New Legislation: Tax Increase Prevention and Reconciliation Act of 2005
Dear Client:
The Tax Increase Prevention and Reconciliation Act of 2005 was passed by Congress on May 11, 2006 and it is expected to be signed into law by the President in the immediate future. The Act impacts a broad cross-section of taxpayers. It is important to be aware that the Act contains a number of revenue-raising provisions to help offset the revenue loss from the taxpayer-favorable provisions. The new law extends the dividend and capital gains tax rate cuts for two additional years, gives taxpayers some immediate relief from the alternative minimum tax (AMT), extends small business expensing thresholds, makes changes in estimated tax payments for large corporations, modifies the calculation of the domestic production activities deduction and allows high-income taxpayers a Roth conversion opportunity. Other less significant amendments are included in the Act, for example, provisions relating to: controlled foreign corporations, tax-free corporate spin-offs, and self-created musical works. Due to the volume of changes not every topic is discussed below, only the highlights of the new legislation.
Provisions affecting Corporations and Small Businesses
Corporate Estimated Tax Provisions
The Act increases estimated tax payments for corporations with assets of at least $1 billion. Estimated tax payments due July, August, and September of 2006 shall be increased to 105 percent of the amount otherwise due and similar provisions apply for such payments in 2012 and 2013. The next required payment shall be reduced accordingly. With respect to corporate estimated tax payments due on September 15, 2010, 20.5 percent of that payment shall not be due until October 1, 2010. A similar provision applies for such payment in 2011.
Small Business Expensing- Code Sec. 179
Since 2003, Congress has enhanced small business fixed asset expensing under Code Sec. 179 several times to encourage business investment. The Act continues this special treatment. The enhanced small business expensing thresholds in the American Jobs Creation Act of 2004 are extended through December 31, 2009. The maximum amount a taxpayer may expense is $100,000 of the cost of qualifying property, reduced by the amount by which the cost of qualifying property exceeds $400,000. Both amounts are indexed for inflation for tax years beginning after 2003 and before 2010. These amounts are increased for Gulf Opportunity Zone property. For 2006, the amounts are $108,000 and $430,000, respectively. Without the extension, the expensing limit would have dropped to $25,000 on a $200,000 cap after 2007.
Modification of Wage Limit for Purposes of Domestic Production Activities Deduction
Code Sec. 199 currently allows a deduction from taxable income for the portion of a taxpayer’s income that arises from qualified production activities but limits the deduction to 50 percent of the wages paid by the taxpayer in the same calendar year. Partners, shareholders, or other persons who are allocated part of the qualified production activities income (QPAI) from pass-through entities were treated as having been allocated their share of the partnership’s wages.
The Act modifies the wage limitation by limiting the deductions to 50 percent of the wages that are deducted in arriving at QPAI. Partners and shareholders will be allocated their share of the partnership’s W-2 wages but will include in their wage limit only wages paid to determine QPAI.
Distributions of Controlled Corporations - Active Business Test
The Act also simplifies the active business test for tax-free corporate spin-offs. Taxpayers can look at all corporations in the distributing corporate group and the spun-off subsidiary’s respective affiliated group to determine if the active business test is satisfied.
Provisions affecting Individuals
Dividend and Capital Gains Rate Cuts
In 2003 Congress lowered the maximum dividend and capital gains tax rates for most, but not all, dividends and capital gains to 15 percent for qualifying taxpayers. Taxpayers in the 10 and 15 percent tax brackets are eligible for an even lower rate of five percent. In 2008, the rate for taxpayers in the 10 and 15 percent tax brackets falls to zero. As originally enacted, these tax rate cuts were temporary. They were scheduled to expire at the end of 2008. The Act extends these cuts for two more years through December 31, 2010.
AMT Relief
To prevent more individuals from being subject to the Alternative Minimum Tax (AMT) in 2006, the Act extends a larger AMT exemption ($62,550 on a joint return and $42,500 on a single return) to 2006. The Act extends through 2006 the provision allowing taxpayers to use nonrefundable personal credits to offset AMT liability. Nonrefundable personal credits include the dependent care credit, the credit for the elderly and disabled, the credit for interest on certain home mortgages, the Hope credit for certain college expenses and the Lifetime Learning credit.
Important Changes to Roth IRA’s
The Act eliminates the $100,000 adjusted gross income ceiling for converting a traditional individual retirement account (IRA) to a Roth IRA, for tax years after 2009. A conversion is treated as a taxable distribution, but is not subject to the 10-percent early withdrawal penalty. Taxpayers who convert in 2010 can elect to recognize the conversion income in 2010 or average it over the next two years. High-income taxpayers with substantial amounts in traditional IRAs previously were shut out of the benefits of conversion. Now, anyone can convert to a Roth IRA. As a reminder, contributions to a Roth IRA are not deductible, but the earnings are permanently tax-free. Also, Roth IRAs have no required minimum distribution at age 70 ½.
Kiddie Tax
The kiddie tax rules require a child’s unearned income, such as dividends and interest, to be taxed at the parents’ tax rate, which is usually a higher rate. Under current law, the kiddie tax applies if the child is under age 14, the child has net unearned income over $1,700, and the parent can claim the child as a dependent. The Act raises the age limit to under 18. This provision is effective immediately, for the entire 2006 tax year.
Offers-in-Compromise
The Act increases the amounts that must be paid by taxpayers submitting an offer-in-compromise. Under the new law, taxpayers are required to make partial payments of their liability in addition to any user fee now imposed by the IRS; however, the user fee will be applied to the outstanding tax liability. For a lump sum offer, taxpayers will pay 20 percent of the amount offered. For an installment payment offer, taxpayers will make their proposed scheduled payments while the IRS considers the offer. If the IRS fails to process the offer within two years, the offer will be deemed to be accepted.
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If you have any questions about how these developments apply to you, or about any other recent tax legislation, please do not hesitate to contact one of our tax professionals at 727-572-1400.
Very truly yours,
Kirkland, Russ, Murphy & Tapp, P.A.
