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October, 2006 - Two new tax bills
were passed earlier this year which will affect your
taxes. They are both described here:
1. The Tax Increase Prevention and
Reconciliation Act of 2005 (which takes affect in
2006) and ...
2. The Pension Protection Act of 2006.
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On December 9, 2006, Tax
Relief and Health Care Act of 2006 was passed.
Click here to see those New
Tax Provisions
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The Tax Increase Prevention and
Reconciliation Act of 2005:
President Bush signed into law the Tax Increase
Prevention and Reconciliation Act of 2005 on May 17,
2006. The key components of the act focus on
individual income taxes. However, the act also
includes several important business tax changes.
Click here for
Business Changes.
Extension of 15% rate on capital gains
and dividends. The act extends through 2010
the lower tax rates applicable to long-term capital
gains and qualified dividend income. A 2003 tax law
had lowered these tax rates for most taxpayers to
15% through 2008 and created a 5% tax rate for
taxpayers who would otherwise be taxed at 10% or 15%
on ordinary income. The 5% tax rate changes to zero
for 2008.
Advice:
- Business owners can continue to consider
dividend payments at the lower rate.
- This provision presents a planning
opportunity to make gifts of appreciated
property to lower-bracket family members and
maximize the benefit of the zero capital gains
tax opportunity for 2008, 2009 and 2010.
Increased AMT exemption. The act
increases the Alternative Minimum Tax (AMT)
exemption amount for 2006. As scheduled, the
exemption for 2006 was $45,000 for married couples
filing a joint return and $33,750 for single
taxpayers. The new law increases the exemption for
2006 to $62,550 (joint) and $42,500 (single). The
act also extends the ability to reduce the AMT in
2006 with additional credits that formerly were not
available as a reduction to the AMT.
Advice:
- Owners of pass-through business entities
need to consider AMT preferences when choosing
among depreciation methods. Although
depreciation is supposed to be a timing
preference, the AMT tax and credit calculations
may lead to near permanent tax differences.
“Kiddie tax” goes older.
Currently children under the age of 14 are taxed at
their parents’ marginal tax rate on their unearned
income, such as dividends and interest, in excess of
$1,700. This provision is often referred to as the
“kiddie tax.” The act raises the age at which
children are taxed at their parents’ higher tax rate
from 14 to 18, effective for taxable years beginning
after Dec. 31, 2005.
Advice:
- This provision is designed to increase tax
revenues. The potential benefit of the extension
of the no capital gains tax on lower-bracket
taxpayers in 2008 through 2010 (discussed above)
will be severely restricted for taxpayers with
children under age 18.
- Higher-income taxpayers may minimize the
“kiddie tax” by putting their money into college
savings programs, such as Connecticut’s CHET,
rather than directing it to their children’s
bank accounts.
New 2010 Roth IRA conversion opportunity.
Roth IRAs come with significant tax
advantages — distributions are income-tax-free after
age 59 1/2 and after the account has been open five
years, and there are no minimum distributions
required during the taxpayer’s lifetime. Conversion
of traditional IRAs to Roth IRAs has been limited to
taxpayers with less than $100,000 of modified
adjusted gross income (AGI). The act repeals the
income limitation after 2009, making Roth IRA
conversions available without regard to the
taxpayer’s AGI. In addition, any taxpayer who
converts an IRA to a Roth IRA in 2010 will be able
to include one-half of the income attributable to
the conversion with the 2011 tax returns and the
other half with the 2012 return.
Advice:
- This provision is designed as a revenue
raiser. The repeal of the AGI limitation is
likely to result in a large number of taxpayers
with significant IRA balances choosing to
convert to Roth IRAs. This will create
significant revenue for the government in the
short run, but will have an offsetting reduction
in future years when this income would have been
drawn down from traditional IRAs.
- Higher-income taxpayers will have four years
to contemplate whether to take advantage of the
Roth IRA conversion opportunity. Many factors
must be considered before converting to a Roth
IRA, including the amount of taxes that will be
triggered upon conversion versus expected future
tax rates on traditional IRA distributions.
The
Pension Protection Act of
2006 offers retirement tax
breaks, tough rules on
charity
The House of
Reprensentatives and the
Senate have both passed
the Pension Protection
Act of 2006 (H.R. 4,
Public Law 109-280), a
massive tax law aimed at
strengthening pension
funds and providing a
multitude of other tax
changes. The President
signed the bill into law
on August 17, 2006.
Here's a summary of the
major tax law changes
enacted in the Pension
Protection Act.
