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Income Tax Increase Prevention Act

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Tax Increase Prevention Act

Congress has just enacted a new tax law called the Tax Increase Prevention and Reconciliation Act. The centerpiece of the new law is the extension of several expired or soon-to-expire tax cuts.

  • The current low tax rates on capital gains and dividends, previously set to expire at the end of 2008, are extended through 2010.
  • The higher exemption amount for the individual alternative minimum tax, which expired at the end of 2005, is extended through 2006 and increased a little. This means fewer taxpayers will be hit with the alternative minimum tax.
  • The current “Section 179” deduction for business machinery and equipment was scheduled to be reduced in 2008.  The new law extends the higher deduction through 2009.

While these extender provisions carry future effective dates, they can have an important impact on your current financial plans. For example, suppose you are selling property and will receive installment payments from the buyer. You can agree to payments through 2010 (instead of 2008) without facing an increased capital gains tax.

Other provisions in the new law also call for advance planning. For example, take the case of Roth IRAs. Contributions to Roth IRAs are not deductible, but withdrawals down the road are tax-free. However, you may have been locked out of the Roth IRA market because your income is too high. Roth IRA contributions are not permitted if your income is over $165,000 on a joint return or $105,000 on a single return.

The tax rules do allow the conversion of a traditional IRA into a Roth IRA. But, again, there is an income limit. No conversion is currently allowed if your income is $100,000 or more. However, starting in 2010, the new law eliminates this income limit on traditional-to-Roth IRA conversions. This will allow you to indirectly fund a Roth IRA even though your income is too high to make direct contributions. We can show you how to sock away dollars now that you can move into a Roth IRA when the law change takes effect.

On the other hand, the new law is not all good news. If, like many taxpayers you have transferred income-producing property to your children to reduce the overall family bill, the new law may have an immediate—and unwelcome—impact. The change has to do with the so-called “kiddie” tax.

Under longstanding rules, the kiddie tax has imposed a special tax on the investment income of a child. Instead of the tax being figured at the child’s regular lower rate, the tax is figured at his or her parent’s higher tax rates. Under prior law, once a child reached age 14, the kiddie tax no longer applied and the child’s income was taxed at his or her own lower rates. Consequently, one common strategy for avoiding the kiddie tax has been to invest in growth stock for a young child and sell it when the child reaches 14. Similarly, many parents have simply waited until the child reached age 14 to make gifts of income producing assets.

The new law extends the kiddie tax to children under age 18. So, if your current financial plans call for a sale of appreciated assets by or a gift of income-producing assets to your teenager, you may want to hold off, if practical, for a few years. What’s more, the kiddie tax change is retroactive to the beginning of 2006, so a sale or gift made earlier this year may generate an unexpected tax increase that calls for new or increased estimated tax payments.

We will be glad to discuss how these and other new law changes affect your individual tax and financial situation.

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