December 11, 2006
Author: , II
In a virtual avalanche of legislation enacted over this past summer, numerous changes have been made in federal, state and local tax laws, including the federal income tax rules governing qualified retirement plans and IRAs, that may be of significance in your personal or business financial, retirement, tax and estate planning. Some of the more widely applicable changes under these legislative and regulatory amendments include:
IRS Announces Standard Amounts for Individual Taxpayer’s 2006 Telephone Tax Refunds
The Internal Revenue Service has announced standard amounts that most long-distance customers can use to figure their telephone tax refunds. These amounts, which range from $30 to $60, will enable millions of individual taxpayers to request the telephone tax refund without having to dig through old phone bills. In general, anyone who paid the long-distance telephone tax can claim the refund on their 2006 federal income tax return. This includes individuals, businesses and nonprofit organizations. The standard amounts are based on the total number of exemptions claimed on the 2006 tax return. The standard amounts will be $30 for an individual filing a return with one exemption, $40 for two exemptions, $50 for three exemptions and $60 for four or more exemptions. Only individuals can use these standard amounts. Alternatively, individual taxpayers can choose to compute their refund using the actual amount of telephone tax paid on service billed after February 28, 2003 and before August 1, 2006.
Charitable Contributions from IRAs
Under the Federal Pension Plan Protection Act of 2006 (PPA), individuals who have reached age 70-1/2 (i.e., the age at which required minimum distributions generally begin) must consider whether charitable contributions in 2006 and 2007 should be made directly from their IRA. For such individuals, the law temporarily permits charitable contributions to be made directly from an IRA to the charity provided that the contribution does not exceed $100,000. If the contribution is made directly from the IRA, then the amount distributed is not included in the individual’s taxable income for the year, and no corresponding charitable contribution deduction is permitted for the amount so distributed. Since such a distribution is not includible in gross income, it will not increase adjusted gross income (AGI) for purposes of the phase out of itemized deductions, personal exemptions, or any other deduction, exclusion or tax credit that is limited or lost completely when AGI reaches certain specified levels. Even though a direct distribution from an IRA to a charity is not included in the taxpayer's gross income, it is taken into account in determining the owner’s required minimum distribution for the year. Thus, if the amount distributed directly from the IRA to an eligible charity at least equals the amount of the owner’s required minimum distribution for the tax year, no further distributions from the IRA are required for that tax year.
More Stringent Requirements for Certain Charitable Contributions
Under the PPA, in order to deduct charitable contributions of money, regardless of the amount, the donor must now maintain a cancelled check, bank record or receipt from the donee organization showing the name of the organization, and date and amount of the contribution. This is effective for cash contributions made in tax years beginning after August 17, 2006. The PPA further provides for the recapture of any tax benefit derived from a charitable contribution of other property with respect to which a fair market value deduction was claimed if the property is not used for an exempt purpose of the charitable organization, effective for contributions made after September 1, 2006, and also generally prohibits a deduction for contributions of clothing and household items unless they are in good used condition or better.
Non-Spousal Beneficiaries Permitted to Rollover Inherited Pensions and IRA Accounts
Beginning January 1, 2007, a non-spouse beneficiary will be permitted to directly roll-over a decedent’s qualified retirement plan or 401(k) benefits into an IRA established by the beneficiary in the decedent’s name. Many retirement plans currently provide that a beneficiary must receive his or her benefits within five years of the decedent’s death. The new rollover provision will allow those beneficiaries to enjoy greater tax deferral by stretching out required minimum distributions from the IRA over the beneficiary’s lifetime.
“Kiddie Tax” Provisions Modified
As part of tax legislation passed earlier this year, the so-called “kiddie tax” provisions, which require that children pay taxes on unearned income at their parent’s higher marginal income tax rates, now apply to children under the age of 18. Under prior law, the kiddie tax only applied to children under age 14.
Pennsylvania Personal Income Tax Deduction for Contributions to Section 529 Qualified Tuition Programs
Pennsylvania now allows contributions to a Section 529 Qualified Tuition Program (including such plans established by a state other than Pennsylvania) to be deducted for Personal Income Tax purposes. The annual deductible contribution limit per beneficiary is equal to the federal annual gift tax exclusion amount (currently $12,000 per year). Moreover, amounts that may be distributed tax free from such plans for educational purposes under the federal statute are likewise excluded from income for Pennsylvania purposes.
Philadelphia Wage and Net Profits Tax Rates Decreased
Effective January 1, 2007, the Philadelphia Wage and Net Profits Tax rates will be reduced to 4.26% for Philadelphia residents and to 3.7557% for non-residents.
