WRESTLING RESULTS
June 2006
AND THE WINNER IS…….
Another Spring, another tax act (the Tax Increase Prevention and Reconciliation Act of 2005 – yes, 2005 because it is last year’s reconciliation bill) and watching lawmakers wrangle over this one reminded us of a wrestling match! Well, the results are in and there are some winners and losers.
WINNERS
Investors – the 15% tax rate on capital gains and most dividend income is extended for two more years – through the end of 2010. A new feature, the tax rate on investment income for taxpayers in the 10- and 15-percent brackets is reduced to zero in 2008. It is anyone’s guess what will happen after 2010, but your long-term tax strategy should consider the possibility of higher rates in the future.
Small Business Owners – the maximum equipment additions that can be expensed will remain at current levels through the end of 2009. For 2006, the amounts are $108,000, with reductions once the amount added exceeds $430,000. Without the extension, the limit would have dropped to $25,000 on a $200,000 cap after 2007.
Middle-Class AMT Payers – For 2006 ONLY, the AMT exemption amount is increased to $62,500 for married couples filing jointly versus the old exemption of $58,000 ($42,500 versus $40,250 for single filers). This is a very modest change to those paying AMT tax and falls far short of any meaningful reform. As we have previously written, the AMT dollars are large and always increasing so meaningful changes will be hard to come by without a change in rates.
High-income IRA owners – the adjusted gross income ceiling of $100,000 for converting a traditional IRA to a Roth IRA (the IRA with contributions that are not deductible but on which the earnings are permanently tax-free and on which there are no required minimum distributions) will be eliminated for tax years AFTER 2009. The tax payable upon conversion can be averaged over the subsequent two years. Traditional IRAs that hold 401(k) balances rolled over at retirement will be eligible. Lawmakers keep trying to float the IRA to Roth conversion because it is tax money to them now and they will be out of office when the impact of Roth IRAs is felt. We have had clients look at converting but not surprisingly stop when they realize how much they will have to pay now. If you want a Roth, the best way is to fund through your employer 401K. See our October 2005 lunch byte.
LOSERS
Taxpayers age 14 to 18 – the “kiddie tax” (whereby kids pay tax at parents’ rates) will now apply up to age 18 – this is effective immediately for the entire 2006 tax year! It is hard to imagine that someone thought kids between 14 and 18 weren't paying enough tax. As well, this change takes a lot of the air out of the zero tax rate for lower income tax payers discussed above. It will now be more complicated to gift appreciated securities to your children that they then sell at their lower tax rate. We have used this strategy to help clients pay for their children's' college education. Now, you will have to wait until your child turns 18 – right at the time college begins- to sell appreciated securities at a lower tax rate. .
Offers in compromise - substantially less appealing now that a payment of 20% of a proposed lump-sum offer is now required at the time of application.
Americans working abroad – the foreign earned income exclusion is indexed, but there are new severe limits on excluding housing costs.
Tax-exempt entities (and their managers) – if they are parties to tax shelter transactions – there are new penalties that may be imposed.
Call Diane Burke at 302-656-6632 or email dburke@coverrossiter.com for more information on these or any other tax planning matters.