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Congress Giveth and Taketh
What the new tax law means to you
Tax and Financial News
August 2006
Congress Giveth and Taketh
What the new tax law means to you
In May 2006, Congress extended some of President Bushâs earlier tax reductions and even added its own reduction. The estate tax reductions of prior years were not extended or otherwise changed, but some positive changes did come about as a result of the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA). This article explores the implications of the major provisions of TIPRA.
Individual Tax Provisions
Tax Reductions and Extensions
By far, the extensions that received the most attention related to the reduced dividend and capital gains tax rates. Instead of sunsetting in 2008, these favorable rates will continue through 2010. Letâs review exactly what those rates will be for the next few years.
Present law taxes capital gains at a rate of 15% if they would be taxed at rate greater than 15% were they ordinary income. If the capital gains would be taxed at 15% or 10% were they ordinary income, then the tax rate would be 5%. Beginning in 2007, the tax rate for capital gains that would otherwise be taxed at 10% or 15% were they ordinary income would be 0%. These rates were scheduled to revert back to rates in effect prior to May 5, 2003, which were generally 20% and 10% depending on your tax bracket for a taxpayerâs year that begins on January 1, 2009.
The new lawâs also provides for the extension of lower dividend tax rates. Rates for qualified dividends were scheduled to revert back to a top rate of 35% after 2008, but these rates will also remain at 15% for years that end before December 31, 2010.
The exemption amount for married taxpayers filing jointly was scheduled to drop to $45,000 in 2006. For unmarried taxpayers, the exemption was scheduled to drop to $33,750. The new law increases that exemption to $62,550 for taxpayers filing jointly and $42,500 for unmarried taxpayers. Additionally, the use of nonrefundable tax credits to offset the AMT has been extended through 2006. Nonrefundable personal credits include the dependent care credit, credit for the elderly and permanently disabled, Hope and Lifetime learning credit, child credit, adoption credit, lower income savers credit and mortgage credit (available only to holders of state issued mortgage credit certificates).
For those few taxpayers who may benefit, the new law also allows capital gains treatment for the sale or exchange of self-created musical compositions or copyrights. This break is available for sales from May 17, 2006 through January 1, 2011.
Tax Increases
The new law contains certain revenue raisers to offset the effect of the tax reductions and extensions. Depending on your situation, there may be some planning opportunities available as a result of these.
Under current law, if you are married, filing jointly, and your income is over $100,000, you are not allowed to convert your traditional IRA to a Roth IRA. For tax years beginning after December 31, 2009, these limitations are removed. Better yet, the income generated by an IRA to Roth IRA conversion is recognized in 2011 and 2012 even if the conversion takes place in 2010. While this change will raise revenue, it does afford higher income taxpayers the ability to convert their traditional IRAs to Roths.
Currently, if your child is under 14 years old, his or her unearned income over $1,700 is taxed at the parentsâ highest marginal rate. For tax years beginning after December 31, 2005, the age limit is increased to 18 years old. From a practical standpoint, if you have placed assets that produce unearned income in your 15 year oldâs name to take advantage of his or her lower rates, think again. This tactic will not work until that child is 18 years of age or older.
Business Tax Provisions
There are a number of both tax savings and increase measures included in the new law. Many of these are narrow in scope and this article will not address those. Two changes do deserve attention, however, because of their widespread application - extension of higher Code Section 179 expensing provisions and reduction in the domestic manufacturing deduction.
Code Section 179 allows business entities (including sole-proprietorships) to deduct up to $108,000 (in 2006) of the cost of certain new or used tangible personal property that would otherwise be depreciated. After 2007, this higher amount was to drop to $25,000, but the new law will keep the current higher limits (adjusted for inflation) in place through 2009. Additionally, current law phases out the deduction if current year expenditures exceed $430,000 (in 2006). The phase out limit was to revert to $200,000 for years beginning after 2007, but the higher amount (adjusted for inflation) will remain in place through 2009.
Current tax law limits what is known as the domestic production deduction to an amount no greater than 50% of W-2 all wages. For tax years beginning after May 17, 2006, the only wages that can be taken into account are those that are directly allocable to domestic production gross receipts. This deduction may seem to apply to only a few business entities, but the definition of domestic production gross receipts enables numerous businesses, not just manufacturers, to take advantage of the deduction.
