In early May, Congress passed the Tax Increase Prevention and Reconciliation Act (TIPRA). President Bush signed it into law on May 17, 2006. The new legislation includes both favorable and unfavorable provisions. The most important changes are as follows:

Preferential Tax Rates on Capital Gains and Dividends Extended through 2010

For individual taxpayers, TIPRA extends through 2010 the preferential federal income tax rate structure for long-term capital gains and qualified dividends. The maximum rate on most long-term gains and dividends will remain at the current 15%. Even better, the current 5% rate will continue through 2007 for long-term gains and qualified dividends earned by individuals in the lowest two regular tax brackets (the 10% and 15% brackets) before dropping to 0% (that’s not a typo) for 2008 though 2010. (Prior law called for the rates to rise after 2008.)

TIPRA also extends the 28% maximum rate on long-term gains from collectible sales and the 25% maximum rate on long-term real estate gains attributable to depreciation through 2010.

One-year Alternative Minimum Tax Fix

TIPRA includes two quick fixes, for this year only, to the individual alternative minimum tax (AMT) rules. These changes will prevent millions more (possibly including you) from owing the dreaded AMT this year.

Under the first fix, the 2006 AMT exemption amounts are increased as follows:

• To $62,550 for married individuals who file jointly (up from the 2005 figure of $58,000). Without the fix, the 2006 exemption would have been only $45,000.

• To $42,500 if you are a single individual or head of household (up from the 2005 figure of $40,250). Without the fix, the 2006 exemption would have been only $33,750.

• To $31,275 if you use married filing separate status (up from the 2005 figure of $29,000). Without the fix, the 2006 exemption would have been only $22,500.

Under the second fix, you can use your nonrefundable personal tax credits (such as the dependent care credit and the Hope Scholarship and Lifetime Learning higher education credits) to reduce both your 2006 regular tax and AMT bills (same as for 2005). You will also be able to use the new residential and nonbusiness energy property credits to reduce both of these taxes for 2006. So, if you are considering making energy efficient improvements to your home, you might want to do it now rather than waiting until next year.

Favorable “Section 179 Deduction” Rules Extended through 2009

The so-called Section 179 rules allow many small businesses to deduct the full cost of most equipment and software additions (whether new or used) in the first year they are put to use. For tax years beginning in 2006, the maximum Section 179 write-off is a generous $108,000. However, the maximum Section 179 deduction was scheduled to decrease to only $25,000 for tax years beginning in 2008 and beyond. Thankfully, TIPRA extends the current taxpayer-friendly Section 179 rules by two years, through tax years beginning in 2009.

Kiddie Tax Rules Now Apply to Older Kids, Starting Right Now!

The so-called Kiddie Tax rules can cause a dependent child’s unearned income (typically from investments) to be taxed at the parent’s higher marginal federal income tax rate. Until now, the Kiddie Tax only applied through the year before a child turned age 14. In other words, the Kiddie Tax issue ceased to exist for the year the child turned 14 and for all subsequent years. Unfortunately, TIPRA extends the Kiddie Tax rules through the year before a child turns 18, starting with 2006. More specifically: for this year and beyond, the Kiddie Tax issue will be lurking until the year that a dependent child turns 18. Children who are still age 17 as of 12/31/06 are potential Kiddie Tax victims this year. The only saving grace is that, for 2006, the Kiddie Tax only affects under-age-18 dependent children with unearned income in excess of $1,700.

Income Restriction for Roth IRA Conversions Is Eliminated (for 2010 and Beyond)

The Roth IRA conversion privilege is currently restricted to individuals with modified adjusted gross income (MAGI) of no more than $100,000. TIPRA eliminates the MAGI restriction, but don’t get too excited. Why? Because this change won’t become effective until way out in 2010. For Roth conversions that occur in that year only, half of the taxable income triggered by the conversion can be reported on your 2011 return and the other half can be reported on your 2012 return. For conversions in 2011 and beyond, all the income must be reported on the return for the conversion year (same as under the current rules).

