Start planning now to take advantage of new tax cuts

The new $70 billion tax cut package signed into law by President Bush on May 17 extends some valuable tax breaks that you need to know about. Under the new Tax Increase Prevention and Reconciliation Act, you can take advantage of reduced tax rates on dividends and capital gains, enhanced treatment of Roth IRAs, some incentives to lower your AMT liability, increased small business expensing, and many other incentives.

Don’t let the “2005” in the title of the new law confuse you. This tax bill was a long time in the making. Negotiations started in 2005 and continued into early May, when Republican leaders in the House and Senate finally reached an agreement. The tax incentives in the new law are important in 2006 and in future years.

Dividends and capital gains

Three years ago, Congress lowered the maximum dividend and capital gains tax rate for most — but not all — dividends and capital gains. The tax on qualifying dividends fell from a high of 35 percent (depending on income tax bracket) to 15 percent. The tax on qualifying capital gains tax rates fell from 20 to 15 percent. Congress also created a special, lower dividend tax rate of five for taxpayers in the 15 and 10 percent brackets. They are eligible for an even lower tax rate of zero percent in 2008.

When the dividend and capital gains tax rate cuts were enacted in 2003, they were intended to be temporary. The lower rates were scheduled to expire on December 31, 2008.

Last year, the White House began lobbying hard for Congress to extend the dividend and capital gains tax rate cuts beyond 2008. Many Republicans agreed but Democrats were very opposed to the extension, which they viewed as premature. They proposed to wait until 2008 and then decide whether to extend the tax cuts. Republicans control both the House and the Senate, and even though their majorities are slim, they had enough votes to extend the dividend and capital gains now rather than waiting until 2008.

Because of the extension, investors can take a significantly longer view on long-term investments. Many investors were anticipating having to act before December 31, 2008 to take advantage of the lower rates. Now, you have two more years to potentially maximize your tax savings.

Roth IRAs

For many years, higher-income individuals could not convert traditional IRAs to Roth IRAs. The new law changes this treatment. In 2010 and beyond, taxpayers with adjusted gross incomes above $100,000 will be allowed to convert traditional IRAs to Roth IRAs.

Even though this tax break is not available until 2010, it’s not too early to be thinking about a Roth IRA conversion plan. You may want to consider rolling over 401(k) balances to IRAs when leaving employment, investing in traditional IRAs in anticipation of conversion to Roth IRAs. These are just two of many options you may have under the new tax law. Give us a call and we’ll craft a Roth IRA conversion plan that is tailored to your needs.

Temporary AMT relief

More than 30 years ago, Congress created the alternative minimum tax (AMT) to combat tax evasion by a handful of extremely wealthy people. Congress did not index the AMT for inflation. Inflation has so eroded the value of the dollar over the past 30 years that the AMT now applies to millions of middle-income taxpayers.

Congress could “fix” the AMT so that it once again applies only to the very wealthy. It hasn’t. Although many politicians on Capitol Hill are hearing from their constituents that they want the AMT abolished, the AMT brings in huge amounts of revenue. Getting rid of it would cost the federal government hundreds of billions of dollars in lost revenue.

Instead, Congress has sought to soften the blow of the AMT by giving taxpayers some breaks. The new law slightly increases the AMT exemption amounts and also allows taxpayers to use the nonrefundable personal credits to offset regular and AMT liability. This special treatment is effective for 2006 only.

“Kiddie” tax

The “kiddie” tax was created to prevent income-shifting from parents to children to get around the parents’ higher tax rate. Until now, children under the age of 14 were taxed at their parent’s marginal tax rate. Over age 14, they were not.

The new law makes a huge change to the “kiddie” tax rules. Effective immediately for 2006, the “kiddie” tax kicks-in when the child has more than $1,700 in passive (unearned) income and other criteria are met.

If you are saving for your child’s college education, you may need to reevaluate your tax strategy because of the change to the “kiddie” tax rules. We can help you evaluate your savings strategy in light of the new “kiddie” tax rules.

Small business expensing

Businesses usually prefer to expense rather than capitalize business investments. In 2003, Congress raised the amount of annual investment that small businesses may elect to deduct from $25,000 to $100,000. The $100,000 threshold is reduced by the amount by which the cost of qualifying property exceeds $400,000. The $100,000 and $400,000 amounts are also indexed for inflation. For 2006, they are $108,000 and $430,000.

Like other tax cuts, the enhanced small business expensing amounts were temporary. They were scheduled to expire on December 31, 2007. The new law extends them for two more years through December 31, 2009.

Because the higher amounts were originally set to expire at the end of next year, you may have been trying to shoehorn purchases into an accelerated schedule. The new law gives you more time to consider when to make these purchases and how to maximize your tax savings.

More tax cuts

The new law includes many more tax cuts. Here’s a quick rundown:

  • Changes to offers-in-compromise;
  • A simplified active business test for tax-free corporate spin-offs;
  • Changes to subpart F;
  • New elections about the tax treatment of musical compositions;
  • Increased estimated tax payments for large corporations in 2006, 2012 and 2013;
  • Repeal of some FSC/ETI transition rules;
  • Modifications to the Code Sec. 199 domestic production activities deduction;
  • Revisions to the foreign income and housing exclusion rules;
  • Penalties for tax-exempt organizations that participate in tax shelters;
  • Codification of earnings stripping rules to curb abuses;
  • New information reporting requirements for payors of interest on tax-exempt bonds;
  • Five-year amortization of geological and geophysical expenditures of large oil companies;
  • Modifications to the scope of the Foreign Investment in Real Property Tax Act; and More

Like every new tax law, the details are important. You may be eligible for some significant tax savings. Don’t hesitate to contact our office. We’ll review your tax situation and together put together a plan that may help lower your tax bill.

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