June, 2006 Issue

NEW TAX LAW CONTAINS MANY BREAKS BUT IT ALSO HAS SEVERAL TAX INCREASES

The new tax law signed by the President last month contains several tax increases that were added to keep the total tax relief below the $70 billion ceiling in the budget.  Some provisions have significant effects.

The Kiddie Tax Has Sharper Teeth Now

Until the year that a child reaches age 18, any unearned income over $1,700 will be taxed at the parents’ marginal rate, not the child’s.  Before this year, the rule applied only to kids who were under 14.  Parents may want to rethink using custodial accounts for college costs.  529 plans now may be a better option…the kiddie tax doesn’t hit them.

Government Contracts Will Be Subject To 3% Tax Withholding

Government contracts will be subject to 3% withholding starting in 2011.  This will affect contracts with the federal government, state governments and any municipality that pays out $100 million or more on contracts per year.  Interest and payments for real estate are excepted.

Interest Paid On Tax Exempt Bonds Will Be Reported To The IRS

Starting in 2006, interest paid on tax exempt bonds will be reported to the IRS.  Although the interest is not taxable, it can be a factor in computing the minimum tax and the taxation of Social Security benefits.

Income Earned Abroad Will Be Taxed More Heavily After 2005

Although the foreign earned income exclusion is increased to $82,400 this year (up from $80,000), the maximum housing cost exclusion is cut to $11,536.  And, in a tricky calculation, amounts above the exclusions are taxed at higher rates instead of starting out in the lowest bracket.

Offers in Compromise

Asking IRS to compromise a tax debt (OIC) will soon be costlier.  A payment of 20% will be required on all compromise offers after July 16.

Unlimited Conversion To Roth IRAs

The $100,000 of adjusted gross income (AGI) cap on switching an IRA to a Roth IRA is repealed after 2009.  On conversions in 2010, taxpayers can spread the tax due over two years.  Half the tax will be due in 2011, and the remaining half will be payable in 2012.  This implicitly negates the income limits on Roth IRA payins.  Couples with adjusted gross incomes over $160,000 and singles with AGIs above $110,000 can make nondeductible payins to IRAs between now and 2010 and then convert the accounts to Roth IRAs in 2010.  They are taxed only on the preconversion earnings, and the tax is spread over two years.  Thus, they will get a nice head start on building a Roth IRA at a low tax cost.

Higher Exemptions For The Alternative Minimum Tax

This year’s exemptions increase to $62,550 for joint return filers and $42,500 for others.  This will reduce the number of AMT payers for 2006.

AMT Relief For Taxpayers Using Dependent Care And Tuition Credits

These credits will continue to offset the minimum tax through 2006.

Extension Of Tax Breaks For Investors

The maximum rate on capital gains and dividends will stay at 15% through 2010.  The 0% tax rate for dividends and gains of low income taxpayers applies for 2008, 2009 and 2010.

Composers Of Songs Benefit

Composers of songs will receive capital gains treatment on sales of their musical works in tax years starting after May 17, 2006.

Higher Ceiling On Expensing Assets For Small Businesses

The scheduled decline to $25,000 is now postponed until 2010.  In addition, off-the-shelf software will still qualify for expensing through 2009.

From the National Society of Accountants