President Signs Tax Bill

1. Two-Year Extension (through 2010) of Reduced Rates on Capital Gains and Dividends. Currently, long-term capital gains and qualified dividend income are taxed at a maximum rate of 15-percent through 2008. For taxpayers in the 10 and 15-percent tax brackets, the tax rate is 5 percent through 2007 and zero in 2008. The Act extends these special tax rates for long-term capital gains and qualified dividends through 2010.



2. Self-created Musical Works May Produce Capital Gains for Tax Years Beginning after May 17, 2006. Effective for sales or exchanges in taxable years beginning after May 17, 2006 and before January 1, 2011, taxpayers may elect for the sale or exchange of musical compositions or copyrights in musical works created by the taxpayer's personal efforts to be treated as the sale or exchange of a capital asset. The Act does not change the charitable deduction rules for these musical works.



3. Increase in AMT Exemption Levels for 2006. The Act increases the AMT exemption levels for 2006 to $62,550 for joint filers and $42,500 for single filers. For 2005, the exemption amounts were $58,000 for joint filers and $40,250 for single filers. Absent additional congressional action, these exemption amounts will fall to $45,000 for joint filers and $33,750 for single filers after 2006.



4. Non-Refundable Personal Tax Credits Continue to Reduce AMT through 2006. Generally, nonrefundable personal credits (including the dependent care; elderly and disabled; Hope Scholarship; Lifetime Learning; and D.C. homebuyer credits) are allowed only to the extent that a taxpayer has regular income tax liability in excess of the tentative minimum tax. This has the effect of disallowing these credits against AMT. However, Congress previously allowed these credits to offset the entire regular and AMT liability through 2005. This new law continues to allow these non-refundable personal tax credits to be claimed against the AMT as well as the regular tax for taxable years beginning in 2006.



5. Unearned Income of Children under Age 18 (Rather than Age 14) Taxed at Parents' Rates After 2005. For 2005 and prior years, children under age 14 at the end of the tax year were taxed on their unearned income (e.g., interest and dividends) at their parent's marginal tax rate if the unearned income exceeded a threshold amount (e.g., $1,600 for 2005). The Act increases the age of children subject to this tax to those under age 18 effective for years beginning after 2005. The rule does not apply to a child who is married and files a joint return for the taxable year. There is also an exception for distributions from certain qualified disability trusts, as defined in sections 1917 and 1614(a)(3) of the Social Security Act. Note! For 2006, the threshold amount is $1,700.



6. 1099-Type Reporting of Interest on Tax-Exempt Bonds After 2005. Under the Act, interest paid on tax-exempt bonds is subject to information reporting in a manner similar to interest paid on taxable obligations. The provision is effective for interest paid on tax-exempt bonds after December 31, 2005. Note! Even though the income is tax exempt, it is relevant for determining eligibility for the earned income credit, the amount of Social Security benefits includable in income, etc.



7. No Income Limitation for Traditional-to-Roth IRA Conversions after 2009. Effective for tax years beginning after 2009, the Act removes the modified adjusted gross income limitation ($100,000) on rollovers from a traditional IRA to a Roth IRA. Thus, taxpayers may convert a regular IRA to a Roth IRA after 2009 without regard to their AGI. Under the Act, taxpayers pay tax on amounts converted in 2010 in equal installments in 2011 and 2012 unless they elect out of this provision.



