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THE NEW TAX LAW AND HOW IT AFFECTS YOU

Written By: Alan A. Lips, C.P.A.
Published By: Aventura News
Date: June 2006

The recently enacted Tax Increase Prevention and Reconciliation Act impacts a broad cross-section of taxpayers. The new law extends the controversial dividend and capital gains tax rate cuts for two more years beyond 2008, gives taxpayers some immediate relief from the alternative minimum tax (AMT), extends small business expensing thresholds, and allows high-income taxpayers a Roth conversion opportunity.

The new law provides greater AMT relief. Originally enacted to make sure that wealthy Americans did not escape paying taxes, the AMT, is a parallel tax system that does not permit several of the deductions permissible under the regular tax system, such as state, local and property taxes, has started to affect more middle-income taxpayers. This is in part due to the fact that the AMT parameters are not indexed for inflation. The new tax law increases for tax year 2006 the AMT income exemption levels that were in effect for 2005. The new exemption levels are $42,500 for single filers, up from $40,450 and $62,550 for joint filers, up from $58,000.

In addition, when calculating whether they're subject to AMT, taxpayers will be allowed to use all nonrefundable personal credits to offset AMT liability. Normally, these credits often end up being disallowed under AMT.

The new law extends reduced capital gains and dividend rates. The new tax law extends for two years the 15 percent rate on long-term capital gains and dividends. Currently scheduled to expire at the end of 2008, the reduced rates will run through 2010.

For those with sizeable dividends in a taxable portfolio, the savings also can be impressive. Say you have a $250,000 portfolio of stocks and mutual funds, with an average dividend yield of 1.8 percent. Your annual dividends would total $4,500 and you'd owe $675 in income tax on them, based on a 15 percent rate. If the reduced rate weren't extended and you're in the 28 percent tax bracket, depending on your adjusted gross income you could owe a total tax hit of $1,260.

The new law eliminates the $100,000 adjusted gross income ceiling for converting a traditional individual retirement account (IRA) to a Roth IRA, for tax years after 2009. A conversion is treated as a taxable distribution, but is not subject to the 10-percent early withdrawal penalty. Taxpayers who convert in 2010 can elect to recognize the conversion income in 2010 or average it over the next two years.

The elimination of the $100,000 ceiling has higher income taxpayers and their financial advisors salivating. High-income taxpayers with substantial amounts in traditional IRAs previously were shut out of the benefits of conversion. Now, anyone can convert to a Roth IRA. Just a Reminder: Contributions to a Roth IRA are not deductible, but the earnings are permanently tax-free.