New Tax Law Increases Costs of Offers-in-Compromise; Expands Scope of “Kiddie Tax”

June 19, 2006

President Bush recently signed the Tax Increase Prevention and Reconciliation Act of 2005 into law, generating a number of tax law changes of interest to clients.

TIPRA increases the scope of the “kiddie tax” on investment income.  The kiddie tax requires children to pay tax on investment income at their parents’ marginal rates.  This prevents a high income taxpayer from reducing his tax burden by investing in his child’s name.  The tax formerly applied to investment income that a child earns up to age 14.  TIPRA applies the tax to investment income that a child earns up to age 18.

TIPRA also increases the cost of submitting an offer-in-compromise with the IRS.  Currently, taxpayers pay only a $150 application fee to file an offer-in-compromise.  Under TIPRA, a taxpayer proposing to settle a debt with the IRS using an offer-in-compromise must include a partial payment with the offer.  A taxpayer who submits a lump sum offer must include a payment of 20% of the proposed offer.  If the taxpayer offers instead to make periodic payments, the taxpayer must make the proposed payments from the time the offer is submitted until it is accepted or rejected.  These rules apply to all offers submitted after July 16, 2006.  A taxpayer considering whether to file an offer-in-compromise, therefore, should file before the deadline to take advantage of the lower fee.

Under TIPRA, most taxpayers will continue to pay a 15% tax on capital gains and dividend income.  This reduced rate was set to expire in 2008, but it has been extended until the end of 2010.  The law also extends the 0% capital gains rate for taxpayers in the 10% and 15% marginal income tax brackets.  Beginning in 2011, capital gains will be taxed at their previous rates of 20% for most taxpayers, and 10% for taxpayers in the 10% and 15% marginal income tax brackets.

TIPRA also extends and increases relief from the alternative minimum tax (AMT) for one year.  For 2006, the exemption from AMT increases from $58,000 to $62,550 for joint filers and from $40,250 to $42,500 for single filers.  Additionally, taxpayers will still be allowed to claim most non-refundable personal credits against AMT.

TIPRA extends the investment deduction under I.R.C. § 179 for equipment and depreciable assets through 2009.  Under this provision, small businesses can deduct the costs of acquiring up to $100,000 in equipment and other depreciable assets.  The deduction phases out to the extent that a business’s total annual investments exceed $400,000.  Without this provision, the business would be forced to recover these investment costs over several years using depreciation deductions.

Finally, TIPRA increases opportunities for taxpayers to convert traditional IRAs into Roth IRAs.  Beginning in 2010, everyone, regardless of his or her modified adjusted gross income, can convert traditional IRAs into Roth IRAs without incurring early withdrawal penalties.  This option was previously restricted to taxpayers with modified adjusted gross incomes under $100,000.  A taxpayer converting funds in 2010 will owe half of the corresponding tax liability in 2011 and half in 2012. 

For more information about how TIPRA may affect you or your business, please call Scott Martz at (513) 651-6881.