Domestic Producers Deduction

For tax years beginning after 5/17/06, TIPRA limits wages for the 50% limit for the new domestic producers to include only those allocable to domestic production gross receipts. TIPRA also repeals a complicated W-2 wages limitation provision for wages allocated to partners and S corporation shareholders for tax years beginning after 5/17/06.

Because of this change, some businesses may find it beneficial to design and implement recordkeeping systems to capture the portion of employees’ time and thus pay devoted to qualifying domestic production activities. These businesses may also want to consider using separate general ledger accounts to separate wages related to domestic production gross receipts from other from those that are not.

There May Be Another New Tax Law this Year

You now understand the key tax changes included in the TIPRA legislation, but there are other provisions that we’ve had to ignore in order to keep this letter from turning into a book. Please call us if you want more information.

Also, don’t be surprised if you see at least one more new tax law passed before year-end. Why? Because additional legislation will be needed to extend various popular federal income tax breaks including (but not limited to) the following:

• The itemized deduction for general state and local sales taxes in lieu of writing off state and local income taxes.

• The write-off for up to $4,000 of higher education tuition costs and related fees.

• The deduction for up to $250 of classroom costs paid by elementary and secondary school educators out of their own pockets.

• The tax credit for expanding research and development activities.

All of these breaks (plus some others not listed here) expired at the end of 2005 and will probably be retroactively resurrected for at least this year by future legislation. If that happens, we will be in touch. In the meantime, please contact us if you have any questions about TIPRA or anything else.

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The Rhode Island Division of Taxation will be offering a Tax Amnesty Program beginning on July 15, 2006 and ending on September 30, 2006.

Tax amnesty is an opportunity to clear up any unpaid tax obligations relative to taxes payable to the State of Rhode Island and collected by the Tax Administrator.

All unpaid penalties will be waived for eligible applicants and eligible taxes upon payment of all tax and interest amounts. In addition, the Tax Administrator shall not seek civil or criminal prosecution for any taxpayer for the taxable period for which amnesty has been granted.

Amnesty covers the penalties imposed under any tax payable to the State of Rhode Island and collected by the Tax Administrator.

Previously billed tax liabilities will be eligible for tax amnesty.

Neither a taxpayer who is under criminal investigation, nor a taxpayer who is involved in any pending criminal or civil court litigation in any court of the United States or the State of Rhode Island for fraud in relation to any state tax imposed by any law of the State of Rhode Island and collected by the Tax Administrator is eligible for amnesty.

A taxpayer who can substantiate a severe financial hardship may apply for an amnesty installment plan upon the terms and conditions set by the Tax Administrator. If a taxpayer fails to pay any installment at the time such installment payment is due under such agreement, the agreement shall cease to be effective and the balance of the amounts required to be paid thereunder shall be due immediately. If an installment payment is approved, fifty percent of the amount due should be paid upon application, with the balance to be paid in two equal monthly installments.

As of October 1, 2006, the interest rate on unpaid taxes will increase to eighteen percent (18%).

PPC, Practioners Tax Action Bulletin, TAM-1158

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For privilege periods ending on or after July 1, 2006, and before July 1, 2009, in addition to a New Jersey taxpayer's business corporation tax liability, a surtax of 4% will be imposed on the liability remaining after any tax credits allowed for c-corporations. No credits are allowed against the surtax other than those for installment payments, estimated tax payments made with filing extensions, or overpayments applied from prior privilege periods.

Minimum Tax Increased

For calendar year 2006 and thereafter, the minimum business corporation tax (currently, $500) is based on New Jersey gross receipts as follows:

• if gross receipts are less than $100,000, the minimum tax is $500;

• if gross receipts are $100,000 or more but less than $250,000, the minimum tax is $750;

• if gross receipts are $250,000 or more but less than $500,000, the minimum tax is $1,000;

• if gross receipts are $500,000 or more but less than $1,000,000, the minimum tax is $1,500; and

• if gross receipts are $1 million or more, the minimum tax is $2,000.