New Jersey Sales Tax Rate Increase
Effective as of July 15, 2006, the New Jersey Sales and Use Tax rate was increased to 7% from 6%. The Sales and Use Taxes also apply to an increased number of services that were previously exempt.
Florida Intangibles Tax
Repeal of the Florida Intangibles Tax effective as of January 1, 2007 was finally signed into law on June 27, 2006. The repeal potentially makes Florida an even more attractive domicile for retirees and others - particularly those individuals who may have a large portfolio of investment assets (stocks, bonds, etc.), since Florida also has no state income or inheritance taxes.
Non-Qualified Deferred Compensation Arrangements
In Notice 2006-79, the IRS has provided additional transitional relief to allow business taxpayers sponsoring deferred compensation arrangements to come into written compliance with forthcoming Code Section 409A final regulations, by generally delaying the effective date until January 1, 2008. Section 409A applies to a wide range of deferred payment plans, including cash bonus plans and future payments under employment contracts for individual employees. We urge all businesses to review every existing employment contract and other compensation plans and agreements to insure compliance with Section 409A prior to January 1, 2008.
Pennsylvania S Corporation Elections
Effective for taxable years beginning after December 31, 2005, Pennsylvania will now automatically follow the federal income tax treatment of S Corporations and Qualified Subchapter S Subsidiaries (QSub). Under prior law, a corporation wishing to be taxed as an S Corporation (or QSub) for Pennsylvania tax purposes had to file a separate Pennsylvania S Corporation Election in addition to the federal S Corporation election. The new rule may have undesirable consequences for some corporations and their shareholders. For example, a foreign S Corporation that has Pennsylvania resident shareholders will automatically be treated as an S Corporation for Pennsylvania purposes and therefore, the shareholders would be required to report a share of undistributed S Corporation income for Pennsylvania income tax purposes. In order to avoid this treatment, the foreign S Corporation must elect out of such treatment by filing PA Form REV-976 signed by all of its shareholders with the Pennsylvania tax authorities on or before the due date for its Pennsylvania tax reports (i.e., by April 16, 2007 for calendar year taxpayers).
Pennsylvania Accelerates Phase out of Capital Stock and Foreign Franchise Taxes
The capital stock and foreign franchise tax rate for 2006 is reduced from 4.99 mills (0.499%) to 4.89 mills (0.489%) of taxable capital stock value. The tax rate is further reduced by 1 mill (0.1%) in 2007 and each succeeding tax year until the taxes are completely phased out by 2011. In addition, for taxable years after December 31, 2006, the exclusion amount for determining a company’s taxable capital stock value has been raised to $150,000 from $125,000 under prior law.
Pennsylvania Corporate Net Income Apportionment Formula
For tax years beginning after December 31, 2006, the weight given to the sales factor component of the three-factor apportionment formula used to determine taxable income of multi-state corporations subject to the Pennsylvania corporate net income tax will be increased to 70 percent (up from 60 percent). The change is expected to help companies in Pennsylvania that have a greater amount of their property and employees located within Pennsylvania than outside the state, such as manufacturers and wholesalers.
Philadelphia Business Privilege Tax Rate on Gross Receipts Reduced
The Philadelphia Business Privilege Tax rate on gross receipts was reduced to 1.75 mills (0.175 percent) per $1.00 of gross receipts as of July 1, 2006 (although the rate applicable to the net income portion of the Business Privilege Tax remains at 6.5 percent).
New Jersey Corporate Franchise Tax Surcharge
A new surcharge equal to 4 percent of the tax has been added to the New Jersey Corporate Franchise Tax for taxable years ending after July 1, 2006. The new surcharge also applies for tax years ending after July 1, 2007 and July 1, 2008, but is eliminated for taxable years ending after July 1, 2009.
IRS Circular 230 Notice: To ensure compliance with certain regulations promulgated by the U.S. Internal Revenue Service, we inform you that any federal tax advice contained in this communication is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of (1) avoiding tax-related penalties under the U.S. Internal Revenue Code, or (2) promoting, marketing or recommending to another party any tax-related matters addressed herein, unless expressly stated otherwise.
Bill Hussey practices in the Business Department from our Philadelphia office where he focuses on taxation and estate planning issues. He can be reached by e-mail at [email protected] If you would like to discuss how any of these changes may affect your financial, tax or estate planning, or have any other tax or estate planning questions, please contact Bill Hussey (215-864-6257), Stephen Zivitz (215-864-6240) or Scott Borsack (215-864-7048).