The Tax Reconciliation Act impacts a broad cross-section of taxpayers.
The new law extends the controversial dividend and capital gains tax
rate cuts for two more years beyond 2008, gives taxpayers some immediate
relief from the alternative minimum tax (AMT), extends small business expensing thresholds, and allows high-income taxpayers a Roth conversion opportunity.
Moreover, it makes over 20 other significant changes.

AMT RELIEF

The Tax Reconciliation Act extends and increases-for 2006 only-the AMT
exemption amount for individuals. It also lessens the sting of the AMT for
2006 by allowing the use of certain nonrefundable personal credits.

Despite dire predictions about the AMT soon becoming the “regular” tax for
millions of middle-income Americans, Congress hasn’t found the wherewithal
to repeal the AMT or reform it. The Tax Reconciliation Act, like many tax
bills before it, merely provides limited AMT relief.

Higher AMT exemption amounts.
Through December 31, 2006, taxpayers will be able to take advantage of higher
AMT exemption amounts. The AMT exemption amount for married couples
filing jointly is $62,550 and for single taxpayers is $42,500.

Nonrefundable personal credits.
The Tax Reconciliation Act extends through 2006 the provision allowing
taxpayers to use nonrefundable personal credits to offset AMT liability.
Nonrefundable personal credits include the dependent care credit, the credit for the elderly and disabled, the credit for interest on certain home mortgages, the Hope credit for certain college expenses and the Lifetime Learning credit.

DIVIDEND AND CAPITAL GAINS RATE CUTS

No recent tax cut has been as controversial as the dividend and capital gains tax rate cut enacted in 2003. While the White House and Republicans credit this tax cut with spurring economic growth, Democrats decry it as a give-away to the wealthy.

In 2003 Congress lowered the maximum dividend and capital gains tax rates – for most, but not all, dividends and capital gains – to 15 percent for qualifying taxpayers. Taxpayers in the 10- and 15-percent tax brackets are eligible for an even lower rate of five percent. In 2008, the rate for taxpayers in the 10-and 15-percent tax brackets falls to zero. As originally enacted, these tax rate cuts were temporary. They were scheduled to expire at the end of 2008. The Tax Reconciliation Act extends these cuts for two more years through December 31, 2010.

SMALL BUSINESS EXPENSING

Since 2003, Congress has enhanced small business expensing under Code Sec. 179 several times to encourage business investment. The Tax Reconciliation Act continues this special treatment. The enhanced small business expensing thresholds in the American Jobs Creation Act of 2004 are extended through December 31, 2009.

DISTRIBUTIONS OF CONTROLLED CORPORATIONS - ACTIVE BUSINESS TEST

The Tax Reconciliation Act also simplifies the active business test for tax-free corporate spin-offs. Taxpayers can look at all corporations in the distributing corporate group and the spun-off subsidiary’s respective affiliated group to determine if the active business test is satisfied.

SETTLEMENT FUNDS

The Tax Reconciliation Act provides special tax treatment to certain settlement funds resolving claims under the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA), commonly known as Superfund. These settlement funds will be treated as beneficially owned by the U.S. government and will not be subject to federal taxation.

The Tax Reconciliation Act also: Permits vessels weighing not less than 6,000 deadweight tons (reduced from 10,000) to elect into the tonnage tax. Modifies the treatment of loans to qualified continuing care facilities.
Expands the Veterans’ Mortgage Bond Program.

IMPORTANT CHANGES TO ROTH IRAS

The Tax Reconciliation Act eliminates the $100,000 adjusted gross income ceiling for converting a traditional individual retirement account (IRA) to a Roth IRA, for tax years after 2009. A conversion is treated as a taxable distribution, but is not subject to the 10-percent early withdrawal penalty. Taxpayers who convert in 2010 can
elect to recognize the conversion income in 2010 or average it over the next two years.