The minimum tax for a taxpayer that is a member of an affiliated group or a controlled group under IRC Sec. 1504 or IRC Sec. 1563 whose group has total payroll of $5 million or more for the privilege period continues to be $2,000.

If you have any questions on how this might impact your multi-state business, please contact your KAF representative.

CCH-EXP, NJ-TAXRPTR Paragraph 10-380

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With the recovering stock market, incentive stock options (ISOs) have once again become an attractive form of compensation. You may receive ISOs from your employer. If so, the good thing is that your entire profit from selling ISO shares can be taxed at lower capital gains rates, assuming you play all your cards right.

However, exercising an ISO when the market value of the company stock is above your exercise price could cause you to owe the alternative minimum tax (AMT) for the year of exercise. In addition, you will lose favorable capital gain treatment for your profit if you sell the option shares: (1) within two years of the option grant date or (2) within one year of the option exercise date.

There may be other important tax considerations as well. Careful advance planning may be advisable before exercising an ISO or selling shares acquired by exercising one. Without advice, your tax results may be much less favorable. Please call us if you have questions or want more information about ISO transactions.

PPC, Practioners Tax Action Bulletin, TAM-1157

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August 2006
	Short Term	Mid Term	Long Term
Annual	5.26%	5.21%	5.36%
Semi annual	5.19%	5.14%	5.29%
Quarterly	5.16%	5.11%	5.26%
Monthly	5.13%	5.09%	5.23%
Adjusted AFR for Original Issue Discount (Code Sec. 1288(b))	3.71%	3.95%	4.52%
Code Sec. 382 Adjusted Federal Long Term Rate			4.52%
Long Term Tax exempt rate			4.52%
Low income Housing Credit (Code Sec. 42(b)(2))
70% present value			8.23%
30% present value			3.53%
Valuation Tables (Code Sec. 7520)			6.20%
Deemed Rate of Return for Transfers to Pooled Income Funds (Code Sec. 642(c)(5))			3.80%

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Discussion: The IRS set forth the requirements for participating in the Attributed Tip Income Program (ATIP), which provides benefits to employers and employees similar to those offered under previous tip reporting agreements without requiring one-on-one meetings with the IRS to determine tip rates or eligibility.

The IRS stated that it was expanding its Tip Rate Determination/Education Program (TRD/EP), which is designed to enhance tax compliance among tipped employees through taxpayer education and voluntary agreements instead of traditional audit techniques. According to the IRS, ATIP is a new reporting alternative for employers in the food and beverage industry designed to promote compliance by employers and employees with Code provisions governing tip income, to reduce disputes on audit, and to reduce filing and recordkeeping burdens. The IRS explained that ATIP is being offered in addition to the existing TRD/EP programs and that ATIP differs from the existing programs in that it does not require an employer to enter into an individual agreement with the IRS.

According to the IRS, ATIP does not alter any of the existing TRD/EP programs, and employers currently participating in an existing TRD/EP program may elect to switch to ATIP. However, the IRS advised that the employer's election to participate in ATIP supersedes and revokes all existing tip compliance agreements between the employer and the IRS with respect to that establishment. Further, the IRS stated, participation in ATIP by employers and employees is entirely voluntary. The IRS added that an employee cannot participate in ATIP unless he or she is employed by a participating employer.

The IRS advised that employers participate in ATIP on an establishment-by-establishment basis. According to the IRS, in order to participate in ATIP with respect to an establishment, an employer must satisfy all of the requirements for that establishment, and if an employer has more than one eligible establishment, the employer must satisfy the requirements for each establishment that is to participate. An employer may have both participating and nonparticipating establishments, the IRS added. Generally, the IRS stated, at least 75% of the establishment's tipped employees must have agreed to participate as of the last day of the first payroll period ending on or after January 1 of the calendar year, and the employer must make a good faith effort to maintain the participation rate throughout the year.

The IRS stated that it will not initiate any tip examinations of a participating establishment for any period during which the establishment participates in ATIP. Also, the IRS stated, a participating establishment will be considered in compliance with the reporting requirements of §6053(c)(2) and (3) regarding allocation of tips to participating employees for the taxable periods during which the employer participates in ATIP.