8. Foreign Income Exclusion and Foreign Housing Exclusion Changed after 2005. The Act makes three changes to the foreign earned income exclusion and housing allowance exclusion effective for tax years beginning after 2005. First, the $80,000 income exclusion is indexed for inflation starting in 2006 (rather than 2008 under prior law).Therefore, the maximum exclusion amount for 2006 is $82,400. Second, the base housing amount used in calculating the foreign housing cost exclusion in a taxable year is 16% of the amount of the maximum foreign earned income exclusion limitation (instead of the prior law 16% of the grade GS-14, step 1 amount). Also, the housing expenses qualifying for the exclusion may not exceed 30% of the maximum exclusion for the year. Therefore, reasonable foreign housing expenses [not to exceed 30% of the maximum foreign earned income exclusion for the year ($24,720 for 2006)] in excess of the above base housing amount ($13,184 for 2006) are excluded from gross income. In effect, the maximum foreign housing cost exclusion is 14% of the maximum foreign earned income exclusion. Therefore, the maximum housing cost exclusion for 2006 is $11,536 (.14 x $82,400). The IRS is given authority to issue regulations or other guidance providing for the adjustment of this 30% housing cost limitation based on geographic differences in housing costs relative to housing costs in the United States. Third, any income in excess of the exclusion amount determined under section 911 is taxed (under the regular tax and alternative minimum tax) by applying to that income the tax rates that would have been applicable had the individual not elected the section 911 exclusion. For example, an individual with $80,000 of foreign earned income that is excluded under section 911 and with $20,000 in other taxable income (after deductions) would be subject to tax on that $20,000 at the rate or rates applicable to taxable income in the range of $80,000 to $100,000.

1. $100,000 (indexed) Section 179 Deduction Extended Through 2009. Under current law, businesses may expense up to $100,000 (indexed for inflation) of investments in depreciable assets. The deduction phases out dollar-for-dollar to the extent the cost of §179 property exceeds $400,000 (indexed for inflation). The 179 deduction was to be reduced to $25,000 and the phase-out threshold would have declined to $200,000 after 2007. The Act extends the $100,000 indexed expense amount and the $400,000 indexed phase-out threshold through 2009. Note! The indexed 179 amounts for 2006 are $108,000 and $430,000 respectively.



2. Domestic Manufacturing Deduction Wage Limitation Changed for Years Beginning after May 17, 2006. For years beginning on or before May 17, 2006, the manufacturing deduction is limited to 50 percent of a taxpayer's qualified W-2 wages. Under the Act, effective for tax years beginning after May 17, 2006, the wage limitation is modified such that taxpayers may only include W-2 wages properly allocable to domestic production gross receipts. Thus, the wage limitation is 50 percent of those wages which are deducted in arriving at qualified production activities income. In addition, as a simplification measure, the conference agreement repeals the special limitation on wages treated as allocated to partners or shareholders of passthrough entities. Therefore, qualified W-2 wages allocated to owners of passthrough entities will no longer be limited to twice the qualified production activities income allocated to those owners from the passthrough entity.



3. Repeal of FSC/ETI Binding Contract Relief. The FSC Repeal and Extraterritorial Income Exclusion Act of 2000 repealed the foreign sales corporation regime. However, transactions pursuant to a binding contract in effect on 9/30/00 continued to qualify for FSC benefits. The American Jobs Creation Act of 2004 repealed the Extraterritorial Income Exclusion. However, transactions pursuant to a binding contract in effect on 9/17/03 continued to qualify for the exclusion. Effective for taxable years beginning after May 17, 2006, the Act repeals the binding contract relief under both the FSC Repeal and Extraterritorial Income Exclusion Act of 2000 and the American Jobs Creation Act of 2004. The repeal of these transition rules was enacted to comply with a recent ruling of the World Trade Organization. Note! The rule allowing 80% of the extraterritorial income exclusion benefits for 2005 and 60% of the exclusion benefits for 2006 was not repealed.



4. 5-Year Amortization of Geological and Geophysical (G&G) Costs for Major Integrated Oil Companies. The Act extends the two-year amortization period for G&G costs to five years for certain major integrated oil companies effective for amounts paid or incurred after May 17, 2006. However, the five year amortization rule for G&G costs applies only to integrated oil companies that have an average daily worldwide production of crude oil of at least 500,000 barrels for the taxable year, gross receipts in excess of $1 billion in the last taxable year ending during calendar year 2005, and an ownership interest in a crude oil refiner of 15% or more.