OFFERS-INCOMPROMISE

The Tax Reconciliation Act increases the amounts that must be paid by taxpayers submitting an offer-in-compromise. Under the new law, taxpayers are required to make partial payments of their liability in addition to any user fee now imposed by the IRS; however, the user fee will be applied to the outstanding tax liability. For a
lump sum offer, taxpayers will pay 20 percent of the amount offered. For an installment payment offer, taxpayers will make their proposed scheduled payments while the IRS considers the offer. If the IRS fails to process the
offer within two years, the offer will be deemed to be accepted.

KIDDIE TAX

The kiddie tax rules require a child’s unearned income, such as dividends and interest, to be taxed at the parents’ tax rate, which is usually a higher rate.

Under current law, the kiddie tax applies if the child is under age 14, the child has net unearned income over $1,700, and the parent can claim the child as a dependent. The Tax Reconciliation Act raises the age limit to under 18.

This provision is effective immediately, for the entire 2006 tax year. Parents who had planned to sell a child’s college stock portfolio after age 13 and before entering college have no opportunity now to accelerate
that planning technique if the child is over 13. If the family was planning to postpone a sale until 2008, when the rate for capital gains would be zero, that’s a loss of 15 percentage points on the tax otherwise not due on the sale of stock or other portfolio assets.

WAGE LIMITATION IN CODE SEC. 199

Code Sec. 199 allows a deduction from taxable income for the portion of a taxpayer’s income that arises from qualified production activities but limits the deduction to 50 percent of the wages paid by the taxpayer in the same calendar year. Partners, shareholders, or other persons who are allocated part of qualified production activities income (QPAI) from passthrough entities were treated as having been allocated their share of the partnership’s wages.

The Tax Reconciliation Act modifies the wage limitation by limiting the deductions to 50 percent of the wages that are deducted in arriving at QPAI. Partners and shareholders will be allocated their share of the partnership’s W-2 wages but will include in their wage limit only wages paid to determine QPAI.

TAX SHELTERS

Tax-exempt entities that are parties to tax shelter transactions risk penalties under the new law. The penalties are imposed on tax-exempt entities and on any entity manager that causes the entity to be a party to the tax shelter transaction. The tax-exempt entities are subject to disclosure requirements and the parties to a prohibited tax shelter transaction are required to disclose to tax-exempt entities the fact that it is a prohibited transaction.

EARNINGS STRIPPING RULES

The Tax Reconciliation Act codifies proposed earnings stripping regulations and provides that a corporation with a direct or indirect interest in a partnership will treat its share of the partnership’s liability as a liability of the corporation for purposes of applying the earnings stripping rules to the corporation. The corporation’s distributive share of interest income or interest expense of the partnership will be treated as income interest or expense
of the corporation.

The IRS is granted regulatory authority to reallocate partnership debt or distributive shares of interest income or expense to prevent avoidance of these rules. The effective date is for tax years beginning on or after the date of enactment.

Three Month Tax Calendar

JULY 17, 2006

Trusts – Last day for filing 2005 form for trusts that obtained an automatic three-month filing extension.

Partnerships – Last day for filing 2005 form for partnerships that obtained an automatic three-month filing extension.

JULY 31, 2006

Employers’ Taxes – Employers of nonagricultural and nonhousehold employees must file return to report income tax withholding and FICA and FUTA taxes for the second quarter of 2006.

AUGUST 15, 2006

Individuals – Last day for filing 2005 income tax return by calendar-year individuals who obtained automatic four-month filing extension; or last day for individuals to file for application for additional two-month extension of 2005 income tax returns.

SEPTEMBER 15, 2006

Estimated Tax – Payment of third installment of 2006 estimated tax by calendar-year corporations.

Payment of third installment of 2006 estimated tax by individuals (other than farmers and fishermen), by trusts, estates and certain residuary trusts in existence more than 2 years.

Last day for filing 2005 income tax return by calendar-year corporations that obtained automatic six-month filing extension.