The IRS stated that employers may elect to participate in ATIP, which is a pilot program, on a calendar year basis for each of the three calendar years beginning on or after January 1, 2007. The IRS added that ATIP terminates on December 31, 2009, unless the IRS issues guidance extending its term, but that the IRS may terminate ATIP at any time.

The IRS stated that Rev. Proc. 2006-30 is effective January 1, 2007.

Reference: Rev. Proc. 2006-30, Internal Revenue Bulletin 2006-31 Page 110 (page 13 of the .pdf file) http://www.irs.gov/pub/irs-irbs/irb06-31.pdf

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Midyear Tax Planning

When it comes to taxes, 2006 is already off to a fast start—we have already seen one Tax Act and it looks likely that there will be more before the year’s end. All this is right on the heels of 2005, where we saw four major Tax Acts. What does all this mean to you? Despite the tax rules being in a seemingly endless state of flux, the current tax environment is about as good as it’s going to get. If you wait until the tax laws settle down before doing any serious planning, you may miss out on some great opportunities to reduce your overall tax burden. What’s important is to set long-term financial goals now and then update them as the tax law evolves.

Use the following ideas as a starting point to identify specific actions you can take while there is still time to take action. Some planning ideas need to be implemented before year-end to be effective for this year. With that in mind, here are some ideas to consider.

Make the Standard Deduction Work for You. If your itemized deductions are just at or below the standard deduction (currently $10,300 for joint filers and $5,150 for singles), they don’t generate any tax benefit for you. Instead, you can bunch itemized deductions into a single tax year to exceed the standard deduction that year and take the standard deduction the following year. Following this two-year pattern results in greater deductions overall. Deductions that work well for this strategy include charitable contributions, property taxes, the fourth quarter estimated state income tax payment, and your January mortgage payment.

Consider Giving Appreciated Securities to Your Children. A great way to reduce the tax hit on an appreciated security is to give it your child (or grandchild). The child can hold the security until the year she turns 18 and then sell without being subject to the “kiddie tax.” Assuming the current tax rate structure is left in place, the resulting capital gain will probably be taxed at only 5% if the stock is sold this year or next. If sold in 2008 through 2010, the tax rate will likely be 0%. Remember, your child’s lower tax rates won’t apply if the stock is sold before the year she turns 18 (until this year the applicable age was 14). Also, giving the security to your child is considered a gift. However, you can use your annual $12,000 gift tax exclusion to shelter the transaction from any gift tax.

Take Advantage of Retirement Plan Options. The earnings on most retirement accounts are tax-deferred. (With Roth IRAs, they’re normally tax-free.) Thus, the sooner you fund such an account, the quicker the tax advantage begins. If you can come up with the cash now, there’s no need to wait until year-end or the April15 tax filing deadline to make your 2006 contributions. However, if your employer offers a 401(k) or SIMPLE-IRA plan at work, you’ll probably want to contribute enough to that plan to receive a full employer match before making an IRA contribution.

Retirement Plans. If your business doesn’t offer a retirement plan, now might be the time to take the plunge. Current retirement plan rules allow for significant deductible contributions. Even if your business is only part-time or something you do on the side, contributing to a SEP-IRA or SIMPLE-IRA can enable you to reduce your current tax load while increasing your retirement savings. With a SEP-IRA, you generally can contribute up to 20% of your self-employment earnings, with a maximum contribution of $44,000. A SIMPLE-IRA, on the other hand, allows you to set aside up to $10,000 plus an employer match that could potentially be the same amount. In addition, if you’re age 50 or older by year-end, you can contribute an additional $2,500 to a SIMPLE-IRA.

This letter is intended to give you just a few ideas to get you thinking about planning for 2006. We would like to discuss your situation in detail to see how these and other planning ideas can be used to reduce your tax bill. Please don’t hesitate to call us if you would like more details or would like to schedule a tax planning strategy session.

PPC, Practioners Tax Action Bulletin, TAM-1162b

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