The Tax Increase Prevention and Reconciliation Act of 2005
HR 4297
Analysis and Comment
May 10, 2006: Passed House 244-185 May 11, 2006: Passed Senate 54-44
May 17, 2006: Signed into Law by President Bush Length: 75 pages
On May 17, 2006, President George W. Bush signed into law the $70 billion tax reconciliation bill known as the Tax Increase Prevention and Reconciliation Act of 2005. The measure includes “offsets” (revenue raisers) to meet reconciliation targets.[1] The measure, herein known as TRA (Tax Reconciliation Act), includes $90 billion in targeted benefits and $20 billion in revenue “offsets.” The official name of the legislation carries a 2005 date because it represents a carry-over from last year’s budget.
In signing the measure into law, President Bush noted that “with this bill, we’re sending the American people a clear message about our policy … We’re going to continue to trust the American people with their own money.”
The Senate vote (54-44) and House vote (244-185) were mostly along party lines. The legislation was protected from a Senate filibuster - only 51 votes were needed. An effort to include an extension of the deduction for tuition and fees and other expired tax provisions failed and they will be considered in a subsequent tax bill.
In the debate over the TRA, The Washington Post noted that “supporters toasted it as essential to continued economic growth while opponents described it as a boom to the wealthy that the nation can’t afford.” The Post noted that the bill would cut taxes by about $23 per person, per year. “But the benefits are concentrated among people with vary particular tax situations, a relative few people who might save thousands of dollars.”
“Today’s really a good day to be a millionaire,” said Senate Minority Leader Harry Reid (D., NV). “That’s because President Bush just signed, with the stroke of a pen, a bill that sealed the fate of those trying to get ahead.”
Highlights of the Legislation
Stock investors are the broadest group of beneficiaries of the bill. The 15% favorable tax rate on long-term capital gains and qualifying dividends is extended through 2010. The Joint Committee on Taxation estimates that the extension of the 15% tax rate will cost $50.8 billion over ten years.
The TRA (one year fix) raises the amount of income exempted from the Alternative Minimum Tax (AMT).[2] The real “winners” appear to be taxpayers with incomes in the $100,000 to $500,000 range. Deloitte Tax LLP has determined that a hypothetical family of four with $185,000 in income and $33,000 in itemized deductions would have faced an AMT of $3,700. Under the May 2006 TRA, the family will not be exposed to the AMT. The bad news is that the so-called AMT fix is limited to 2006. Approximately 3.6 million taxpayers exposed to the AMT in 2005 will face it again in 2006.
The Joint Committee on Taxation estimates that the AMT relief will cost $33.9 billion over ten years.
One of the interesting, controversial and challenging revenue “offsets” in the bill concerns ROTH IRAs. Starting in 2010, taxpayers with incomes in excess of $100,000 will also have the opportunity to convert their regular IRAs to a ROTH IRA. Proponents of this measure noted that it will raise revenue since taxpayers converting to a ROTH IRA must pay taxes based on the value at the time of the conversion.
While no one knows for sure just how many taxpayers will be attracted by this opportunity, the Joint Committee on Taxation estimates that the conversions will yield $6.4 billion in revenue between 2010 and 2015.
Americans living and working abroad will pay an estimated $2.1 billion in taxes over the next decade. Expatriates will face tighter rules on how employer-provided housing will be treated and they could face higher taxes on investment income.
The Details
AMT Relief: A One-Year Fix
The amount of income exempted from the AMT is increased to $62,550 for married couples filing jointly ($58,000 in 2005). Without the tax measure, the exempted amount was scheduled to decrease to $45,000 in 2006. The exemption for single filers would be raised to $42,500 for 2006 ($40,250 in 2005).
Without the 2006 “fix,” an additional 15.3 million taxpayers (total of 18.8 million) would have had to pay about $35 billion more in taxes for 2006. By the end of the decade, more than 30 million taxpayers (20% of all filers) would be forced to pay AMT.
The Working Families Tax Relief Act of 2004 extended the higher AMT exemption amounts through December 31, 2005, but at lower levels ($58,000 for married filing jointly and $40,250 for single taxpayers).
