deductions. In 2004, this amount is increased to $142,700 ($71,350 if married filing separately). In 2003, the amount was $139,500 ($69,750 if married filing separately). For more information and a worksheet to figure the amount you can deduct, see Schedule A (Form 1040) instructions for line 28.

The amount of taxable investment income a child under age 14 can have without it being subject to tax at the parent's rate has increased to $1,600 for 2004. Previously, the amount was $1,500.

You can generally elect to include nontaxable combat pay in earned income for figuring the amount of dependent care benefits you can exclude or deduct from income. You may be able to increase your exclusion or deduction by making the election. For more information on dependent care benefits, see Publication 503, Child and Dependent Care Expenses.

The credit limit based on earned income is increased to 15% (previously 10%) of your earned income that exceeds $10,750. If you were a member of the U.S. Armed Forces who served in a combat zone, your nontaxable combat pay counts as earned income when figuring this credit limit. See Form 8812, Additional Child Tax Credit, for more information.

Beginning in 2004, you cannot claim the health coverage tax credit for premiums that you pay with a tax-free distribution from your health savings account. See Form 8885, Health Coverage Tax Credit, and Publication 502, Medical and Dental Expenses, for more information on this credit.

The following paragraphs explain the changes to the credit for 2004. For details, see Publication 596, Earned Income Credit.

Nontaxable combat pay election.   You can elect to have your nontaxable combat pay included in earned income for the earned income credit (EIC). If you are filing jointly and both you and your spouse received nontaxable combat pay, each of you can make your own election. In other words, one of you can choose to include your nontaxable combat pay in earned income, and the other one can choose not to include it. Electing to include nontaxable combat pay in earned income may increase or decrease your EIC. Figure the credit with and without your nontaxable combat pay before making the election.

  The election cannot be made on the return of a taxpayer whose tax year ended before October 5, 2004, due to his or her death.

  

You can make a separate election to have your nontaxable combat pay included in earned income if you are excluding or deducting dependent care benefits from income. In other words, you can choose to include your nontaxable combat pay in earned income when figuring your exclusion or deduction of dependent care benefits, even if you choose not to include it in earned income for the EIC.

The maximum clean-fuel vehicle deduction and qualified electric vehicle credit were scheduled to be 25% lower for 2004 and 50% lower for 2005. The full deduction and credit are now allowed for qualified property placed in service in 2004 and 2005. The deduction and credit are still scheduled to be reduced by 75% for qualified property placed in service in 2006, and no deduction or credit will be allowed after 2006. For more information about electric and clean-fuel vehicles, see chapter 12 in Publication 535, Business Expenses.

Changes to the straddle rules went into effect for positions established after October 21, 2004. In general, the new rules:

The changes are described in chapter 4 of Publication 550, Investment Income and Expenses.

Beginning in 2004, if you are a rural mail carrier and your allowable vehicle expenses are more than your qualified reimbursement, you can deduct the unreimbursed expenses as a miscellaneous itemized deduction on Schedule A (Form 1040). You must complete Form 2106 and attach it to your Form 1040. See chapter 4 of Publication 463, Travel, Entertainment, Gift, and Car Expenses, for more information on allowable expenses and qualified reimbursements.

Beginning in 2005, one definition of a “qualifying child” will apply for each of the following tax benefits.

Dependency Exemption

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.

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.

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.

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:

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.

For 2005, the employer and employee will continue to pay: