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A Recap of the Tax Increase Prevention and Reconciliation Act

The Tax Increase Prevention and Reconciliation Act

On May 17, 2006 President George W. Bush signed into law the “Tax Increase Prevention and Reconciliation Act of 2005” (TIPRA). TIPRA provides $70 billion in tax incentives. TIPRA affects a broad spectrum of taxpayers, including individuals, small business owners, corporations and expatriates. The following information outlines the major provisions affecting individuals and small business owners:

Investments and Capital Gains

The most notable result of TIPRA is the extension, through 2010, of the very favorable federal income tax rate structure for long-term capital gains (which applies to investment assets held for more than one year) and qualified dividends (which include most dividends paid by large corporations as well as those by paid out by small closely held domestic C corporations).

Specifically, the highest federal rate on most long-term gains will remain at the current 15 percent mark through 2010. The current 5 percent rate on most long-term gains earned by individuals in the 10-15 percent federal income tax brackets (the two lowest brackets) will continue through 2007 and then drop to 0 percent for 2008 through 2010.

These same rates will also apply through 2010 to qualified dividends. (Before the TIPRA changes, the rates on long-term gains and qualified dividends were scheduled to rise after 2008.) TIPRA also extends through 2010 the current 28 percent top federal rate for long-term gains from collectible sales and the 25% maximum rate for long-term real-estate gains attributable to depreciation write-offs.

The bottom line is that this is a favorable provision for investors, particularly for those in the lowest two tax brackets who will benefit from three years of a 0 percent tax rate from 2008-10.

Section 179 Deduction Rules Extended Two More Years

The Section 179 deduction privilege allows many small business owners to immediately deduct the full cost of most equipment and software additions (whether new or used) in their first year. For 2006, the maximum Section 179 write-off is $108,000, a significant amount. However, the deduction was scheduled to fall back to only $25,000 after 2007. TIPRA extends the current pro-taxpayer Section 179 rules by another two years — through 2009, which is a significant benefit to small business owner

Alternative Minimum Tax Changes

TIPRA also includes a pair of one-year fixes (for 2006 only) that greatly reduce the odds you many taxpayers will be hit with the dreaded Alternative Minimum Tax (AMT) this calendar year.

The first fix increases the 2006 AMT exemption to the following amounts:

· $62,550 if you are married and file jointly (up from $58,000 for 2005). Without the fix, your 2006 exemption would have been only $45,000.

· $42,500 if you file as a single person or head of household (up from $40,250 for 2005). Without the fix, your exemption for this year would have been only $33,750.

· $31,275 if you are married and file separately from your spouse (up from $29,000 for 2005). Without the fix, your 2006 exemption would have been only $22,500.

The second change to the AMT law for this year allows taxpayers to use their nonrefundable personal tax credits (such as the dependent care credit and the education tax credits) to reduce both your 2006 regular tax bill and your 2006 AMT, similar to last year.

This means that those taxpayers who did not owe the AMT last year probably won't owe it this year either — unless a significant life change that affects your tax status has occurred (i.e. a significant raise, triggering numerous capital gains, exercising appreciated employer stock options, moving into a state with a hefty personal income tax, or becoming the parent of multiple children).

Kiddie Tax Rules to Affect More Dependents

There is one tax drawback to TIPRA. It has exposed more dependent children to the so-called Kiddie Tax.

Under the Kiddie Tax rules, a dependent child's unearned income (typically from investments) can be taxed at the parent's federal income tax rates, which can be as high as 35 percent, or 15 percent for long-term gains and dividends, instead of at the child's lower rates, which can be as low as 10 percent, or 5 percent for long-term gains and dividends.

Before 2006, the Kiddie Tax only applied to dependent children who had not reached the age of 14 by year-end. In other words, the Kiddie Tax wasn’t in effect for the year a child turned 14 and for all later years. But that has now changed.

Starting in 2006 (applied retroactively to the start of 2006), the Kiddie Tax rules apply to dependent children who have not reached age 18 by year-end. So those taxpayers who have a dependent child who will still be 17 or younger as of Dec. 31, 2006, will be potentially subject to provisions of this tax.

The good news is that the Kiddie Tax won't apply unless an under-age-18 dependent child has 2006 unearned income in excess of $1,700. Even if that's the case, the higher Kiddie Tax rates will only apply to unearned income above the $1,700 threshold.

Roth IRA Conversions

Beginning in 2010, TIPRA eliminates the income limits on conversions of traditional IRAs to Roth IRAs. Thus, taxpayers could make such conversions without regard to their adjusted gross income (currently the limit is $100,000). Additionally, in contrast to current law, TIPRA allows married taxpayers filing separate to convert amount in a traditional IRA into a Roth IRA.

Under TIPRA, the conversions occurring in 2010, unless the taxpayer elects otherwise, none of the amounts converted in 2010 are includable in gross income in 2010. Half of the income resulting from the conversion is includible in 2011 and the other half in 2012.

If you have any questions about TIPRA and how it could affect your 2006 tax situation, feel free to contact us at 248-362-5000. We would be happy to discuss ways to potentially limit your tax liability, or to best take advantages of these changes, based on your situation.