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Opportunities and Pitfalls in the New Tax Law

On May 17, 2006, the President signed the new Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) into law. In addition to extending several tax breaks, the new law creates both tax planning opportunities and pitfalls for certain taxpayers. In particular, TIPRA may have a significant impact on Roth IRA (individual retirement account) conversions and “kiddie tax” planning strategies.

Following is a summary of some of the key provisions in the new tax law.

Roth IRAs: As opposed to a traditional IRA, contributions to a Roth IRA are never tax-deductible. However, distributions from Roth IRAs may be completely tax-free, providing an advantage over traditional IRAs. In addition, you don't have to take mandatory lifetime distributions from a Roth IRA.

Previously, a taxable conversion to a Roth IRA was allowed only in a year in which your adjusted gross income did not exceed $100,000. Effective for the 2010 tax year, the new law removes the $100,000 cap for Roth IRA conversions. For conversions taking place in 2010, you may elect to spread the resulting tax ratably over a three-year period.

Kiddie tax: Under the kiddie tax, a child's unearned income above a specified limit ($1,700 for 2006) is taxed at the top marginal tax rate of the child's parents. Prior to the new tax law, this tax rule applied to children under the age of 14. However, the new law hikes the age limit to 18, effective for the 2006 tax year.

Alternative minimum tax (AMT): The AMT continues to affect a wide range of middle- and upper-income taxpayers. Congress had created higher exemption amounts in the AMT calculation through 2005. The new law grants an additional one-year reprieve with even slightly higher exemption amounts for 2006.

Section 179 deductions: Section 179 of the tax code permits a business to currently deduct (or “expense”) the cost of assets in the year they are placed in service, within certain limits. The maximum expensing allowance under Section 179 was quadrupled from $25,000 to $100,000 by the Jobs and Growth Tax Relief Reconciliation Act of 2003. This dollar cap has been subsequently increased slightly over a period of years. Originally, the allowance was scheduled to revert to $25,000 in 2008, but the new law extends enhanced write-offs for two more years.

Capital gains and dividends: For 2006, the maximum tax rate on long-term capital gains and qualified dividends is only 15% (5% for low-income taxpayers) as opposed to ordinary income rates reaching 35%. This preferential tax treatment was scheduled to be repealed after 2008, but the new law extends it through 2010.

Note that a separate piece of legislation may revive certain other tax breaks that expired at the beginning of the year. We will report any significant developments as soon as possible. In the meantime, it is recommended that you seek professional assistance with respect to your personal and business circumstances.

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	[ return to list ] Opportunities and Pitfalls in the New Tax Law On May 17, 2006, the President signed the new Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) into law. In addition to extending several tax breaks, the new law creates both tax planning opportunities and pitfalls for certain taxpayers. In particular, TIPRA may have a significant impact on Roth IRA (individual retirement account) conversions and “kiddie tax” planning strategies. Following is a summary of some of the key provisions in the new tax law. Roth IRAs: As opposed to a traditional IRA, contributions to a Roth IRA are never tax-deductible. However, distributions from Roth IRAs may be completely tax-free, providing an advantage over traditional IRAs. In addition, you don't have to take mandatory lifetime distributions from a Roth IRA. Previously, a taxable conversion to a Roth IRA was allowed only in a year in which your adjusted gross income did not exceed $100,000. Effective for the 2010 tax year, the new law removes the $100,000 cap for Roth IRA conversions. For conversions taking place in 2010, you may elect to spread the resulting tax ratably over a three-year period. Kiddie tax: Under the kiddie tax, a child's unearned income above a specified limit ($1,700 for 2006) is taxed at the top marginal tax rate of the child's parents. Prior to the new tax law, this tax rule applied to children under the age of 14. However, the new law hikes the age limit to 18, effective for the 2006 tax year. Alternative minimum tax (AMT): The AMT continues to affect a wide range of middle- and upper-income taxpayers. Congress had created higher exemption amounts in the AMT calculation through 2005. The new law grants an additional one-year reprieve with even slightly higher exemption amounts for 2006. Section 179 deductions: Section 179 of the tax code permits a business to currently deduct (or “expense”) the cost of assets in the year they are placed in service, within certain limits. The maximum expensing allowance under Section 179 was quadrupled from $25,000 to $100,000 by the Jobs and Growth Tax Relief Reconciliation Act of 2003. This dollar cap has been subsequently increased slightly over a period of years. Originally, the allowance was scheduled to revert to $25,000 in 2008, but the new law extends enhanced write-offs for two more years. Capital gains and dividends: For 2006, the maximum tax rate on long-term capital gains and qualified dividends is only 15% (5% for low-income taxpayers) as opposed to ordinary income rates reaching 35%. This preferential tax treatment was scheduled to be repealed after 2008, but the new law extends it through 2010. Note that a separate piece of legislation may revive certain other tax breaks that expired at the beginning of the year. We will report any significant developments as soon as possible. In the meantime, it is recommended that you seek professional assistance with respect to your personal and business circumstances. [ return to list ]
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