The TRA extends through 2006 the provision allowing taxpayers to use non-refundable personal credits to offset AMT liability. Those credits include:
Dependent Care Credit
Credit for Elderly and Disabled
Hope Credit
Lifetime Learning Credit
Capital Gains and Dividends: Two-Year Extension
The May 2006 TRA extends the current 15% tax rate[3] on capital gains and qualifying dividends from the end of 2008 through 2010. By extending the capital gains/dividends break through 2010, the provisions are now aligned with the tax cuts enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001. The Joint Committee of Taxation reports that the two-year extension would reduce government revenue by $21 billion. According to the Urban Institute, approximately 53% of the benefits of the two-year extension will go to the 0.2% of households with more than $1 million in income. About 99% of the gains will go to households making more than $100,000 in income.
Musicians/Musical Compositions/Musical Composition Copyrights
Musicians benefit from a special provision in the TRA. The TRA allows taxpayers to elect to treat the sale or exchange of self-created musical compositions or copyrights as the sale or exchange of a capital asset.
This change is effective for tax years beginning after the President signed the bill and through 2010.[4]
The TRA allows a taxpayer who puts any musical composition or musical copyright into service to elect to use the 5-year amortization period for certain expenses paid or incurred with respect to all musical compositions and musical composition copyrights placed in service in that tax year.[5]
Small Business Expensing
The TRA continues the special small business expensing under Code section 179. The enhanced small business thresholds contained in the American Jobs Creation Act of 2004 are extended through 2009.
The maximum amount that may be expensed is $100,000 of qualifying property, reduced by the amount by which the cost of qualifying property exceeds $400,000. The $100,000 and $400,000 amounts are indexed for inflation after 2003 and before 2010. For 2006, the amounts are $108,000 and $430,000, respectively. Without the extension in the TRA, the amounts would have dropped to $25,000 on a $200,000 cap after 2007.
Foreign Sales Corporation Export Subsidy
European leaders said they would cancel plans to impose punitive tariffs (14%) on U.S. imports. The move ends a contentious and costly trade dispute. The TRA ends a U.S. tax break that the World Trade Organization ruled illegal. The punitive tariffs were designed to compensate Europe for part of the tax benefits to U.S. exporters, which have been estimated to be about $4 billion a year.[6]
The exporting tax credit was eliminated for most U.S. companies in a 2004 tax bill and replaced with a new manufacturing credit. Concerns were expressed by the European Union since the 2004 bill effectively kept in place the tax credit for manufacturers that entered into long-term sales contracts with overseas companies.
U.S. Financial-Service Firms
Citigroup, General Electric and J.P.Morgan Chase won a $4.8 billion extension of an expiring law that allows U.S. financial-services firms a delay in paying taxes on overseas profits.
Oil Companies
Exxon Mobil, Chevron and Conoco Phillips defeated an attempt to raise taxes on the oil industry by $6 billion. House Republicans dropped a provision on how the industry accounts for oil inventory.
House-Senate negotiators dropped a measure that would have stripped $700 million in tax incentives for large oil companies to explore for oil and gas.
One item that works against the oil industry is a provision requiring a 5-year period for writing off certain exploration costs. The current law provided a more favorable two-year period. This change will cost the oil industry an estimated $189 million.
Revenue “Offsets”
1. Kiddie Tax: Age Increase
The TRA provides for increasing the age limit of the “kiddie-tax” to children under 18 years of age (up from under 14). If a child under 18 has investment income, the first $850 in tax-free and the next $850 is typically taxed at the child’s tax rate. “Unearned” income above $1,700 is taxable at the parents’ top tax rate. This change in the law is effective immediately.
2. ROTH IRAs: Increase in Eligibility
The TRA eliminates the $100,000 AGI test for converting a traditional IRA to a ROTH IRA. The change is effective for tax years after 2009. Taxpayers who convert in 2010 can elect to recognize the conversion income in 2010 or average it over the next two years (2011 and 2012).
A married couple 50 or older could contribute $50,000 in total to after-tax IRA accounts from 2006 through 2010 and than convert the accounts to a tax-free ROTH IRA.
