President Signs Tax Reconciliation Legislation

Following House passage on May 10, 2006 and Senate passage on May 11, 2006, The President on May 17, 2006, signed the Tax Increase Prevention and Reconciliation Act of 2005. The enactment date for the legislation, and the effective date for many of its provisions, thus becomes May 17, 2006. The budget-protected legislation with a net cost of $70 billion reflects a careful juggling act to squeeze in as many tax breaks as possible that might be controversial enough to need the budget protection afforded by this reconciliation bill, and enough revenue raisers to try to prevent procedural challenges to the legislation for its out-year costs beyond the budget window.

Key tax break extensions include the following:

1. Two-year extension of reduced rates on capital gains and dividends through 2010;
2. Increase in the AMT exemption levels for 2006 to a higher level than 2005;
3. Extension through 2006 of the provision allowing nonrefundable credits to be claimed against the AMT;
4. Two-year extension of the Code Sec. 179 small business expensing election; and
5. Extension of the exception from Subpart F for active financing income and exempt insurance income for two years, and creation of a Controlled Foreign Corporation look-through rule exception from Subpart F for cross-border payments of dividends, interest, rents, and royalties funded with unrepatriated active income.

Provisions to raise revenue and to preserve budget protection for the legislation include the following:

1. Waiver of the income limits on eligibility to convert from an IRA to a Roth IRA starting in 2010;
2. Manipulation of the timing of corporate estimated tax installment payments;
3. Application of earnings stripping rules to C Corporations which are partners;
4. Expansion of information reporting requirements to interest on tax-exempt bonds;
5. Lengthening the amortization period for geological and geophysical expenditures for major integrated oil companies;
6. Three provisions tightening the rules under the Foreign Investment in Real Property Tax Act (FIRPTA) involving RICs, REITS, the treatment of distributions not treated as gain, and creation of a wash-sale rule;
7. Restrictions on tax-free treatment for certain corporate cash-rich spin-off transactions;
8. Imposition of loan and redemption requirements on pooled financing bonds;
9. Tightening of offers-in-compromise requirements;
10. Increase in the age for taxation of unearned income of minors at their parents' rate;
11. New withholding requirements of certain payments by government entities;
12. Repeal of the Foreign Sales Corporation/Extra-Territorial Income grandfather rules for certain binding contracts in order to comply with a recent World Trade Organization ruling;
13. Clarification that the domestic manufacturing deduction wage limitation may only include those wages allocable to domestic production gross receipts;
14. Several modifications to the foreign earned income and employer-provided housing exclusion rules for U.S. citizens living abroad; and
15. Extension of tax shelter penalties to accommodation parties and their managers.

Other provisions included in the legislation address a variety of areas:

1. Tax treatment of environmental cleanup funds;
2. Simplification of the active trade or business test;
3. Enhancement of veterans' access to affordable mortgages in Alaska, Oregon and Wisconsin;
4. Availability of capital gains treatment for sale of self-created music works and election of five-year amortization for a created or acquired music work;
5. Expansion of the tonnage tax option to lighter vessels;
6. Codification and extension of the exception for the Texas Permanent University Fund from the tax-exempt arbitrage rules;
7. Acceleration of the increased limits for industrial development bonds; and
8. Revisions to the tax treatment of loans to continuing care facilities.

Expired provisions that did not make it into this reconciliation legislation are likely to be taken up in a follow-on piece of tax legislation that Congress would also hope to pass this year.