Tax law Featured

6:44am EDT September 21, 2006
After much wrangling, Congress recently passed, and the President signed into law, the Tax Increase Prevention and Reconciliation Act of 2006 (TIPRA). While most of the law’s provisions are favorable to taxpayers, some will result in additional taxes for some individuals and businesses.

“The time to start thinking about planning for 2006 is now,” says Jim O’Rilley, a CPA and director of taxation at Doeren Mayhew. “Take time to review your 2006 tax situation and consider strategies that will help save you money.”

Smart Business talked with O’Rilley about the new provisions.

Will investor tax rates stay the same?
Individuals’ long-term capital gains and qualified dividend income are taxed at rates significantly lower than regular rates. Before TIPRA, these favorable rates were set to expire at the end of 2008. Under TIPRA, the favorable rates are extended through 2010. Without the extension, maximum capital gains tax rate would have increased from 15 percent to 20 percent, and qualified dividend income would have been taxed at the investor’s ordinary income tax rate.

What about the Alternative Minimum Tax (AMT)?
The AMT has affected many middle-income taxpayers in recent years because its tax brackets and exemptions have not been adjusted for inflation. Prior tax law increased the AMT exemptions available to individuals, but those increases expired after 2005. TIPRA reinstated those exemptions for 2006 only; to $62,550 for joint filers and $42,500 for unmarried individuals. Absent an extension, the extensions will drop to 2000 levels after 2006.

What is the ‘kiddie tax?’
To minimize ‘income shifting’ from parents to their young children, tax law requires children with more than a small amount of unearned income (interest, dividends and capital gains) to pay tax at their parents’ marginal tax rate. TIPRA raises the age limit to 18, where previously it applied to children under 14.

How does TIPRA affect IRAs?
Under the tax law, a person with a traditional IRA can convert it to a Roth IRA by paying tax on the previously untaxed IRA money. From the time of the conversion, any earnings on IRA investments will be tax free. Under TIPRA, beginning in 2010, taxpayers will be allowed to convert traditional IRAs to Roth IRAs no matter how high their income.

Does TIPRA provide any new corporate provisions?
Section 179 Expensing states that taxpayers may elect to deduct the cost of new or used assets placed in service during the tax year as a business expense. For 2006, after adjustment for inflation, the maximum deductible amount is $108,000 and the amount of purchases after which the deduction is to be phased out is $430,000. TIPRA extends these higher totals through tax years beginning before 2010.

The Domestic Production Activities Deduction states that the amount of the domestic production activities deduction for any one year may not exceed 50 percent of the taxpayer’s W-2 wages paid to employees for the year.

Under TIPRA, the term ‘W-2 wages’ becomes more tightly defined. For tax years beginning after May 17, 2006, W-2 wages will include only wages allocable to domestic production gross receipts, which will increase record keeping requirements.

Do itemized deductions generate any tax benefits?
Not if they are below the standard deduction of $10,300 for joint filers and $5,150 for singles. Bunch itemized deductions into a single tax year to exceed the standard deduction for that year and take the standard deduction the following year. Use this strategy for charitable contributions, property taxes, the fourth quarter estimated state income tax payment, and your January mortgage payment.

How can I reduce my taxes on appreciated securities?
A great way to reduce the tax hit is to give the security to your child or grandchild. They can hold onto the security until they turn 18 and then sell it without being subjected to the kiddie tax. At the current tax rate, the resulting capital gain should only be 5 percent if the stock is sold this year or next, and 0 percent if sold 2008 through 2010. Giving your child the security is considered a gift, but you can use your annual $12,000 gift tax exclusion to shelter the transaction.

How can retirement plans help?
Generally you can contribute up to 20 percent of your self-employment earnings with a maximum of $44,000 in a SEP-IRA. A SIMPLE-IRA allows you to set aside up to $10,000 plus an employer match of potentially the same amount. In addition, if you’re age 50 or older by year end you can contribute an additional $2,500 to a SIMPLE-IRA.

JAMES P. O’RILLEY is a Certified Public Accountant and director of taxation at Doeren Mayhew, a regional accounting firm in Troy, Mich. Doeren Mayhew provides a wide range of professional services to middle-market companies. Reach O’Rilley at orilley@doeren.com or 248.244.3171.