 President Bush recently signed a new tax bill into law that includes sweeping changes to the tax code. Investors have been eagerly anticipating tax revisions - but one needs to be aware that good and bad news is embedded in the changes. These changes affect not only invest-ing but also retirement planning, college funding, and taxes.
Most publicized was the extension of favorable capital gains and dividend tax rates until 2010. Previously, these low rates were scheduled to expire in 2008. The standard tax rate on long-term capital gains and qualified dividends remains at 15 percent, and taxpayers in the bottom two tax brackets may only pay 5 percent. Wise investors will use the next four years as a golden opportunity to take profits and sell highly appreciated securities while tax rates are near historical lows.
High income taxpayers will also be able to convert their traditional IRAs to Roth IRAs. Previously, annual income greater than $100,000 disqualified taxpayers from making Roth conversions. Under the new law, anyone - regardless of income - may make a Roth IRA conversion. By converting your IRA into a Roth, no tax will be paid on qualified withdrawals, saving you (and potentially your heirs) from making massive tax payments down the road. However, the ability to make this Roth IRA conversion does not begin until 2010.
Relief has finally arrived for the Alternative Minimum Tax (AMT). The AMT exemption amount has been raised for married taxpayers (to $62,550), and for single taxpayers (to $42,500). The net effect means that many middle and upper-middle income households will avoid this complex stealth tax.
It's the timing associated with the changes that makes the new law a mixed bag. The AMT relief is only for one year, 2006, and does not extend for 2007 and beyond.
With political pundits predicting Democratic control of at least one chamber of Congress after the 2006 elections, we may have seen the last tax cut package for several years. No action has been taken on the tax laws enacted in 2001, meaning that many of the favorable rules currently in place are scheduled to "sunset" (expire) after 2010. Those provisions include: lower tax brackets, child tax credits, estate tax thresholds (the "unified credit"), capital gains tax rates, qualified dividends, and favorable tax treatment of 529 College Savings Plans.
Education planning received the biggest hit in the new tax package. College Savings Plans are currently tax-free when the money is used for college education, yet a sunset in the 2001 laws means that college withdrawals will be taxed at the student's rate.
Many families use another vehicle - custodial (UGMA/UTMA) accounts - as a way to finance education. A great provision of these accounts has been that once a child is 14, Custodial accounts were taxed at the child's rate, meaning that they were virtually tax free or a low 5 percent tax bracket. The new law pushes back this "Kiddie Tax", and it does not go into effect until the child turns 18. This is a disappointment, since custodial accounts are taxed at higher, parental tax rates until the child's freshman year of college.
While there are negative implications associated with the new tax law, tax relief is always welcome. Even so, careful financial planning becomes even more critical to navigate the numerous traps in the new laws. Optimistically speaking, with the November elections should come a clearer sense of what lies ahead in the future of these short-lived tax changes. In the meantime, thorough planning is critical.
Owen Malcolm, CFP, is vice president and CFO of Sanders Financial Management. He can be reached at (770) 448-5111 or at omalcolm@sandersfmi.com. |
