After many months of wrangling, the $70-billion, Tax Increase Prevention and Reconciliation Act of 2006 is now a reality. To pay for some of the tax breaks extended or created, lawmakers included more than a dozen “revenue offsets,” including one that removes restrictions on rollovers to Roth individual retirement accounts (IRAs) and another that affects the so-called “kiddie tax.”
Beginning in 2010, those electrical contractors and business owners who employ IRAs as a saving method will be able to roll over the IRA into a Roth IRA. The ability to make such a rollover is currently limited to taxpayers with adjusted gross incomes of no more than $100,000. The amount being rolled over must be included in gross income, so taxes will be due, although they can be spread over a two-year period if the rollover is made in 2010. Qualified withdrawals from Roth IRAs are not taxable, and Roth IRAs are not subject to the minimum distribution requirements of conventional IRAs and 401(k) plans.
The new bill also ended a practice that allowed high-income families to lower their tax bills by transferring assets to minor children. The new rules require taxing unearned income at their parents’ rates until children reach age 18.
The ‘kiddie tax’
Generally, when the unearned income of a child exceeds the annual inflation-adjusted amount, it is taxed at the higher tax rates of the parents. This so-called “kiddie tax” is designed to lessen the effectiveness of intrafamily transfers of income-producing property that would shift income from the parents’ high marginal tax rate to the child’s generally lower tax bracket, thereby reducing the family’s overall tax liability.
The new law increases the age the “kiddie tax” applies from under 14 to under 18 years of age. These special rules apply to the “unearned” income of a child—such as that from dividends paid to them as partial owners of the parents’ electrical contracting business, not from wages or other income earned while performing actual services.
Since this increased age provision is in effect for 2006, an electrical contractor or business owner might want to seek professional advice. If the unearned income of children under 18 is significant, some tax strategies might require rethinking. Gifting appreciated stock to your children may, for example, no longer produce a tax saving if they sell the stock while subject to the new rules. Nor would holding dividend-paying stocks or interest from bonds be as profitable in the hands of underage children.
The dreaded AMT
The alternative minimum tax (AMT) is a separate method of determining income tax for an electrical contracting operation and its owner. It was originally devised to ensure that a minimum amount of tax is paid by high-income corporate and non-corporate taxpayers who reap large tax savings thanks to so-called “tax preferences.”
In essence, the AMT functions as a recapture mechanism, reclaiming some of the tax breaks primarily available to high-income taxpayers such as certain tax deductions, exemptions, losses and tax credits. Unfortunately, because the amount of income exempted from the bite of the AMT is not indexed for inflation, increasing numbers of electrical contracting business owners feel the pain each year.
To calculate the tentative minimum tax, an electrical contractor must first determine alternative minimum taxable income (AMTI) and then subtract the AMTI exemption amount. The new tax law provides an exemption amount—an amount that is phased-out for married couples filing jointly with AMTI of $150,000 or more, or unmarried individuals with AMTI of $112,500 or more. While the $4,500 exemption amount in the new law will help, it is hardly a solution for many electrical contractors, as it does not affect businesses.
The exemption amount was scheduled to decrease from $58,000 to $45,000 for married filing jointly (from $40,250 to $33,750 for unmarried individuals) for tax years beginning after Dec. 31, 2005. Instead, under the new law, for taxpayer years beginning in 2006, the exemption amounts are increased to:
- $62,250 in the case of married individuals filing a joint return and surviving spouses
- $42,500 in the case of unmarried individuals other than surviving spouses
- $31,275 in the case of married individuals filing a separate tax return.
Also, don’t forget the Energy Tax Incentive Act of 2005—enacted and effective for 2006—which is a nonrefundable tax credit for alternative fuel motor vehicles and alternative fuel motor vehicle refueling property. These tax credits—along with the credit for nonbusiness energy property, the credit for residential energy-efficient property and others—all qualify as nonrefundable personal credits. The new law extends the allowance for nonrefundable personal credits against both the regular tax and the AMT for one year through 2006.