Conclusion
Every year, Congress enacts measures that have potentially significant effects on numerous taxpayers. This year is no different and TIPRA can have significant positive and negative effects on your tax picture. Give us a call and letâs discuss your current situation and how the new law may affect you.
Have a great, and hopefully cooler, August.
Individual Tax Provisions
Tax Reductions and Extensions
By far, the extensions that received the most attention related to the reduced dividend and capital gains tax rates. Instead of sunsetting in 2008, these favorable rates will continue through 2010. Letâs review exactly what those rates will be for the next few years.
Present law taxes capital gains at a rate of 15% if they would be taxed at rate greater than 15% were they ordinary income. If the capital gains would be taxed at 15% or 10% were they ordinary income, then the tax rate would be 5%. Beginning in 2007, the tax rate for capital gains that would otherwise be taxed at 10% or 15% were they ordinary income would be 0%. These rates were scheduled to revert back to rates in effect prior to May 5, 2003, which were generally 20% and 10% depending on your tax bracket for a taxpayerâs year that begins on January 1, 2009.
The new lawâs also provides for the extension of lower dividend tax rates. Rates for qualified dividends were scheduled to revert back to a top rate of 35% after 2008, but these rates will also remain at 15% for years that end before December 31, 2010.
The exemption amount for married taxpayers filing jointly was scheduled to drop to $45,000 in 2006. For unmarried taxpayers, the exemption was scheduled to drop to $33,750. The new law increases that exemption to $62,550 for taxpayers filing jointly and $42,500 for unmarried taxpayers. Additionally, the use of nonrefundable tax credits to offset the AMT has been extended through 2006. Nonrefundable personal credits include the dependent care credit, credit for the elderly and permanently disabled, Hope and Lifetime learning credit, child credit, adoption credit, lower income savers credit and mortgage credit (available only to holders of state issued mortgage credit certificates).
For those few taxpayers who may benefit, the new law also allows capital gains treatment for the sale or exchange of self-created musical compositions or copyrights. This break is available for sales from May 17, 2006 through January 1, 2011.
Tax Increases
The new law contains certain revenue raisers to offset the effect of the tax reductions and extensions. Depending on your situation, there may be some planning opportunities available as a result of these.
Under current law, if you are married, filing jointly, and your income is over $100,000, you are not allowed to convert your traditional IRA to a Roth IRA. For tax years beginning after December 31, 2009, these limitations are removed. Better yet, the income generated by an IRA to Roth IRA conversion is recognized in 2011 and 2012 even if the conversion takes place in 2010. While this change will raise revenue, it does afford higher income taxpayers the ability to convert their traditional IRAs to Roths.
Currently, if your child is under 14 years old, his or her unearned income over $1,700 is taxed at the parentsâ highest marginal rate. For tax years beginning after December 31, 2005, the age limit is increased to 18 years old. From a practical standpoint, if you have placed assets that produce unearned income in your 15 year oldâs name to take advantage of his or her lower rates, think again. This tactic will not work until that child is 18 years of age or older.
Business Tax Provisions
There are a number of both tax savings and increase measures included in the new law. Many of these are narrow in scope and this article will not address those. Two changes do deserve attention, however, because of their widespread application - extension of higher Code Section 179 expensing provisions and reduction in the domestic manufacturing deduction.
Code Section 179 allows business entities (including sole-proprietorships) to deduct up to $108,000 (in 2006) of the cost of certain new or used tangible personal property that would otherwise be depreciated. After 2007, this higher amount was to drop to $25,000, but the new law will keep the current higher limits (adjusted for inflation) in place through 2009. Additionally, current law phases out the deduction if current year expenditures exceed $430,000 (in 2006). The phase out limit was to revert to $200,000 for years beginning after 2007, but the higher amount (adjusted for inflation) will remain in place through 2009.
Current tax law limits what is known as the domestic production deduction to an amount no greater than 50% of W-2 all wages. For tax years beginning after May 17, 2006, the only wages that can be taken into account are those that are directly allocable to domestic production gross receipts. This deduction may seem to apply to only a few business entities, but the definition of domestic production gross receipts enables numerous businesses, not just manufacturers, to take advantage of the deduction.
Conclusion
Every year, Congress enacts measures that have potentially significant effects on numerous taxpayers. This year is no different and TIPRA can have significant positive and negative effects on your tax picture. Give us a call and letâs discuss your current situation and how the new law may affect you.
Have a great, and hopefully cooler, August.
These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.
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