On May 17th, President Bush signed into law the “Tax Increase Prevention and Reconciliation Act of 2005,” which provides $70 billion in tax incentives, extends the 15% capital gains and dividend rates through December 31, 2010, and increases the AMT exemption amount for married taxpayers to $62,550. The Section 179 expense allowance ($108,000 in 2006), scheduled to revert to $25,000 in 2008, will instead remain in effect for two additional taxable years, 2008 and 2009. (P.L. 109-222; H.R. 4297).
To finance these tax incentives, Congress (i) imposed a new estimated tax regime on corporations; (ii) made the kiddie tax applicable to children up to 18 years; (iii) eliminated the $100,000 modified AGI limit on conversions of traditional IRAs to Roth IRAs; (iv) imposed information reporting for tax-exempt interest on tax-exempt bonds beginning in 2006 (which, although unlikely to affect federal income tax liability, could affect state income tax liability); (v) imposed new earnings stripping rules on corporations and partnerships; (vi) increased the amortization period for geological costs from 2 years to 5 years; (vii) imposed a new rules requiring taxpayers who submit offers in compromise to make partial payments pending consideration of their offer (the new rule requires taxpayers to make a down payment of 20% on a lump sum offer); and (viii) imposed tax increases of approximately 6% on Americans living overseas.
With respect to item (viii), while many taxpayers working abroad will see no increase, others’ tax liabilities will quadruple. For example, Americans working in high-tax European countries, will not be substantially affected. However, Americans working in low-tax jurisdictions with high housing costs, such as the Middle East, Singapore and Hong Kong, will have sharply increased tax liability, since the law changes taxation on subsidies.
The Senate on June 8th, voting mainly along party lines, rejected legislation permanently repealing the estate tax. Although Iraq and Katrina, as well as Mr. Bush’s own political troubles, could be factors which reversed the momentum for estate tax repeal, the issue seems to have become ideological. Senator Voinovich of Ohio, one of two Republicans voting against repeal, opposed further tax cuts given the current deficit. The Joint Committee on Taxation estimates that full repeal would cost $600 billion over 10 years. If Congress takes no action, the present exemption of $2 million will increase to $3.5 million in 2009, the estate tax will be eliminated for one year in 2010, and the pre-EGTRRA exemption amount of $1 million, with tax rates between 41% to 55%, will return in 2011.
Since Republicans fell only 3 votes short of full repeal, compromise could occur. Senator Baucus (D-Mont.), senior Democrat on the Senate Finance Committee, and one of four Democrats who voted for repeal, favors a $5 million exemption and an estate tax rate of 15%. Senator Clinton has in the past mentioned a $5 million exemption, but at a time when full repeal seemed more likely. Senator McCain has switched course, now voting for full repeal. He had previously voted against repeal in 2005, and had opposed even partial repeal.
Senate Majority Leader Frist (R-Tenn), a vocal advocate of repeal, had until recently refused to discuss compromise. However, he recently held meetings with several Democrats to discuss a compromise. The House, which has approved repeal several times, would likely take up compromise legislation if it clears the Senate.