Did you Miss the News?

In May 2006, a new tax law passed that has the potential to affect investors of all stripes. Because the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) received only brief attention from the news media, you may have overlooked some of the changes. It’s important to understand how this new tax law applies to your situation. The fact that you are reading this means you will almost certainly be affected by some of the major provisions.

Dividends and Capital Gains
The centerpiece of TIPRA is a two-year extension of the temporary lower tax rates on dividends and capital gains (through 2010). Dividends and long-term capital gains are taxed at a maximum 15% rate for Americans in the upper marginal income tax brackets. For taxpayers in the 10% and 15% brackets, the tax rate is 5% through 2007 and zero through 2010. Without the extension, dividend income would have been subject to rates up to 35%, and long-term capital gains would have been taxed at a maximum 20% rate in 2009.

AMT Relief
An exemption that helped many middle income taxpayers avoid the alternative minimum tax in 2005 was increased and extended through 2006. The new exemption levels are $62,550 for joint fi lers and $42,500 for single filers. Also extended was a provision that allows some taxpayers to claim many nonre- fundable personal credits to offset AMT liability. These include the dependent-care credit, the credit for the disabled and elderly, the credit for interest on certain home mortgages, and the Hope and Lifetime Learning credits for qualified education expenses.

Roth IRAs
Currently, only joint and single fi lers with modified adjusted gross incomes of $100,000 or less are eligible to convert a traditional IRA to a Roth IRA; income taxes are due on the amount converted. TIPRA changed the eligibility rules: Beginning in 2010, individuals will be able to convert a traditional IRA to a Roth IRA regardless of income or filing status. The new law also allows taxpayers who make the conversion in 2010 to spread the tax liability over two years (in 2011 and 2012).

Distributions from traditional IRAs are taxed as ordinary income and may be subject to an additional 10% federal income tax penalty if taken prior to reaching age 59 1/2. To qualify for the tax-free and penalty-free withdrawal of earnings, a Roth IRA must be in place for at least fi ve tax years, and the distribution must take place after age 59 1/2 or be due to death, disability, or a fi rst-time home purchase (up to a $10,000 lifetime maximum).

For the past several years, tax-law changes have occurred with surprising regularity. To benefit from them, it’s important to stay informed and to understand how you may be affected.

INHERITED IRAs

Special rules for spouses
You may treat an IRA inherited from your spouse as if you were the original owner. You may contribute to it (if you’re eligible to make IRA contributions), name your own beneficiary and even roll it over into another IRA. You also may delay distributions from an inherited traditional IRA until about age 701⁄2, and delay Roth IRA distributions indefinitely.

* But note that if you do choose to treat it as your own, you will be subject to the 10% early withdrawal penalty if you are under age 591⁄2.

All other beneficiaries
If you inherit an IRA from anybody else, you need to make annual withdrawals starting by the end of the year following the year in which the person dies, or you must withdraw the entire amount within fi ve years. Distri- butions to IRA benefi ciaries are exempt from the 10% penalty that normally applies to withdrawals taken before age 591⁄2. If the decedent had started taking required minimum distributions (RMDs), then you usually must continue withdrawals based on your own life expectancy. If the decedent hadn’t started taking RMDs, then you must make annual withdrawals to empty the IRA over your life expectancy or withdraw the entire amount within five years.

*Required minimum distributions (RMDs) from traditional IRAs generally must begin by April 1 of the year after you reach age 701⁄2. Roth IRAs are not subject to RMDs during your lifetime.