Capital gains and dividends
For electrical contracting business owners, this is probably the most important provision in the new tax law. The reduced tax rates on long-term capital gains and dividends were scheduled to expire at the end of 2008. Now, the owners of incorporated electrical contracting operations that distribute profits in the form of dividends can safely make plans to benefit from those lower tax rates on all dividend payments received. What’s more, these lower tax rates are also extended for capital gains that result from the sale of business property—even the business itself.
The new law extends the reduced rates of 0, 5 and 15 percent on dividends and long-term capital gains to taxable years beginning on or before Dec. 31, 2010. As under prior law, capital gains and dividends that would otherwise be taxed at a 5 percent rate will be taxed at 0 percent for taxable years beginning after 2007.
Since 2003, lawmakers have provided enhanced expensing or write-offs under the Tax Code’s Section 179. The new tax legislation extends this unique treatment through Dec. 31, 2009, allowing larger, first-year deductions for newly acquired business equipment.
Today, and through 2009, the maximum amount that an electrical contractor may expense or immediately deduct is $100,000 of the cost of property (adjusted for inflation, of course).
While that $100,000 write-off must be reduced dollar-for-dollar by the amount of qualifying property acquisitions in excess of $400,000, inflation has increased the maximum amount that can be expensed to $108,000 for 2006, with a $430,000 cap beyond which the first-year write-off must be reduced. Without the extension, the expensing limit would drop to $25,000 on a $200,000 cap after 2007.
Other provisions included in the new legislation address a variety of areas, some of which are listed below.
New tax treatment for environmental cleanup costs: Under current law, income earned by certain environmental cleanup funds is taxable to the company that contributed to the funds.
This is the case even though the taxpayer has permanently surrendered all control and dominion over the money in the fund. Under the new law, special tax treatments for certain settlement funds established to resolve “superfund” claims have been created.
Funds created to resolve claims will no longer be taxed to the company involved. These settlement funds will now be treated as if owned by the U.S. government and will not be subject to federal taxation—at least until after Dec. 31, 2010.
Eliminating the tax surcharge will, it is hoped, encourage more companies to establish settlement funds devoted to environmental cleanup.
Higher bond limits for financing: Those qualified small issue bonds, tax-exempt state and local bond issues that have been used to finance private business property or the acquisition of land and equipment by farmers, have, in the past, had limits on the amount of financing that could be provided to individual borrowers.
In general, for bonds issued after Sept. 30, 2009, the tax law permits up to $10 million of capital expenditures to be disregarded, in effect, increasing from $10 million to $20 million the maximum allowable amount of total capital expenditures by an eligible business in the same municipality or country.
The new law accelerates the application of the $10 million capital expenditure limitation from bonds issued after Sept. 30, 2009, to bonds issued after Dec. 31, 2006. This higher limit on small issue bonds could enable some electrical contractors to obtain additional funding from local development agencies.
As mentioned, in order to reach agreement and keep within budget constraints, lawmakers removed some important provisions that will likely appear in stand-alone legislation, in a “trailer bill,” or could be tacked onto the pending pension reform bill.
Included among the additional provisions likely to be included in any new legislation is the extension of the deduction for state and local sales tax, the teachers’ classroom expense deduction, research and development provisions, some employment tax credits, and other popular, but temporary, tax incentives.
Although these are popular provisions, when added together, they total about $90 billion in one-year tax “relief” at a time of significant budget deficits. Despite 2006 being an election year and, traditionally, a period when not much tax legislation passes, the months ahead may see even more changes to our tax law, changes that could impact every electrical contractor and his or her business. EC
BATTERSBY is a freelance writer based in Ardmore, Pa. For more than 25 years, his tax and financial features have appeared in ELECTRICAL CONTRACTOR and other leading trade publications.