5. Amortization of Song Rights. The Act allows taxpayers to elect to amortize over five years expenses paid or incurred in creating or acquiring musical compositions or related copyrights. For example, this five-year amortization method would be an alternative to the income forecast method of accounting for advances made by music publishers to songwriters. This provision is effective for expenses paid or incurred with respect to property placed in service in tax years beginning after 2005 and before 2011. Note! Amortization begins in the month the property is placed in service.



6. Increase Corporate Estimated Tax Payments for Corporations with Assets of at Least $1 Billion. The Act increases corporate estimated tax payments for corporations with assets of at least $1 billion for the payments due in July, August and September of 2006, 2012 and 2013. For example, the payments due in July, August, and September, 2006, shall be increased to 105 percent of the payment otherwise due, and the next required payment shall be reduced accordingly.



7. Deferral of Corporate Estimated Payments for All Corporations. The Act delays the due date until October 1 for a percentage of corporate estimated taxes that are otherwise due on September 15, 2010 and September 15, 2011. Thus, with respect to corporate estimated tax payments due on September 15, 2010, 20.5% shall not be due until October 1, 2010 and with respect to corporate estimated tax payments due on September 15, 2011, 27.5% shall not be due until October 1, 2011.



8. Modify Rules for Distributions of Controlled Corporations in Spin-Offs. The Act simplifies the active business test for tax-free corporate spin-offs by looking at all corporations in the distributing corporation's and the spun-off subsidiary's respective affiliated group to determine if the active business test is satisfied. This rule is effective for distributions after May 17, 2006 and before 2011.



9. Limitation on Certain Corporate "Cash Rich" Spin-Off Transactions after May 17, 2006. The Act denies tax-free treatment to certain spin-offs where either the distributing corporation or the controlled corporation is a "disqualified investment corporation." A "disqualified investment corporation" is defined as a corporation having investment assets that are two-thirds or more of the value of the corporation's total assets. However, for distributions occurring within one year after May 17, 2006, the investment asset threshold is three-fourths. This rule is generally effective for distributions after May 17, 2006.

1. Tax-Exempts Penalized for Serving as Accommodating Parties in Tax Shelter Transactions. The bill generally subjects tax-exempt entities (including qualified retirement plans, etc.) to penalties for participating in prohibited tax-shelter transactions as accommodation parties. For example, if a tax-exempt entity knows or has reason to know that the transaction is a prohibited tax-shelter transaction, the entity is subject to a penalty tax equal to the greater of 1) 100% of the entity's net income for the year attributable to the transaction or 2) 75% of the proceeds received by the entity that are attributable to the transaction. A prohibited tax-shelter transaction is generally any transaction that the Treasury Secretary determines is a listed transaction or a reportable transaction as defined under current law. In addition, a tax of $20,000 is imposed on an entity manager that approves or otherwise causes a tax-exempt entity to be a party to a prohibited tax transaction if the manager knows or has reason to know that the transaction is a prohibited transaction.


The bill also clarifies that an exempt organization that participates in a reportable transaction (including a listed transaction) in order to shelter from tax the organization's own tax liability (e.g., the unrelated business income tax) is subject to the current-law rules pertaining to disclosure of such transactions.

These rules are generally effective for tax years ending after May 17, 2006. However, the new penalty provisions generally do not apply to transactions before May 17, 2006.

1. Partial Payments Required with Offer-In-Compromise Submissions Made 60-days or More after May 17, 2006. The Act requires that a taxpayer make a good faith down payment of 20 percent of any lump sum offer-in-compromise with any application for an offer. For periodic payment offers, the taxpayer is required to comply with their own proposed payment schedule while the offer is being considered. The provision also provides that an offer is deemed accepted if the IRS does not make a decision with respect to the offer within two years from the date that the offer was submitted.



2. Withholding on Payments Made to Persons Providing Goods or Services to Federal Government or State Governments After 2010. The Act requires three-percent withholding on payments (including payments made in connection with a government voucher or certificate program) for property and services made by the Federal government and by all State and local governments (other than local governments with less than $100 million of annual expenditures) and their instrumentalities. The provision excludes a number of payment types from withholding, including payments related to certain public benefits programs.