Tax Increase Prevention and Reconciliation Act of 2005
Public Law 109-222
H.R. 4297: Signed into law by the President on May 17, 2006, the Tax Increase Prevention and Reconciliation Act of 2005 contains $90 billion in tax cuts and $20 billion in revenue raisers. It is also expected to keep 15 million taxpayers from being hit by the alternative minimum tax. However, Congress failed to reach an agreement on extending the state and local sales tax deduction, the teacher classroom expense deduction, certain employment tax credits, 15-year straight-line depreciation for leasehold and restaurant improvements, and other temporary incentives set to expire. It is expected that some of these could be tacked onto the pending pension reform bill. The following is our coverage of the Tax Increase Prevention and Reconciliation Act of 2005, which will be included in TheTaxBook™, 2006 tax year edition.
Capital Gain and Qualified Dividends Maximum Tax Rates
Current law, TheTaxBook™ 2005 Edition, page 6-6: Long term capital gains and qualified dividends are subject to a 15% maximum tax for taxpayers whose regular tax rate is 25% or higher. The maximum rate is 5% for taxpayers in the 10% or 15% tax brackets. Beginning in 2008, the 5% maximum rate is reduced to 0% for taxpayers in the 10% or 15% tax brackets. [IRC §1(h)]
These rules were scheduled to expire for tax years beginning in 2009, and revert back to the rules in effect prior to 5/6/2003. Prior to tax years ending on or after 5/6/2003, the maximum long term capital gain rate was 20% for taxpayers whose regular tax rate is 25% or higher, and 10% for taxpayers in the 10% or 15% tax brackets. The 0% rate for taxpayers in the 10% and 15% tax brackets was not scheduled to begin in 2008. Qualified dividends were subject to ordinary tax rates.
New law, Section 102 of the Tax Increase Prevention and Reconciliation Act of 2005: The 15%, 5% and 0% tax rates for long term capital gains and qualified dividends is extended 2 years through December 31, 2010. The rates do not revert to pre-5/6/2003 levels until the 2011 tax year.
Alternative Minimum Tax Relief
Current law, TheTaxBook™ 2005 Edition, page 1-4: For 2005, the AMT Exemption amounts are:
- $58,000 for MFJ
- $40,250 for Single and HOH
- $29,000 for MFS
- $5,850 plus earned income for the Kiddie tax exemption.
The 2006 AMT exemption amounts (other than the Kiddie tax exemption amounts) were scheduled to drop back down to the 2000 tax year exemption amounts.
New law, IRC §55(d)(1): The new law increases these amounts for 2006 as follows:
- $62,550 for MFJ
- $42,500 for Single and HOH
- $31,275 for MFS
The 2006 Kiddie tax exemption amount was not changed by the new law. The inflation adjusted amount remains at $6,050 plus earned income.
Unless a new law increases the AMT exemption amounts, the 2007 amounts will be:
- $45,000 for MFJ
- $33,750 for Single and HOH
- $22,500 for MFS
Current law, TheTaxBook™ 2005 edition, page 1-10: All nonrefundable personal credits are allowed against regular tax and AMT [IRC §26(a)(2)]. Nonrefundable personal credits include:
- Child and dependent care expense credit (TheTaxBook™, page 11-3),
- Credit for elderly or the disabled (TheTaxBook™, page 11-7),
- Adoption expense credit (TheTaxBook™, page 11-7),
- Child tax credit (TheTaxBook™, page 11-3),
- Mortgage interest credit (TheTaxBook™, page 11-8),
- Education credits (TheTaxBook™, page 12-2),
- Retirement savings contribution credit (TheTaxBook™, page 11-6),
- Nonbusiness energy property credit (TheTaxBook™, page 1-17), and
- Residential energy efficient property credit (TheTaxBook™, page 1-17).
Except for the adoption expense credit, the child tax credit, and the retirement savings contribution credit, the rule that allows nonrefundable personal credits to be taken against AMT was scheduled to expire for tax year 2006. (The rule allowing the adoption expense credit, child tax credit, and retirement savings contribution credit against AMT is permanent.)
New law, IRC §26(a)(2): All nonrefundable personal credits are allowed against regular tax and AMT for the 2006 tax year. Except for the adoption expense credit, the child tax credit, and the retirement savings contribution credit, nonrefundable personal credits will not be allowed against AMT for the 2007 tax year.
Section 179 Expense
Current law, TheTaxBook™ 2005 Edition, page 9-15: The maximum annual Section 179 deduction is $105,000 for 2005 and $108,000 for 2006. If the total cost of Section 179 property placed in service in 2005 exceeds $420,000, the available deduction is reduced dollar for dollar by the excess. For 2006, the investment limit increases to $430,000.
The maximum Section 179 deduction was scheduled to drop to $25,000 for tax year 2008 and beyond with no inflation adjustment provision. The investment limit was scheduled to drop to $200,000 for tax year 2008 with no inflation adjustment provision.
If a return is filed without claiming a Section 179 deduction, an election to claim the deduction can be made on an amended return. This provision was scheduled to expire for tax year 2008 and beyond, where the election must be made on a timely-filed return, including extensions.
Off-the-shelf computer software is eligible for a Section 179 deduction. This provision was scheduled to expire for tax year 2008 and beyond.
New law, IRC §179: All of the above rules set to expire in 2008 have been extended 2 years through December 31, 2009. They are now scheduled to expire for tax year 2010 and beyond.
Current law, TheTaxBook™ 2005 Edition, page 12-9: Children under age 14 with investment income of more than $1,600 ($1,700 for 2006) are subject to tax at their parent’s rate and must file Form 8615. An election is available to report interest income, dividends, and capital gain distributions of a child under age 14 on the parent’s return using Form 8814 if the child’s gross income is less than $8,000 ($8,500 for 2006).
New law, IRC §1(g)(2): Beginning in 2006, the kiddie tax rules apply to a child under age 18, unless the child files a MFJ return for the year.
New law, IRC §1(g)(4)(C): Beginning in 2006, taxable income as a beneficiary of a qualified disability trust is considered earned income for purposes of the kiddie tax rules, and is thus not subject to tax at the parent’s rate.
Roth IRA Conversions
Current law, TheTaxBook™ 2005 Edition, page 13-14: Money in a traditional IRA, SEP-IRA, or a SIMPLE IRA can be converted to a Roth IRA if, in the year of conversion, modified AGI is $100,000 or less, and the filing status is not MFS. The conversion is taxable to the extent money converted does not represent a return of nondeductible basis. By paying tax on the conversion now, a taxpayer can plan for future tax free withdrawals from the Roth IRA. Distributions are tax free under the following:
- Distributions of nondeductible contributions and conversion amounts are always tax free, regardless of how long they were inside the Roth IRA.
- Distributions of conversion amounts are not subject to the 10% early withdrawal penalty if they were held in the Roth IRA for at least five years, or one of the early withdrawal penalty exceptions apply.
- Distributions of earnings are tax free if the participant is over age 59˝, the participant is disabled or deceased, or the participant uses the funds as a qualified first time home buyer. A taxpayer must also have had a Roth IRA for five years to qualify for the tax free distribution of earnings rule to apply.
New law, IRC §408A(c)(3): Beginning in 2010, the $100,000 modified AGI limitation no longer applies. Taxpayers of any income level qualify for a Roth IRA conversion. Taxpayers filing MFS will also qualify for a Roth IRA conversion.