After much wrangling, Congress recently passed – and the President signed into law – the Tax Increase Prevention and Reconciliation Act of 2006 (TIPRA). While most of the new law’s provisions are favorable to taxpayers, some of them will result in additional taxes for some individuals and businesses. Following is a brief rundown of TIPRA’s main provisions.

Investor Tax Breaks

Capital Gains. Individuals’ long-term capital gains are taxed at rates significantly lower than regular tax rates. Generally, under pre-TIPRA law, the tax rate on long-term gains is no higher than 15%. The rate is reduced to 5% (0%, in 2008 only) for gain that would otherwise be taxed at 10% or 15% if it were ordinary income. However, under pre-TIPRA law, these favorable rates were to expire at the end of 2008.

Under TIPRA, the favorable capital gains tax rates are extended through 2010. Moreover, the 0% capital gains tax rate for those paying ordinary income taxes at the 10% or 15% rate will be in effect for three years – 2008, 2009, and 2010.

Dividends. Under pre-TIPRA law, qualified dividends are taxed at the same rates as long-term capital gains, with those favorable rates due to expire after 2008. TIPRA extends the special rates on qualified dividends through 2010 in the same way it does for capital gains.

Alternative Minimum Tax

The alternative minimum tax (AMT) has received a lot of press in recent years. Originally enacted as an alternate tax system to ensure that higher-income taxpayers with large deductions or tax credits pay a minimum amount of tax, the AMT has affected many middle-income taxpayers in recent years. A major reason: the AMT tax brackets and exemptions have not been adjusted for inflation. A prior tax law had increased the AMT exemptions available to individuals, but those increases expired after 2005.

Under TIPRA, the higher exemptions are reinstated for 2006 only, and are increased over the 2005 level by $4,550 for joint filers (to $62,550) and by $2,250 for unmarried individuals (to $42,500). Absent a further extension, though, the exemptions will drop dramatically after 2006 to the levels applicable in 2000. In addition, the new law extends through 2006 another expired AMT provision that allows those claiming certain tax credits (e.g., the dependent care credit and the HOPE Scholarship and Lifetime Learning Credits) to use them for both regular and AMT tax purposes.

Kiddie Tax

To minimize "income shifting" from parents to their young children, the tax law requires children who have more than a small amount of unearned income to pay tax on that income at their parents’ marginal tax rate. This "kiddie tax" applied to children under age 14. Beginning after 2005, TIPRA raises the age limit to children under age 18. Under the new law, however, the kiddie tax does not apply to a child who is married and files a joint return for the year, or to distributions from certain qualified disability trusts.

Roth IRA Conversions

There are two main types of Individual Retirement Accounts:

· Traditional IRAs to which taxpayers may make tax-deductible or nondeductible contributions and receive distributions that are taxable (except for the nondeductible portion that has already been taxed) and

· Roth IRAs to which taxpayers make after-tax contributions but receive all qualifying distributions (including earnings) tax free.

Under the tax law, a person with a traditional IRA can “convert” it into a Roth IRA by paying tax on the previously untaxed traditional IRA money. The benefit: No further tax will be owed on the IRA money. So, from the time of the conversion, any earnings on the IRA investments will be tax free. Under pre-TIPRA law, the ability to convert to a Roth IRA is limited to taxpayers with $100,000 or less in modified adjusted gross income. Married taxpayers filing separate returns are also prohibited from making Roth IRA conversions.

Under TIPRA, beginning in 2010, taxpayers will be able to convert traditional IRAs to Roth IRAs no matter how high their income. Married individuals filing separate returns will be allowed to convert to Roth IRAs, as well. Moreover, individuals who convert their IRAs in 2010 may spread the income from the conversion and the resulting tax payments over the next two years — 2011 and 2012.

Business Provisions

The new law also includes a number of corporate and other business provisions. Among them:

Section 179 Expensing. Taxpayers may elect to deduct as a business expense the cost of new or used assets placed in service during the tax year, rather than depreciate the cost over time. A prior tax law had increased the limit on the amount that could be expensed, as well as the amount of assets that could be purchased before the deduction would be phased out.

For 2006, after adjustment for inflation, the maximum deductible amount is $108,000, and the amount of purchases after which the deduction is to be phased out is $430,000. Those amounts were to be reduced significantly for tax years beginning after 2007. However, TIPRA extends the higher expensing deduction and phaseout limits through tax years beginning before 2010.

The Domestic Production Activities Deduction. The tax deduction available to businesses for certain U.S. production activities is subject to various limits. One of the limits is the “50% of W-2 wages” limitation. Under this limit, the amount of the domestic production activities deduction for any year may not exceed 50% of the taxpayer’s W-2 wages paid to employees for the year.

Under TIPRA, the term “W-2 wages” for purposes of the domestic production activities deduction is more tightly defined. For tax years beginning after May 17, 2006, W-2 wages includes only wages that are allocable to domestic production gross receipts. This will require employers to implement recordkeeping systems to properly allocate employees’ wages to qualified domestic production activities.

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