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May
seems to be the traditional month in Washington
for tax cuts and May 2006 is no different from past years. Congress has just
passed a $70 billion tax cut package, the Tax Increase Prevention and
Reconciliation Act, which impacts you.
Although
one tax incentive – extending the dividend and capital gains tax rate cuts
for two more years – has received the most press coverage, the new law
includes many other important tax breaks that could help reduce your tax
liability this year and in future years. Every time Congress changes the Tax
Code there are exciting new opportunities for strategic tax planning. This
article highlights some of the important incentives in the new tax law.
Dividends
and capital gains. Three years
ago, Congress lowered the tax rate on certain dividends and capital gains.
The rate reductions were temporary and were scheduled to expire after 2008.
The new law extends the lower rates for two more years.
The maximum tax rate on qualifying dividends and capital gains
through December 31, 2010 is 15 percent. Not all dividends and capital gains
qualify for the 15 percent rate. For example, the maximum capital gains rate
on collectibles is 28 percent. Taxpayers in the 15 and 10 percent rate
brackets can take advantage of even more generous tax treatment.
Roth
IRAs.
Until Congress passed this new tax law, higher-income individuals could not
convert traditional IRAs to Roth IRAs. Only individuals earning less than
$100,000 could convert traditional IRAs to Roth IRAs. The new law removes
this limitation starting in 2010.
AMT
relief.
Taxpayers who are liable for the alternative minimum tax (AMT) know that its
bite can be painful. Congress has talked for years about reforming the AMT
so it doesn’t impact as many middle-income taxpayers but so far hasn’t
made any substantial changes to the AMT rules. Instead, the new law extends
some temporary measures designed to reduce the burden of the AMT. Through
2006, AMT taxpayers can take advantage of higher exemption amounts of
$62,550 for married individuals filing jointly and surviving spouses
($42,500 for unmarried individuals) and use the nonrefundable personal tax
credits to offset regular and AMT liability.
Kiddie
tax.
The “kiddie” tax rules require that a child’s unearned income, such as
dividends and interest, be taxed at the tax rate of the parents. In most
cases, the child’s parents will be in a higher tax bracket. Currently, the
“kiddie” tax applies if the child is under age 14 and some other
criteria are met. The new law raises the age limit from 14 to 18 and this
change is effective immediately. Taxpayers who had envisioned the lower age
limit being effective for 2006 now have to revisit their tax plans.
Small
business expensing.
Over the past several years, small businesses have been able to expense
rather than capitalize more purchases because of higher expensing
thresholds. The amount was increased to $100,000 in 2003.
The new law extends the more generous expensing thresholds for two
more years. For 2006, taxpayers
can expense up to $108,000 of the cost of qualifying property reduced by the
amount that the cost of the property exceeds $430,000.
Remember, the $100,000 amount is indexed for inflation.
That’s why it is $108,000 for 2006 and will be higher for 2007.
If Congress had not extended the enhanced thresholds, the expensing
limit would have dropped to $25,000.
Manufacturing
deduction. There's a "sleeper" deduction
that can be very valuable but hasn't received the attention it deserves in
many cases. Two years ago, Congress created the new manufacturing deduction,
also known as the domestic production activities deduction or the Code Sec.
199 deduction (after the section of the Tax Code that describes the
deduction). Congress created this new deduction because it had to repeal the
old FSC/ETI regime, which the World Trade Organization declared was an
illegal trade subsidy. The FSC/ETI regime was mostly valuable to large
exporters. The new manufacturing deduction is much broader, covering even
some small "mom and pop" type operations. Many more businesses are
eligible for this important tax break.
The
maximum deduction is nine percent of lesser of the taxpayer's qualified
production activities income or taxable income for the tax year without
regard to Code Sec. 199 or in the case of individuals, adjusted gross
income. The maximum deduction is phased-in over five years. For tax years
beginning in 2005 and 2006, the deduction is three percent. For 2007, 2008
and 2009, the deduction is six percent. In 2010 and thereafter, the
deduction is nine percent.
The
deduction cannot exceed 50 percent of the W-2 wages paid by the taxpayer.
Under the new tax law, effective for tax years beginning after May 17, 2006,
only wages allocable to domestic production gross receipts are included for
purposes of computing the Code Sec. 199 deduction limitation. While the new
law allows the old rules to apply for 2006 calendar year taxpayers, fiscal
year taxpayers with tax years beginning after May 17, 2006 are not as lucky.
By next years, when the deduction grows larger, the W-2 wage restriction
will be imposed by the new law on all businesses and will prove to be an
even greater limitation on taking the "full" deduction.
Large
corporate estimated tax payments. Corporations with
more than $1 billion in assets will have to pay increased estimated tax
payments that are due this year, in 2012 and in 2013. Payments due in July,
August and September of 2006 are increased to 105 percent. Payments due in
July, August and September of 2012 are increased to 106.25 percent and
payments due in July, August and September of 2013 are increased to 100.75
percent. In addition, 20.5 percent of the corporate estimated tax payment
due on September 15, 2010 will not be due until October 1, 2010. Similarly,
27.5 percent of the corporate estimated tax payment due on September 15,
2011 will not be due until October 1, 2011. Congress made these changes to
keep the cost of the new law with the $70 billion overall cap.
More
tax cuts. In addition to all of these tax breaks, the new law also:
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Changes
the offer-in-compromise rules;
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Modifies
the foreign earned income and employer-provided housing exclusion rules
for
U.S.
citizens living abroad;
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Extends
and creates a new exception to Subpart F, which taxes foreign
subsidiaries of
U.S.
companies;
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Gives
tax breaks to some environmental clean-up funds;
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Simplifies
the active trade or business test for certain corporate distributions;
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Allows
musical artists and publishers to elect special tax treatment;
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Tightens
earnings stripping rules to prevent abuses;
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Requires
withholding on payments made by some government agencies;
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Repeals
the FSC/ETI grandfather provisions;
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Accelerates
increased limits for industrial development bonds;
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Cracks
down on exempt organizations engaging in tax shelters;
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Expands
information reporting requirements for some tax-exempt bonds;
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Lengthens
the amortization period for certain expenditures by oil and gas
companies;
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Tightens
the rules under the Foreign Investment in Real Property Tax Act;
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Restricts
the tax-free treatment for certain corporate cash-rich spin-off
transactions;
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Imposes
loan and redemption requirements on pooled financing bonds; and
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Revises
the tax treatment of loans to continuing care facilities.
The
new tax law impacts taxpayers across-the-board. Many of the new incentives
build on tax breaks enacted in past years.
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