James B. Urie, Esquire
Joseph A. Bellinghieri, Esquire

Congress uses new legislation to correct inconsistencies and extend some popular but expiring deductions and provisions.

Another wave of tax changes, impacting both individuals and businesses, is upon us! In May of 2006, Congress passed the Tax Increase Prevention and Reconciliation Act (TIPRA), which was signed into law by President Bush on May 17, 2006. TIPRA was enacted in order to correct some perceived inconsistencies in prior tax legislation and also to serve as a stopgap for some popular yet expiring provisions. This article will explain briefly some of the changes found in TIPRA, not all of which are necessarily good news for taxpayers.

Alternative Minimum Tax Relief
TIPRA extends and increases, for the tax year 2006 only, the alternative minimum tax (AMT) exemption amount for individuals. Through December 31, 2006, taxpayers will be able to take advantage of higher AMT exemption amounts. The AMT exemption amount for married couples filing jointly is $62,550. For single taxpayers, it is $42,500. Also extending through 2006 are provisions allowing taxpayers to use non-refundable personal credits to offset AMT liability. Non-refundable personal credits include the Dependent Care Credit, the credit for elderly and disabled, the credit for interest on certain home mortgages, the Hope Credit for certain college expenses, and the Lifetime Learning Credit.

Dividend and Capital Gains Rate Cuts
TIPRA extends through 2010 the preferential federal income tax rate structure for capital gains and qualified dividends. Generally, the maximum rate on most long-term capital gains and dividends will remain at the current 15 percent rate, and the rate for those taxpayers in the 10 to 15 percent brackets rate will be five percent. In 2008, the long-term capital gains rate for taxpayers in the 10 to 15 percent bracket falls to zero.

Changes in Small Business Expensing
TIPRA also extends certain available deductions to small businesses. Pursuant to Section 179 of the Internal Revenue Code, many small businesses are able to deduct the full cost of equipment and software additions (179 Property) in the first year they are put into service. Generally, the amount of expense is limited to $100,000, but may be reduced in the event the total cost of 179 Property placed into service exceeds $400,000. The $100,000 amount is indexed for inflation, and in 2006 the amount of deduction availed for 179 Property is $108,000 and the ceiling for 179 Property placed into service is $430,000. Without the extension, the expensing limit under Section 179 would have dropped to $25,000 with a ceiling of $200,000 for property placed into service.

Changes to Roth IRAs
TIPRA eliminates the $100,000 adjusted gross income ceiling for taxpayers who wish to convert a traditional IRA to a Roth IRA for tax years after 2009. Under TIPRA, a conversion will be treated as a taxable distribution, but will not be subject to the 10 percent early withdrawal penalty under Section 72 of the Internal Revenue Code. Taxpayers who convert their traditional IRAs to Roth IRAs in 2010 can elect to recognize the conversion income in 2010 or average it over the next two years.

New Requirements to Make an Offer in Compromise
TIPRA has also changed the amount that a taxpayer must pay when submitting an Offer in Compromise, an IRS program that allows those who do not have the income, assets, or means to pay a tax liability now or in the foreseeable future to offer a lesser amount for a tax liability. Now, when a taxpayer files for an Offer in Compromise, they are required to make a partial payment of their liability in addition to any user fees now imposed by the IRS; however, the user fee will be applied to the outstanding tax liability. If a taxpayer is proposing a lump sum offer, he/she/it will now be required to pay 20 percent of the amount offered with the submission of the offer. For installment payment offers, taxpayers are now required to make their proposed scheduled payments while the IRS is considering the offer. If the IRS fails to process the offer within two years, the offer submitted will be deemed accepted by the IRS.

"Kiddie Tax" Age Limitations Raised
Under the "kiddie tax" rules, a child's unearned income, such as dividends and interest, is taxed at the parent's tax rate. The old law provided that the kiddie tax applies to children under the age of 14, with net unearned income over $1,700, and such child can be claimed by the parent as a dependent. Under TIPRA, the age limitation for the kiddie tax is raised from 14 to 18.

Code Section 199 Wage Limitation Revised
TIPRA also made an adjustment to Internal Revenue Code Section 199, which allows a deduction for income attributable to domestic production activities. Beginning on May 17, 2006 and thereafter, TIPRA modified the wage limitation under Code Section 199 by limiting the deduction to 50 percent of the wages that are deducted in arriving at qualified production activities income. In addition, partners and shareholders will be allocated their share of the partnership W-2 wages, but will include in their wage limits only wages paid to determine qualified production activities income.

Modifications to Earnings Stripping Rules
Earnings Stripping rules refer to a complex set of rules to prevent U.S. subsidiaries and branches of foreign corporations from diverting U.S. earnings to other jurisdictions, where they might be subject to little or no tax. TIPRA codifies certain proposed regulations regarding Earnings Stripping and provides that a corporation with a direct or indirect interest in a partnership will treat its share of the partnership's liability as a liability of the corporation for purposes of applying the Earnings Stripping rules to the corporation. The corporation's distributive share of interest income or interest expense of the partnership will be treated as income interest or expense of the corporation.

TIPRA also grants the IRS regulatory authority to reallocate partnership debt or distributive shares of interest income or expense to prevent avoidance of these rules.

Amortization of Geological and Geophysical Expenditures
Currently, Geological and Geophysical Expenses are costs incurred for gathering data to acquire minimal properties. Geophysical and geological costs for oil and gas exploration in the U.S. can be amortized over two years. TIPRA requires amortization of geological and geophysical costs over five years for certain major integrated oil companies.

And More …
Please note that there are several other provisions that were included in TIPRA but not included in this article. In addition, this may not be the last round of tax changes for 2006 as Congress may look to extend several other popular federal tax provisions that are set to expire.

The information set forth above is meant to serve as a brief informational update with respect to the new legislation. If you have any questions regarding the tax changes described in this article or other tax issues, please do not hesitate to contact us.

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