Tax Increase Prevention and Reconciliation Act of 2006

Tax Increase Prevention and Reconciliation Act

First, we don't know why this Act has the year 2005 in its titled since it isn't signed into law until 2006, but here goes. The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) is now on its way to the President, who is expected to sign it on May 17, 2006. Following are some of the more common provisions from this bill.

1) Alternative Minimum Tax (AMT) – FORMER LAW – For a few years we have had an AMT exemption amount of $40,250 ($58,000 for MFJ). The AMT exemption amount was scheduled to return to the former amounts for 2006 and later years.

- NEW LAW – TIPRA has increased the AMT exemption amount to $42,500 ($62,550 for MFJ), but only for 2006. Then the AMT exemption amount returns to the former amount of $33,750 ($40,250 for MFJ) for 2007 and later years (unless the law changes again).

2) AMT – FORMER LAW – For a few years the AMT has been calculated BEFORE applying several nonrefundable personal credits including the dependent care, elderly and disabled, Hope Scholarship, Lifetime Learning, D.C. homebuyer, and interest on certain home mortgages. The AMT was scheduled to return to the former ordering and be applied AFTER these nonrefundable personal credits for 2006 and later years.

- NEW LAW – TIPRA retains the ordering rule of calculating AMT BEFORE applying the credits, but only for one more year. The AMT is now scheduled to return to the former ordering and be applied AFTER these nonrefundable personal credits for 2007 and later years.

3) IRC Section 179 – FORMER LAW – Since 2003, the amount of §179 election that can be made and deducted in a year has been $100,000 (as indexed). The §179 election was scheduled to return to the former $25,000 level starting with 2008.

- NEW LAW - TIPRA retains the $100,000 (as indexed) level for two more years. Now the §179 election is scheduled to return to the former $25,000 level starting with 2010.

4) Dividend and capital gains rates – FORMER LAW – Since 2003, the maximum rate applicable to qualifying dividends and capital gains has been 5% for taxpayers in the 10% and 15% tax brackets, and 15% for taxpayers in the tax brackets higher than 15%. For tax year 2008, the 5% rate was scheduled to decrease to 0%. Starting with 2009, qualifying dividends would return to their prior character of ordinary income and the capital gains tax rates would revert back to the former 20%/10% rates.

- NEW LAW – TIPRA keeps the capital gains tax rates applicable to qualifying dividends through 2010 and also keeps the 0% tax bracket through 2010. Starting with 2011, qualifying dividends would return to their prior character of ordinary income and the capital gains tax rates would revert back to former 20%/10% rates.

5) Capital gains rates on self-created musical works – FORMER LAW – Self created musical works are part of the taxpayer’s self-employment income subject to ordinary tax rates and self-employment taxes.

- NEW LAW – Sales and exchanges of self-created musical works in tax years beginning after the date of enactment (date the President signs the bill) and prior to January 1, 2011 can be treated as the sale or exchange of a capital asset IF the taxpayer elects such treatment. It appears the new law still denies a charitable contribution for the value of these works and limits the contribution deduction to the adjusted basis.

(On the surface this would appear to be an easy decision to make since it replaces ordinary income tax with the lower capital gains tax. If this election also makes the sale not subject to self-employment taxes, it seems even better. However if this income is not considered business income, it could impact a taxpayer’s ability to build up of Social Security retirement and disability benefits, contribute to a retirement plan, claim a §179 deduction, or claim any other benefit tied to BUSINESS income.)

6) Amortization – FORMER LAW – A taxpayer that puts any musical composition or musical copyright into service amortizes the costs using the income forecast method.

- NEW LAW – A taxpayer that puts any musical composition or musical copyright into service can ELECT to use a five-year amortization period for certain expenses paid or incurred with respect to all musical compositions and musical composition copyrights placed in service during that tax year. This applies to the taxpayer who puts the asset into service, whether it is the creator or a music publisher. This provision is effective for property placed in service in tax years beginning after December 31, 2005 and before January 1, 2011.

7) Kiddie Tax – FORMER LAW – Kiddie tax applies to the unearned income of a child under the age of 14 as of the end of the year. This unearned income is taxed at the parent’s rate (after the first $1,700 (for 2006)).

- NEW LAW – The kiddie tax applies to the unearned income of a child under the age of 18 as of the end of the year. Income from a qualified disability trust (as defined in §642(b)(2)(C)(ii)) is considered to be earned income for this purpose.

This provision is effective for taxable years beginning after December 31, 2005. (THIS MEANS THE YEAR 2006 for most taxpayers.)

8) Production deduction (§199) – FORMER LAW – The wage limitation portion of the production deduction calculation uses all wages paid by the business.

- NEW LAW – The wage limitation portion of the production deduction calculation uses only wages paid by the business that are included in the calculation of the qualified production activities income (QPAI). This is effective for tax years beginning after the date of enactment.