While contributions to a ROTH IRA are not deductible – the earnings are tax-free. ROTH IRAs do not require minimum distributions at age 70 ½. [7]
3. Offers-in-Compromise: Increase in Fees
The TRA 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 fees now imposed by the IRS. Note that the user fee will be applied to the outstanding tax liability.
For a lump sum offer, taxpayers will pay 20% of the amount being offered.
For an installment payment offer, taxpayers will make their proposed scheduled payments while the offer is being considered.
NOTE: If the IRS fails to process the OIC within two-years, the offer will be deemed to be accepted.
TRA: Average Tax Savings Per Taxpayer
Income (2005 dollars) Average Tax Savings
Less than $10,000 $ 0
10,000-20,000 $ 3
20,000-30,000 $10
30,000-40,000 $17
40,000-50,000 $47
50,000-75,000 $112
75,000-100,000 $406
100,000-200,000 $1,395
200,000-500,000 $4,527
500,000- 1 million $5,656
Over 1 million $42,766
Source: Tax Policy Center
Future 2006 Tax Legislation: The “Trailer” Bill
Following the enactment of the Tax Increase Prevention and Reconciliation Act of 2005, another tax bill (referred to as the “trailer” bill) will be offered to extend a number of important tax provisions that expired at the end of 2005. CNN reported that “passage of the tax-cut extension was the first step of a two-track strategy for advancing the GOP’s election-year tax cut agenda. A separate bill containing about $22 billion to $23 billion in tax breaks backed by Republicans and Democrats is expected to advance soon as a follow-up.” Among the subjects under consideration are:
Educator’s Deduction
Research and Development Credit
Saver’s Credit
State and Local Sales Tax Deduction
Tuition and Fees Deduction
Sources
@2006 All Rights Reserved
CCH
CNN The New York Times
Deloitte Tax LLP The Washington Post
Financial Times The Washington Times
Joint Committee of Taxation The Wall Street Journal
Tax Policy Center Urban Institute
Thomas B. Cooke
1
[1] The bill is less kind to Americans living abroad and parents of children (14-18) who want to invest
money on their behalf.
[2] The AMT is a parallel income tax enacted into law in 1969 to prevent upper-income taxpayers from taking so many deductions and credits that they could effectively escape taxation. Unfortunately, the amount of income exempted from the AMT hasn’t been indexed for inflation – therefore the number of taxpayers exposed to the AMT increases annually.
In recent years, the number of taxpayers exposed to the AMT has grown sharply. In 2001, about 1.4 million taxpayers paid the AMT. In 2004, the number more than tripled to 3.6 million according to the Tax Policy Center, a joint venture of the Urban Institute and the Brookings Institution.
Among the taxpayers hardest hit by the AMT are those who live in high-tax states such as New York, Maryland and Oregon. That’s because the AMT doesn’t provide for the deduction of state and local income taxes.
Taxpayers with large families pay more under the AMT because there is no allowance for personal exemptions for family members or dependents.
The Treasury Department estimates that the government collects an average of $2,770 more on taxes per return filed under the AMT than under the regular tax code.
If left unadjusted, the AMT would bring in more than $500 billion in revenue over the next decade.
[3] In 2003, Congress lowered the maximum dividend and capital gains rate to 15%. Taxpayers in the 10% and 15% tax brackets qualify for 5%. In 2008, the tax rate for taxpayers in the lower two brackets were scheduled to drop to 0. The TRA extends the 5% through December 31, 2010.
Once the extension ends in 2011, capital gains will be taxed at 20% and those in the highest tax bracket (set to revert to 39.1%) will pay 130% more tax on dividends.
[4] Note: Efforts to lower the capital gains tax on collectibles failed – the rate stands at 28%.
[5] This provision allows music publishers to amortize advances they make to song writers over five years.
[6] Ending the tax breaks would particularly hurt U.S. aircraft manufacturer Boeing. Reports indicate that Boeing has received $1.6 billion in tax breaks from 1995 to 2005.
[7] While the changes to the ROTH IRA conversion rules do not extend to 401(k) plans – nothing would prevent a ROTH IRA conversion of traditional IRAs that have received proceeds of 401(k) plans when an individual leaves employment. One very important aspect of the TRA is opportunity that high-income taxpayers have to establish traditional non-deductible IRAs and convert that account to a ROTH IRA.