June 2006

Dear Clients and Friends:

On May 17 President Bush signed the Tax Increase Prevention and Reconciliation Act into law.  Following are some of the key tax planning areas:

New Roth IRA conversion opportunity
The new tax law eliminates the $100,000 adjusted gross income ceiling for converting a traditional IRA into a Roth IRA. While this benefit won’t begin to apply until after 2009, plans to maximize this opportunity should start immediately for many taxpayers. For persons in the upper tax brackets, a Roth IRA can save a significant amount of tax, especially when incorporated into an estate plan in which Roth assets are eventually passed down to the next generation.

Currently, a taxpayer is allowed to convert a traditional IRA to a Roth IRA only if their adjusted gross income in the year of conversion does not exceed $100,000. The amount converted is treated as distributed from the traditional IRA and, as a consequence, is included in the taxpayer’s income, but the 10-percent additional tax for early withdrawals does not apply.

Starting in 2010, the $100,000 adjusted gross income cap is eliminated. All other rules continue to apply, which means that the amount converted to a Roth IRA still will be taxed as income at the individual’s marginal tax rate. One exception for 2010 only: taxpayers will have a choice between recognizing the conversion income in 2010 or averaging it over 2011 and 2012.

Benefits
While recognizing income sooner rather than later is usually not smart tax planning, in the case of this new opportunity to convert a traditional IRA to a Roth IRA, the math encourages it. The difference is twofold:

• All future earnings on the account are tax free; and
• The account can continue to grow tax-free longer than a traditional IRA without being forced to be distributed gradually after reaching age 70 ½.

These can be significant advantages, especially valuable to individuals with substantial assets who won’t need their IRA account to live on during retirement.
Following are steps you can start taking now:

Nondeductible IRA strategy
Taxpayers who currently don’t qualify for either a traditional IRA or a Roth IRA should consider making nondeductible IRA contributions.

After 2009, any nondeductible traditional IRA can be converted into a Roth IRA. Only the growth on the accounts will be income at the time of conversion.  As a result, the present $95,000 / $150,000 AGI Roth contribution limits will no longer be barriers. An individual with higher income can begin to make nondeductible IRA contributions now and then convert that amount into a Roth IRA in 2010.

401K rollovers
Contributions to a 401K cannot be rolled over directly to a Roth IRA.  However, they often can be rolled over into a traditional IRA.  After 2009 your traditional IRA can then be rolled over into a Roth IRA.

Save now to pay the tax on conversion
Converting from a traditional IRA or a nondeductible IRA to a Roth will create some additional taxable income. Depending on your tax situation the amount of taxable income may or may not be significant.  If you are thinking of converting, start planning now and start saving now to cover the additional tax costs. 

Changes to the “Kiddie Tax” in this tax act
The new tax law raises the age for which the  “Kiddie Tax” applies from under age 14 to under 18 years of age.  That means investment income for kids ages 14 through 17 are now taxed at their parents tax rates.  Some planning techniques would include:

• You should review your children’s portfolio for possible changes.  Alternatives to consider would be municipal bonds, low dividend paying growth stocks (but in this market?), and treasury bills.
• If your child has earned income from a part time job, consider investing in a Roth IRA for them.  (If your child doesn’t have earned income, but you are self-employed consider hiring your child.)
• Consider setting up a Coverdale Education Savings Account or a Section 529 Tuition plan instead of opening an investment account for your child.

AMT relief
The tax act included a small increase in the Alternative Minimum Tax exemption (deduction).  The increase will not save many people from being affected by this tax.

Some additional tax provisions
• Extending the 15% tax bracket on capital gains and qualified dividends two additional years until 2010. 
• Extending the $100,000 expensing of business equipment (179 expense) for two additional years until 2010.

You may be eligible for some significant tax savings so please do contact us if you have any questions about this information.