In early May, Congress passed the Tax Increase Prevention and Reconciliation Act (TIPRA). President Bush signed it into law on May 17, 2006. The new legislation includes both favorable and unfavorable provisions. This letter briefly explains the most important changes.

Preferential Tax Rates on Capital Gains and Dividends Extended through 2010

For individual taxpayers, TIPRA extends through 2010 the preferential federal income tax rate structure for long-term capital gains and qualified dividends. The maximum rate on most long-term gains and dividends will remain at the current 15%. Even better, the current 5% rate will continue through 2007 for long-term gains and qualified dividends earned by individuals in the lowest two regular tax brackets (the 10% and 15% brackets) before dropping to 0% (that’s not a typo) for 2008 though 2010. (Prior law called for the rates to rise after 2008.)

TIPRA also extends the 28% maximum rate on long-term gains from collectibles sales and the 25% maximum rate on long-term real estate gains attributable to depreciation through 2010.

One-year Alternative Minimum Tax Fix

TIPRA includes two quick fixes, for this year only, to the individual alternative minimum tax (AMT) rules. These changes will prevent millions more (possibly including you) from owing the dreaded AMT this year.

Under the first fix, the 2006 AMT exemption amounts are increased as follows:

· To $62,550 for married individuals who file jointly (up from the 2005 figure of $58,000). Without the fix, the 2006 exemption would have been only $45,000.

· To $42,500 if you are a single individual or head of household (up from the 2005 figure of $40,250). Without the fix, the 2006 exemption would have been only $33,750.

· To $31,275 if you use married filing separate status (up from the 2005 figure of $29,000). Without the fix, the 2006 exemption would have been only $22,500.

Under the second fix, you can use your nonrefundable personal tax credits (such as the dependent care credit and the Hope Scholarship and Lifetime Learning higher education credits) to reduce both your 2006 regular tax and AMT bills (same as for 2005). You will also be able to use the new residential and nonbusiness energy property credits to reduce both of these taxes for 2006. So, if you are considering making energy efficient improvements to your home, you might want to do it now rather than waiting until next year.

Favorable “Section 179 Deduction” Rules Extended through 2009

The so-called Section 179 rules allow many small businesses to deduct the full cost of most equipment and software additions (whether new or used) in the first year they are put to use. For tax years beginning in 2006, the maximum Section 179 write-off is a generous $108,000. However, the maximum Section 179 deduction was scheduled to decrease to only $25,000 for tax years beginning in 2008 and beyond. Thankfully, TIPRA extends the current taxpayer-friendly Section 179 rules by two years, through tax years beginning in 2009.

Kiddie Tax Rules Now Apply to Older Kids, Starting Right Now!

The so-called Kiddie Tax rules can cause a dependent child’s unearned income (typically from investments) to be taxed at the parent’s higher marginal federal income tax rate. Until now, the Kiddie Tax only applied through the year before a child turned age 14. In other words, the Kiddie Tax issue ceased to exist for the year the child turned 14 and for all subsequent years. Unfortunately, TIPRA extends the Kiddie Tax rules through the year before a child turns 18, starting with 2006. More specifically: for this year and beyond, the Kiddie Tax issue will be lurking until the year that a dependent child turns 18. Children who are still age 17 as of 12/31/06 are potential Kiddie Tax victims this year. The only saving grace is that, for 2006, the Kiddie Tax only affects under-age-18 dependent children with unearned income in excess of $1,700.

Bottom Line: You may have a dependent child who is exposed to the Kiddie Tax this year, even though it didn’t apply last year.

Income Restriction for Roth IRA Conversions Is Eliminated (for 2010 and Beyond)

The Roth IRA conversion privilege is currently restricted to individuals with modified adjusted gross income (MAGI) of no more than $100,000. TIPRA eliminates the MAGI restriction, but don’t get too excited. Why? Because this change won’t become effective until way out in 2010. For Roth conversions that occur in that year only, half of the taxable income triggered by the conversion can be reported on your 2011 return and the other half can be reported on your 2012 return. For conversions in 2011 and beyond, all the income must be reported on the return for the conversion year (same as under the current rules).

Reality Check: Believe this change when you see it! Congress could decide to change its mind and eliminate this favorable provision long before 2010.

Corporate Estimated Tax Payments

TIPRA increases some estimated tax payments for corporations with assets of $1 billion or more. The increases only apply to payments due in: (1) July, August, and September of 2006 when affected corporations must pay in 105% of the normal amount; (2) July, August, and September of 2012 when 106.25% of the normal amount must be paid in; and (3) July, August, and September of 2013 when 100.75% of the normal amount must be paid in. The next payment due after an increased payment is then reduced by the amount of the increase in the previous payment. In a second change that’s actually taxpayer-friendly: 20.5% of corporate estimated tax payments that are otherwise due on 9/15/10 can be deferred until 10/1/10, and 27.5% of payments that are otherwise due on 9/15/11 can be deferred until 10/1/11. This prospective change will apply to all corporations regardless of size.

Domestic Producers Deduction

For tax years beginning after 5/17/06, TIPRA limits wages for the 50% limit for the new domestic producers to include only those allocable to domestic production gross receipts. TIPRA also repeals a complicated W-2 wages limitation provision for wages allocated to partners and S corporation shareholders for tax years beginning after 5/17/06.

Bottom Line: Because of this change, some businesses may find it beneficial to design and implement recordkeeping systems to capture the portion of employees’ time and thus pay devoted to qualifying domestic production activities. These businesses may also want to consider using separate general ledger accounts to separate wages related to domestic production gross receipts from other from those that are not.

There May Be Another New Tax Law this Year

You now understand the key tax changes included in the TIPRA legislation, but there are other provisions that we’ve had to ignore in order to keep this letter from turning into a book. Please call us if you want more information.

Also, don’t be surprised if you see at least one more new tax law passed before year-end. Why? Because additional legislation will be needed to extend various popular federal income tax breaks including (but not limited to) the following:

· The itemized deduction for general state and local sales taxes in lieu of writing off state and local income taxes.

· The write-off for up to $4,000 of higher education tuition costs and related fees.

· The deduction for up to $250 of classroom costs paid by elementary and secondary school educators out of their own pockets.

· The tax credit for expanding research and development activities.

All of these breaks (plus some others not listed here) expired at the end of 2005 and will probably be retroactively resurrected for at least this year by future legislation. If that happens, we will be in touch. In the meantime, please contact us if you have any questions about TIPRA or anything else.

This information is also available at www.stappfinancial.com. If you do not want to receive future e-mail news from Stapp Financial, link to our subscription form, or send an e-mail to bstapp@stappfinancial.com. Before acting on any advice it is recommended to seek appropriate counsel applicable to your individual circumstances