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Nuggets in the new tax law: 5 strategies

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in Small Business Tax,Small Business Tax Deduction Strategies

Some of the key provisions in the new tax law signed by the president last month won’t take effect for years to come. But that doesn’t mean you should sit on your hands in the meantime.

Advice: Act now. In some cases, you’ll reap instant tax gratification. In other cases, you’ll lay the groundwork for a future tax payoff.

Here are five ways you can reap benefits from what the new tax law—the Tax Increase Prevention and Reconciliation Act (TIPRA)—has sown:

1. Take the first IRA rollover step. Beginning in 2010, any individual taxpayer will be able to convert or “roll over” a traditional IRA into a Roth IRA. Currently, this privilege is restricted to those with annual adjusted gross incomes (AGI) of no more than $100,000. Of course, you still have to pay tax on the transferred funds. But if you convert in 2010, you can spread out the tax bite over three years (2010, 2011 and 2012).

Why do it? Qualified Roth IRA payouts are 100 percent free of federal income tax. Plus, you’re not required to begin withdrawing amounts after age 701/2.

If a Roth meets your needs, start bulking up your traditional IRA—you can contribute to traditional IRAs on a nondeductible basis—in anticipation of converting it in 2010.

Strategy: Roll over qualified plan assets to a traditional IRA. Then, in 2010, include the assets in the Roth IRA conversion. You can’t roll over directly from your retirement plan to a Roth; it’s a two-step process.

2. Protect college-bound kids. The new tax law hikes the age threshold for the “kiddie tax.” For 2006, any unearned income above $1,700 that your underage- 18 child receives this year—instead of age 14, as under previous law—is subject to tax at your top tax rate.

If you have teenagers, you might want to shift some funds to tax-deferred or tax-free investment vehicles, such as growth stocks and muni bonds, respectively.

Strategy: Sock away money in a Section 529 college-savings plan, which will provide tax-free accumulation plus tax-free distributions so long as the funds are used for qualified education expenses. Best of all, the plan earnings are exempt from the kiddie tax.

Note that the tax break for Section 529 plan distributions is still scheduled to “sunset” after 2010, but Congress probably will extend it.

3. Check for vital AMT signs. If you’ve been hit by the alternative minimum tax (AMT) the past few years, you may have thrown in the towel. But here’s a ray of hope: Not only does the new law extend higher AMT exemption amounts for another year, it bumps up the exemptions again for 2006. (See box above.)

In addition, the new law allows you to use nonrefundable credits (such as the dependent care credit and education tax credits) to reduce AMT liability.

Strategy: Find out where you stand in 2006. If you can avoid the AMT this year by postponing tax preference items or cutting back on state income tax prepayments— or both—do it.

4. Preserve lower tax rates for investments. In 2003, Congress carved out a special tax break for long-term capital gains and qualified dividends. As a result, the maximum federal tax rate for those items is only 15 percent (5 percent for low-income taxpayers), as opposed to ordinary-income rates reaching as high as 35 percent.

These preferential tax rates were scheduled to expire after 2008, but the new law extends them for two more years, through 2010.

Strategy: Factor taxes into your investment decisions. For instance, you might acquire or hold onto dividend-paying stocks, absent extenuating circumstances.

Similarly, you might contemplate real estate purchases that could take a few years to appreciate in value.

Remember that the holding period for long-term capital gains is more than a year. If you want, you can buy and sell more quickly within your retirement plan.

5. Stretch out top-dollar business write-offs. Section 179 of the tax code allows you to “expense,” or currently deduct, the cost of qualified business assets placed in service during the year. The maximum deduction quadrupled from $25,000 to $100,000 in 2003. (It has inched up since then for inflation.) For 2006, you can write off up to $108,000 of the assets your business buys.

The Section 179 deduction limit originally was to revert to $25,000 after 2007. The new law extends the inflation-adjusted $100,000 write-off for two more years, through 2009.

Strategy: Spread out equipment purchases over the next few years. You don’t have to worry any longer about cramming all your purchases into the next year-and-a-half.

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