Steven A. Branson, Esq. - Financial Strategies

The IRS announced that it will stop collecting the excise tax on long-distance calls. Furthermore, there will be a refund of this 3% tax available when you file your 2006 income tax returns.

Congress passed the Deficit Reduction Act of 2005 in February of 2006. This law makes access to Medicaid more difficult by:

1. extending the general look-back period from 3 to 5 years,
2. delaying the start of the penalty period for transfers of assets within that period,
3. limiting the amount of home equity that can be excluded,
4. making a mandatory designation of your state as the contingent beneficiary of any annuities you own,
5. requiring a mandatory shift of income from the nursing home spouse to the healthy spouse, and
6. changing the test on when investment in an annuity is an excluded asset. The law has raised concerns that charitable donations, payment of college tuition for children or grandchildren, and gifts to children may be reachable by the state. Some also believe that children may become responsible to the state for their parent’s care.

The new Roth 401(k) plan combines features of Roth IRAs as discussed above with the features of a regular 401(k) account. Employees can contribute after-tax dollars to their retirement funds from salary in place of, or as part of, their plan contributions. The after-tax contribution can later be withdrawn tax-free.

The contribution limit is the same as the traditional 401(k) limit, which is substantially higher than the Roth IRA limit. Also, participants in 401(k) plans often are excluded from also making Roth IRA contributions.

When an employee leaves his company, he can roll the Roth 401(k) account into a Roth IRA, continuing the tax deferral and avoiding the minimum required distributions of traditional IRAs that begin at age 70½.

To decide if the Roth 401(k) is better for you, you need to decide that forgoing the tax savings now (and thus having less take-home pay) is better than paying taxes on the traditional 401(k) distributions at retirement. If you believe that future tax rates will be higher for you in retirement, then the case becomes more compelling. Of course, if the plan allows, you can hedge the decision by participating in both Roth and traditional 401(k) accounts. Note that the new plan will only be in effect until 2011.

New Tax Law and Related Planning: Congress passed the Tax Increase Prevention and Reconciliation Act of 2005 (“TIPRA”) last week. Principally, this law provides $70 billion in tax cuts consisting largely of extending the dividend and capital gains tax rate cuts for two more years beyond 2008, the original expiration date. The law also provides some relief from the Alternative Minimum Tax (“AMT”). The law eliminates the cap on converting IRAs to Roth IRAs for one year, allowing the resulting taxes to be paid over two years. The taxes anticipated from conversions are part of the $20 billion of revenue increases used to offset the revenue loss from other provisions. Some provisions originally proposed were removed from this bill but may appear in future bills, including items such as extending the state sales tax deduction and teachers’ expense deduction.

Capital Gains and Dividends – The 2003 lowering of the tax rate on long term capital gains and dividends was set to expire in 2008. TIPRA extends these rates until 2010, which lessens any pressure to sell stocks by 2008. AMT relief – TIPRA increases the exemption for the AMT to $62,550 for joint filers (from $58,000 for 2005) and to $42,500 for single files (from $40,250). The change seems small but will save 15 million people from the AMT. We had anticipated this possibility when doing year-end planning in 2005, shifting deductions to 2006. Now, those deductions need to be used because the new law increases the exemption for one year only. Planning for 2007 will be different.

Roth Conversions – The $100,000 cap on Roth conversions is lifted after 2009, and the taxes due on conversions can be paid over two years. Eliminating the cap would allow high income filers to shift from IRAs, where distributions are taxed, to Roth IRAs, where there is no tax on distributions and no requirement to begin minimum distributions at age 70½. If the income tax rates will be higher after 2010, as many predict, paying the tax in 2010 may make sense. This is especially true if the tax is paid with money outside of the Roth IRA so that thee maximum amount can be rolled over.

“Kiddie” Tax – Currently, children under age 14 are required to pay tax on unearned income in excess of $1,700 at their parents’ marginal tax rate. TIPRA increases the age to 18, subjecting more children to their parent’s tax rate. For families planning to sell assets in a child’s name at the low tax rates before he or she enters college, Congress has now frustrated that plan.