9) Foreign housing costs – FORMER LAW – The base housing amount is 16% of the daily salary of an employee of the United States who is compensated at a rate equal to the annual rate paid for step 1 of grade GS-14 multiplied by the number of days of foreign residence or presence in that year.

- NEW LAW – The base housing amount is 16% of the foreign earned income exclusion limitation, multiplied by the number of days of foreign residence or presence in that year. The exclusion is limited to 30% of the maximum amount of a taxpayer’s foreign earned income exclusion. This provision is effective tax years beginning after December 31, 2005.

10) Foreign earned income exclusion – FORMER LAW – The exclusion is limited to $80,000 with indexing starting with taxable years beginning after December 31, 2007.

- NEW LAW – The exclusion is now indexed starting with taxable years beginning after December 31, 2005.

11) Tax-exempt interest – FORMER LAW – Payers of tax-exempt interest are not required to issue information reporting forms (Forms 1099).

- NEW LAW – Payers of tax-exempt interest are required to issue information reporting forms (Forms 1099) in the same manner as interest paid on taxable obligations. This provision is effective for interest paid on tax-exempt bonds after December 31, 2005.

12) Offers-in-Compromise – FORMER LAW – Other than the processing fee, a payment was not required to be submitted with an offer-in-compromise.

- NEW LAW – An offer than is for a “lump sum” must now be accompanied by a payment of at least 20% of the offer amount. A “lump sum” is defined as any offer of payments made in 5 or less installments.

- An offer that contains periodic payments must now be accompanied by the amount of the first proposed installment. During the time the offer is being considered, the proposed installment payments must also be submitted as offered. Any failure to make an installment payment can be treated by the Secretary as a withdrawal of the offer.

- The taxpayer can specify how these payments (prior to acceptance) is to be applied.

- Any offer-in-compromise is deemed accepted if it is not rejected by the Secretary within 24 months after the date of its submission (plus any time the tax liability is in dispute in a judicial proceeding).

- These provisions are effective with offers submitted on or after the 60th day after the enactment of TIPRA.

13) Roth IRAs – FORMER LAW – Generally a taxpayer can convert a traditional IRA to a Roth IRA as long as the taxpayer’s modified AGI is less than $100,000 for the year of the conversion.

- NEW LAW – The $100,000 limitation no longer exists for conversions in tax years beginning after December 31, 2009.

- A taxpayer who does a conversion in the taxable year beginning in 2010 reports the conversion income as received 50% during 2011 and 50% in 2012, unless the taxpayer ELECTS to not report the income as such. (Since the tax rates return to their old levels for tax years beginning after 2010, many taxpayers may choose to elect not to have this apply and therefore report all of the conversion income in 2010.)

14) Corporate estimated tax payments – FORMER LAW – Estimated tax payments for corporations can be based on 100% of the prior year’s tax (providing the prior year’s tax is at least $1).

- NEW LAW – Estimated tax payments for corporations with assets of at least $1 billion have higher thresholds. Payments for these corporations due in July, August and September 2006 are increased to 105%; payments due in July, August, and September of 2010 are increased to 106.25%; and payments due in July, August, and September of 2010 are increased to 100.75%.

- Also 20.5% of the corporation estimated tax payment due on September 15, 2010 can be delayed until October 1, 2010.

- Also 27.5% of the corporation estimated tax payment due on September 15, 2011, can be delayed until October 1, 2011.

Other provisions exist for:

- Taxation of certain settlement funds (treated as beneficially owned by the United States government) established prior to January 1, 2011

- Controlled foreign corporations and the active financing and insurance income exception

- Distributions from controlled corporations involving the active business test for tax-free corporation spin-offs

- Tax-free distributions from control corporations denied when over two-thirds or more of the value of the distributee or controlled corporation’s total assets are investments assets. (This increases to ¾ or more if the distribution occurs within one year after the date of enactment.)

- Expansion of Qualified Veterans’ Mortgage bond program

- Extension of the special grandfather exception from the arbitrage bond rules for Texas permanent university funds for bonds issued after the date of enactment and before August 31, 2009

- Vessels weighing not less than 6,000 deadweight tons to elect into the tonnage tax

- Loans to qualified continuing care facilities

- Withholding of 3% from many payments from federal, state, and local government agencies for services or property provided by a taxpayer starting in 2011.

Both the 75 page pdf version and the 40 page printer-friendly version of this Bill can be found on Thomas.loc.gov by searching for Bill HR4297. We can also email you this pdf file or the Word printer-friendly version upon request.

This text has been shared with you courtesy of: David & Mary Mellem, EAs & Ashwaubenon Tax Professionals, 920-496-1065 (fax 920-496-9111) , , , and

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