The Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), signed in May, will require some taxpayers to rethink their long-term tax planning. The bill has something for everybody - businesses, families and potential retirees.
Here's a rundown:
Roth IRA participation widens for higher-income taxpayers: Beginning in 2010, TIPRA will allows anyone to convert an ordinary IRA to a Roth IRA no matter what their income. That means someone who has a non-deductible IRA could keep shoveling money in and convert to a Roth IRA in 2010, owing additional tax only on the earnings that had accumulated up until then, and even that tax could be paid "ratably" over two years.
Then the investor wouldn't have to pay tax on withdrawal of any further earnings as long as certain holding periods were satisfied and they wouldn't have to take distributions until age 70 ½. The great unknown, however, is what tax policy could change in the meantime.
Kiddie tax/capital gains issues: Under the new law, the child's unearned income will be taxed at the parents' rate until the child reaches age 18. That's a big change for parents who had been using their kids over the age of 14 to shield their investment income from the parents' tax rate.
In 2003, The Jobs and Growth Tax Relief Reconciliation Act established a maximum tax rate of 15 percent for long-term capital gains and qualifying dividend income. For taxpayers in the lowest two tax brackets, the maximum is now 5 percent and will drop to zero in 2008, when those rates were initially scheduled to expire. TIFRA extends the rate structure through 2010.
Parents may want to shift gifted assets to children from income-producing investments to stocks with hope of capital appreciation so they'll have better tax treatment.
Some relief on the AMT front: TIFRA increases the alternative minimum tax (AMT) exemption for 2006 to $62,550 for married couples and $42,500 for single taxpayers. It's a short-term fix, though, since Congress will have to revisit limits for 2007 and beyond.
However, the government is allowing additional tax credits to reduce AMT exposure. In 2005, adoption credit, child credit, saver's credit and foreign tax credit were allowed to reduce AMT, but in 2006 the following have been added: credit for the elderly and disabled, energy-saving credits, tuition credits, some homeowners credits and the dependent care credit.