| New Tax Act Contains Tax Breaks; Adds Revenue Raisers |
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The new Tax Increase Prevention and Reconciliation Act (TIPRA)
retroactively extended a number of popular tax breaks, added several new
tax breaks, and included a number of revenue raisers. TIPRA's provisions
are significant to both individual taxpayers and business owners as well.
We will cover TIPRA's more significant changes in detail beginning with
those affecting individuals.
Increase in the alternative minimum tax (AMT) exemption amounts. The
AMT first appeared in 1970 as a way to ensure that wealthy individuals
paid at least some amount of federal tax on their income and affected
approximately 19,000 taxpayers that year. The AMT exemption allows many
middle and lower income taxpayers to escape the AMT, but the exemption
amounts were scheduled to be reduced in 2006. Without Congressional action
to continue the AMT exemption amounts at the levels effective in 2005, it
was estimated that up to 15 million additional taxpayers, including many
middle-class individuals, could have been subjected to the AMT in 2006.
TIPRA actually increased the AMT exemption amounts for 2006 to provide
real, although temporary, tax relief. That's the good news. The bad news
is the increased exemption amounts are only effective for 2006. So,
further action by Congress is needed to find a permanent solution to the
AMT problem.
Lower capital gains and dividend rates. TIPRA extends for two years the
0%, 5%, and 15% tax rates on capital gains through tax years beginning
before 2011. These capital gains rates were to expire at the end of 2008
and rates ranging from 8% to 20% were due to come into effect in 2009. In
addition, TIPRA also extends for the same two-year period the treatment of qualified
dividend income as capital gains.
Kiddie Tax. The kiddie tax is intended to inhibit the sheltering of
unearned income (e.g., dividends and interest) by transferring
income-generating investments from parents to children. A child is subject
to the kiddie tax at his or her parents' marginal tax rate on unearned
income over $1,700 (for 2006) if that tax rate is higher than the tax rate
the child would otherwise pay on it. Prior to TIPRA, a child was subject
to the kiddie tax if he or she had not attained the age of 14 before the
close of the tax year and either parent of the child was alive at the end
of the tax year.
Under TIPRA, for tax years beginning after 2005, a child is subject to
the kiddie tax if he or she has not attained the age of 18 (previously 14)
before the close of the tax year; either parent of the child is alive at
the end of the tax year; and the child does not file a joint return for
the tax year. TIPRA also created an exception to the kiddie tax for
distributions from certain qualified disability trusts. The opportunity to
lower a family's overall tax bite by transferring cash or income-producing
assets to children under 18 is inhibited by the kiddie tax. But, investing
a child's funds in savings bonds, municipal bonds, growth stocks, and
unimproved real estate can reduce the child's exposure to the kiddie tax.
Note that earned income from a job is not subject to taxation under the
kiddie tax provision. (See the related article on page 4.)
AGI ceiling for Roth IRA conversions. For qualified individuals, Roth
IRAs offer benefits like tax-free distributions and no minimum required
distributions, features not available with a traditional IRA. Prior to
TIPRA, a traditional IRA could be converted to a Roth IRA if, for that tax
year, the taxpayer's modified adjusted gross income (MAGI) did not exceed
$100,000 and the taxpayer was not a married individual filing a separate
return. The income resulting from the conversion (the transfer amount) was
included in taxable income subject to the appropriate income tax. However,
the 10% premature distribution penalty provision does not apply.
For tax years beginning after December 31, 2009, TIPRA eliminates the
$100,000 MAGI limitation and permits married taxpayers filing a separate
return to convert amounts in a traditional IRA into a Roth IRA. Thus,
taxpayers can make such conversions beginning in 2010 without regard to
their MAGI. In addition, for 2010 only, the taxes on the conversion amount
will be paid 50% in each of the next two years, 2011 and 2012.
Enhanced equipment expensing election. Business owners can elect to
expense, rather than depreciate, the cost of certain new or used equipment
placed in service within their business during the tax year. The maximum
dollar amount that may be deducted annually is $100,000 ($108,000 in 2006,
as adjusted for inflation). The maximum expensing amount is reduced on a
dollar-for-dollar basis after business equipment purchases exceed $400,000
($430,000 in 2006, as adjusted for inflation). Prior to TIPRA, the
expensing and phase-out amounts were to drop to $25,000 and $200,000,
respectively, for equipment placed in service in tax years beginning after
2007. TIPRA extends the $100,000 expense election and the $400,000
phase-out ceiling (as inflation adjusted) for two additional years to tax
years beginning before 2010.
Domestic production activities deduction/W-2 wage limitation. For
business owners, the domestic production activities deduction is generally
limited to, among other limitations, 50% of the W-2 wages paid by the
taxpayer for the year. Prior to TIPRA, there was nothing in the definition
of W-2 wages that required those wages to be allocable or attributable to
production activities. For tax years beginning after the enactment date
(May 17, 2006), TIPRA provides that W-2 wages include only amounts that
are properly allocable to a qualified production activity.
Please contact us if you have questions about the Tax Increase
Prevention and Reconciliation Act or any other personal or business tax
compliance or tax planning issue.
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