By Kenneth H. Bridges, CPA, PFS May 2006
In May 2006, Congress passed the Tax Increase and Prevention Reconciliation Act (the “Act”). Highlights of the act include the following:
Extension of the 15% tax rate on capital gains and dividends – Legislation enacted in 2003 cut the maximum Federal rate on long-term capital gains and qualified dividends to 15%. However, these favorable rate cuts were set to expire at the end of 2008. The Act extends these favorable rates through the end of 2010.
Alternative minimum tax relief – The alternative minimum tax (“AMT”) is a separate but parallel system to the regular income tax. You must compute your tax under both systems, and pay the greater of the two. If the AMT is higher than the regular tax then this excess shows up on your return as an additional tax. For 2005, married individuals filing jointly were permitted a maximum exemption in computing the AMT of $58,000 and singles were permitted a maximum exemption of $40,250. For 2006, these maximum exemption amounts (which are subject to phase-out for higher income taxpayers), were scheduled to be reduced to $45,000 and $33,750, respectively. This would have meant millions more taxpayers being subject to the AMT for 2006. To avoid this, Congress has increased the exemptions for 2006 to $62,550 and $42,500, respectively. This represents a tax savings of up to $4,563 for those directly affected.
Enhanced Code section 179 expensing extended – Most small businesses can elect to immediately expense up to $100,000 each year ($108,000 for 2006, as adjusted for inflation) of the cost of furniture and equipment purchased for use in the business. For tax years beginning after 2007, this amount was scheduled to revert to the old $25,000 per year limit. The Act extends the favorable higher amount through the end of 2009.
Kiddie tax age increased – Ever since the Tax Reform Act of 1986, children under the age of 14 have had their unearned income (e.g. interest and dividends) over a minimal amount ($1,700 for 2006) taxed at their parents’ marginal tax rate. This provision was designed to prevent parents from shifting income to their children’s typically lower tax rate bracket. Under the new Act, beginning with tax year 2006 the age for the “kiddie tax” is increased to apply to children under the age of 18.
Income limit on Roth IRA conversions eliminated beginning in 2010 – With a traditional deductible IRA, you get a tax deduction on the front end when you make the contribution, but then are subject to ordinary income tax rates on any withdrawals (with an additional 10% penalty generally applying if you make withdrawals before age 59 ½). With a nondeductible traditional IRA, you get no tax deduction on the front end and then are subject to ordinary income tax rates on a portion of your withdrawals (the portion representing the income earned by the IRA account). The Taxpayer Relief Act of 1997 introduced a third type of IRA, called the “Roth IRA”, with which you get no front-end tax deduction but the appreciation in value permanently escapes tax. Traditional IRAs can be converted to Roth IRAs, but only if your income for the year of conversion is less than $100,000. The conversion is a taxable event. Under the new law, beginning in 2010, taxpayers will be able to convert a traditional IRA into a Roth IRA regardless of their level of income. We often suggest the Roth conversion as a strategy in a tax year in which a client is in a very low tax rate bracket or is in danger of wasting deductions (e.g. a substantial amount of itemized deductions and exemptions, but no income to utilize them against and no ability to create a net operating loss carryback or carryforward). However, if a client has income for the year in excess of $100,000, the tax cost associated with a Roth conversion will in most cases make this an unappealing strategy.
The Tax Relief and Health Care Act of 2006
On December 20, 2006, President Bush signed into law the Tax Relief and Health Care Act of 2006. Highlights of the Act include:
Alternative minimum tax credit relief – Taxpayers who exercised incentive stock options (ISOs) during 1999 and then tried to hold onto the stock for a year in order to qualify for long-term capital gains treatment were in many cases badly burned when the stock price fell dramatically in 2000. The excess of the value of the stock over the exercise price on the day of exercise is an addback for purposes of the alternative minimum tax (AMT). Accordingly, many were left with a substantial AMT bill, and nothing to show for but an AMT credit carryforward. Unlike the AMT that results from “permanent differences” (like the addback for the deduction of state income taxes), AMT that results from “timing differences” (like the exercise of ISOs or accelerated depreciation) gives rise to a credit that can be carried forward and utilized to offset tax in future years. Heretofore, the tax law has provided that you could only use the AMT credit to the extent your “regular tax” exceeded your “minimum tax”. Under the current AMT scheme, taxpayers who live in a state with a state income tax (like Georgia) and have annual income between $150,000 and $500,000 are almost by default in the AMT each year, making it difficult for them to ever utilize their AMT credit. The new law, designed to provide a little help to those who got burned by ISO exercises, provides that up to 20% of your AMT credit carryforward (or $5,000, if greater) can potentially be claimed each year, even if you are in the AMT posture for the year.
Kenneth H. Bridges, CPA, PFS is a partner with Bridges & Dunn-Rankin, LLP an Atlanta-based CPA firm.
This article is presented for educational and informational purposes only, and is not intended to constitute legal, tax or accounting advice. The article provides only a very general summary of complex rules. For advice on how these rules may apply to your specific situation, contact a professional tax advisor.