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Tax Newsletter
September 2006

Congress has been busy again and additional tax acts have been enacted during 2006, resulting in a number of changes and incentives for both individuals and businesses.

On May 17, 2006 the President signed into law the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA). The most notable provisions include:

Extension of the 15% Capital Gains Rate. TIPRA extends the 15% income tax rate for capital gains and qualifying dividend income through December 31, 2010. Previously, the 15% rate was set to expire on December 31, 2008.

Expansion of the "Kiddie Tax". The "Kiddie Tax" refers to the imposition of the parent’s income tax rate upon a child’s unearned income greater than $1,700 for children under age 14. TIPRA extends the age children are subject to this "Kiddie Tax" to under 18, beginning in 2006.

ROTH IRA Conversion. Beginning in 2010, TIPRA eliminates the modified AGI limit (currently set at $100,000) required to convert a traditional IRA to a Roth IRA. By converting a traditional IRA to a Roth IRA, a taxpayer will ultimately be able to withdraw assets income tax free from one’s Roth IRA. However, at the time of conversion the taxpayer will be treated as having received a penalty-free taxable distribution from the IRA. The Act allows taxpayers to defer the payment of income taxes associated with such Roth conversion so that one half may be paid with the taxpayer’s 2011 income tax return and the remainder with his or her 2012 income tax return.

Changes to the Alternative Minimum Tax. TIPRA extends and increases the AMT exemption amount for individuals for 2006 only. This act merely provides limited AMT relief, since Congress hasn’t repealed or reformed AMT.

Sec. 179 Expense. The §179 election allows a current deduction for items that would normally be capitalized and depreciated. The enhanced small business expensing thresholds in the American Jobs Creation Act of 2004 have been extended through December 31, 2009. For 2006 the amount eligible for the election is $108,000. California does not conform to the Federal maximum, but limits the deduction to $25,000 for the calendar year 2006.

On August 17, 2006 the President signed into law the Pension Protection Act of 2006. Notable provisions include:

Retirement Plan Automatic Enrollment. The Act makes it easier for employers to automatically enroll their employees into the company’s 401(k) plan. In such an arrangement, employees must affirmatively opt-out in order not to participate.

Direct Deposit of Refund. The new law allows taxpayers to direct the IRS to deposit their refund into an IRA. Additionally, the IRS announced that taxpayers will be able to split their refunds and deposit them into as many as three different bank accounts.

Retirement Provisions made Permanent. In 2001 many retirement provisions were enacted on a temporary basis; the new law has made the following provisions permanent:

  • Higher dollar amounts for IRA contributions ($4,000 in 2006);
  • Higher dollar limits on defined contribution plans ($44,000 in 2006), elective deferrals, including $15,000 in 2006 for 401(k) plan deferrals;
  • Catch-up contributions for older workers ($1,000 for IRAs and $5,000 for 401(k) plans);
  • Roth 401(k)s;
  • Start-up tax credit for new small employer-sponsored plans (maximum $500/year for each of the first three years);

Sec. 529 College Savings Plans. The rules applicable to Sec. 529 plans will not expire in 2010, but are now permanent. Distributions from a qualified Sec. 529 plan that are used to pay qualified higher education expenses are tax-free. Contributions to the program are treated like gifts. A lump-sum contribution of $60,000 can be treated as if made over a five-year period. If you make this election, you will not exceed the $12,000 per-year gift-tax exclusion.

Charitable Donations. The new law tightens the rules for donations of cash, clothing, household items, easements and other items.

  • A deduction is not allowed for used clothing and household items unless the items are in "good" condition. At this time, there is no guidance on "good condition". This change is effective as of 8/17/06.
  • Beginning in 2007, a deduction is not allowed for any contribution of cash, check or other monetary gift unless the donor can show a bank record or a written communication from the charity indicating the amount, date made and the name of the charity.
  • For the 2006 and 2007 tax years, the deduction limits for qualified conservation easements are raised from 30% to 50% of AGI. The limit for "qualified farmers or ranchers" is raised to 100% of AGI.
  • Taxpayers, age 70 ½ or older, will be able to make tax-free distributions from IRAs to charities. The distributions must be direct from IRA to charity and the maximum amount per year is $100,000. This provision is available for tax years 2006 and 2007.

As always, the passage of tax legislation creates planning challenges and opportunities. Please feel free to contact us should you have any questions regarding the foregoing.

The information contained in this newsletter is general in nature and does not constitute tax advice or opinion. Applicability to specific situations should be determined through consultation with your tax advisor.

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