New tax act offers
pros, and a few
cons, for owners
by Vicki Johnson
IT SEEMS THAT A YEAR doesn’t go by without Congress passing a major new tax act. The year 2006 is no different. In May, Congress passed the Tax Increase Prevention and Reconciliation Act (TIPRA), and President Bush signed it into law.
TIPRA contains many favorable provisions for businesses and individual taxpayers, as well as a few unfavorable ones, which is to be expected. Some highlights of the new tax law include:
Extension of Section 179. Most small-business owners are familiar with the favorable Section 179 rules that allow a deduction for the full cost of most equipment and software purchases in the year they are placed in service.
For 2006, the maximum amount that can be written off for Section 179 is $108,000. Prior to the new law, this maximum deduction was scheduled to decrease to $25,000 for tax years beginning in 2008 and beyond.
Under TIPRA, the favorable limits have been extended by two years, through the end of 2009, with the maximum amounts indexed for inflation each year. This provides an excellent opportunity for small-business owners to develop a plan for future equipment purchases and their timing for optimal tax deductions.
Extension of preferential tax rates. Another favorable extension relates to the federal tax rate on long-term capital gains and qualified dividends. A two-year extension means the 15 percent tax rate on most long-term gains will remain in effect through 2010.
For those taxpayers falling in the 10 percent or 15 percent tax brackets, their 5 percent tax rate on long-term gains will continue through 2007, but it will then drop to 0 percent for 2008 through 2010.
This extension also applies to the 15 percent tax rate on qualified dividends, which was scheduled to increase after 2008 along with the long-term gain rates. Most dividends from domestic corporations and some foreign corporations qualify for these preferential tax rates.
Changes to the Alternative Minimum Tax. Although only a one-year fix, TIPRA includes two changes to the individual alternative minimum tax (AMT) rules for 2006.
The 2006 AMT exemption amounts have been increased to $62,550 for married individuals filing jointly and to $42,500 for single individuals and heads of households. While these exemption amounts were increased only slightly from the 2005 figures, without the TIPRA provisions the exemptions would have decreased to well below the 2005 amounts.
Individual taxpayers can use nonrefundable personal tax credits to offset both their regular tax and their AMT liabilities for 2006. Examples of these credits include the dependent care credit and the Hope and Lifetime Learning higher education credits.
AMT was originally enacted to make sure wealthy Americans did not escape paying taxes, but many middle-income taxpayers are now falling into this tax. The two quick fixes provided by TIPRA should keep millions of taxpayers out of reach of AMT.
Kiddie tax. Under previous law, children younger than 14 who had more than a small amount of unearned income (interest, dividends, etc.) had to pay tax at their parents’ higher marginal tax rate.
For 2006, the amount of unearned income at which the kiddie tax kicks in is $1,700. Under TIPRA, these requirements still apply but the age limit has been raised from 14 to 18, and this change applies to tax years beginning after December 31, 2005, which is now.
For small-business owners who have children performing duties for the company, it now makes even more sense to employ them, pay them a reasonable wage for the work they perform, and take a deduction through the business.
It is better to shift taxable income into their lower tax brackets as earned income than to have the child younger than 18 with unearned income taxed at the parents’ higher rates.
Domestic Production Activities Deduction rules. Some clarification has been made to the recently created Domestic Production Activities Deduction (DPAD). It is a new tax deduction that became available in 2005 to taxpayers engaged in eligible business activities in the United States.
These eligible activities include: the manufacture, production or growth of tangible personal property; construction; and engineering and architectural services. DPAD encompasses a wide range of activities, so if you’re not sure your company qualifies, ask your tax adviser about the deduction.
The DPAD is equal to a percentage of the net income from eligible business activities conducted in the U.S. For 2005 and 2006, the percentage is 3 percent; for 2007-2009, it is 6 percent; and after 2009, it is 9 percent. There is the potential to achieve some substantial tax savings! An additional limit is placed on the deduction in that it can’t exceed 50 percent of the W-2 wages paid for the eligible business activity.
With this limit, the eligible business must have payroll, since the amount of W-2 wages paid from the business is used in the calculation of the deduction amount. This is where the TIPRA provision comes in.
Under the new law, wages eligible for use in the calculation of the deduction must include only those allocable to the qualifying activity. Previously, total W-2 wages paid were used in the calculation, whether or not the payroll was related to the activity qualifying for the deduction.
Keeping current on what is new in the tax code is an important part of running your business, especially since it often involves planning to take advantage of tax savings.
Consult your tax adviser to learn of the opportunities you may be missing and what you need to plan for. It can mean more money in your pocket.
contact Vicki Johnson is a senior manager with Wipfli LLP in St. Paul, the accounting and business consulting firm: 651.766.2876; vjohnson@wipfli.com; www.wipfli.com