Pension Provisions
The bulk of the
Pension Protection Act
is designed to force
employers to shore up
their pension plans.
Many pensions are
underfunded, which means
that promised pension
benefits could
potentially exceed the
funds available, leaving
pensions strapped for
cash. The Pension
Protection Act of 2006
"requires most pension
plans to become fully
funded over a seven-year
period" starting in
2008, according to a CCH
Tax Briefing. To achieve
full pension funding,
the new law allows
employers to deduct the
cost of making
additional contributions
to fund the pension,
provides strict funding
guidelines, and imposes
a 10% excise tax on
companies that fail to
correct their funding
deficiencies.
IRA, 401k, and
other Retirement Plan
Provisions
The Pension
Protection Act provides
or extends over 20 tax
benefits for other
retirement savings.
Employers are now
allowed to automatically
enroll their employees
into a 401K retirement
plan with default
contribution levels.
Employees will need to
opt-out of the 401k if
they don't want to
utilize the 401k plan.
Military personnel who
are called to active
duty can now take a
penalty-free withdrawal
from their 401k or IRA
if they are called to
active duty between
September 11, 2001, and
December 31, 2007. The
IRS will allow these
individuals to
re-deposit the
withdrawal up to two
years after the end of
their active duty and
thereby avoid paying
income tax on the
withdrawal. The new law
also makes it much
easier to make hardship
withdrawals from 401k
plans. The new law also
allows hardship
withdrawals "with
respect to any person
listed as a beneficiary
under the 401(k) plan,"
according to CCH.
Additionally, there's
an important new
provision for non-spouse
beneficiaries of a
retirement plan. The new
law allows non-spouse
beneficiaries to roll
over assets inherited
from a qualified
retirement plan into an
IRA. The beneficiary
will avoid tax on the
rollover, and will be
taxed only when the
assets are withdrawn.
Previously, this tax
treatment was available
only for people who
inherited retirement
assets from a deceased
spouse. The new law will
mean more flexible
retirement and estate
planning for non-spouse
beneficiaries, such as
domestic partners.
The Pension
Protection Act allows a
direct rollover from a
401k to a Roth IRA, with
the rollover treated as
a Roth conversion.
The new law extends a
number of retirement
benefits. IRA
contributions will be
$4,000 in 2006 and 2007,
$5,000 in 2008, and
adjusted for inflation
after 2008. Catch-up
contributions for
individuals age 50 or
older will be $1,000 for
IRAs, $2,500 for
SIMPLE-IRAs, and $5,000
for 401k plans. IRA
catch-up contribution
limits, however, will
not be adjusted for
inflation. SIMPLE and
401k catch-up
contributions will be
adjusted in $500
increments based on
inflation.
The new law
permanently allows for
Roth 401k and Roth 403b
plans. Under previous
tax law, Roth-type 401k
and 403b plans were not
allowed after 2010. The
new law removes this
sunset provision. Like a
Roth IRA, an individual
makes post-tax
contributions to a Roth
401k or Roth 403b plan,
up to the plan limits.
The assets grow
tax-deferred and may be
withdrawn tax-free in
retirement.
The new law also
permanently allows the
Retirement Savings Tax
Credit, which would have
expired at the end of
2006.
Stricter Rules on
Charitable Donations
The Pension
Protection Act toughens
the tax laws for
charitable donations.
Under the new law,
taxpayers must keep
records of all cash
donations. Individuals
must show a receipt from
the charity, a canceled
check, or credit card
statement to prove their
donation. No tax
deduction will be
allowed if the taxpayer
cannot provide any
supporting
documentation. Taxpayers
will not need to mail in
the receipts with their
tax return. Instead,
taxpayers will need to
keep receipts and other
documentation with their
copy of the return in
the event of an IRS
audit.
The new law also
toughens the rules for
non-cash donations.
Donated items, such as
cars, clothing, and
household goods, must be
in good condition. "The
new law does not define
'good condition,'"
according to CCH. No tax
deduction is allowed for
items in less than good
condition. Kay Bell
provides this word of
warning, "Perhaps the
IRS will, at least for a
while in this new
requirement's initial
stages, start pulling
more returns that list
donated property and
asking filers to confirm
the worth of their
gifts."
Charitable IRA
Donations
The Pension
Protection Act allows
taxpayers to donate
money to charity
directly from their IRA
account. The
distributions will be
tax-free and avoid the
penalty on early
withdrawals. Taxpayers
are allowed to donate up
to $100,000 per year
from their IRA. Since
the distribution will
not be included in
taxable income,
individuals will not be
able to claim a tax
deduction for the
charitable contribution.
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