Tax Incentives for 2006
Stewart H. Welch, III, CFP, AEP
With the new year comes new tax incentives and rules for individuals and businesses. New for this year is a wide array of incentives ranging from retirement savings contribution limit increases to energy efficient tax credits. This article presents an outline of the key changes and the strategies needed to take advantage of the 2006 tax credits and incentives.
- Retirement Plans
- 401k plans. More money can now be deferred into 401k, 403(b), and 457 plans. The maximum employee deferral was raised to $15,000, which is a $1,000 increase. If you are 50 years or older in 2006, you are allowed an additional “catch-up” contribution of $5,000.
- IRA plans. Catch-up contributions for traditional and Roth independent retirement account (IRA) plans also increased. The contribution limit for both a traditional IRA and a Roth IRA remains the same at $4,000, but the catch-up contribution for people age 50 years or older has increased to $1,000 (from $500). Remember that IRAs have income limit restrictions. If you participate in a retirement plan at work, to be eligible to contribute to a traditional IRA and get a full deduction, the modified adjusted gross income must be less than $75,000 (married filing jointly) or $50,000 (single or head of household).
- Profit-sharing plans. The total limits for defined contribution plans such as profit-sharing plans and Keoghs increased to $44,000, which is a $2,000 increase. The law allows a contribution of up to 25% of your compensation (20% of net income for self-employed taxpayers). For purposes of calculation, compensation up to $220,000 is considered (up from $210,000 in 2005). Many dental practices use a qualified profit-sharing plan, Keogh plan, or simplified employee profit-sharing plan to fund retirement for themselves and their employees. To reduce plan costs, some will combine a 401(k) contributory plan with a profit-sharing plan. With this combined plan, participants age 50 or older may have total contributions of $49,000.
- Health Insurance
- Long-term care insurance. More people may now be able to deduct their long-term care premiums under medical expenses. Taxpayers between the ages of 41 and 50 years can deduct $530, those ages 51 to 60 can deduct up to $1,060, those ages 61 to 70 can deduct up to $2,830, and anyone over the age of 71 years can deduct $3,530 per person. However, only the amount of out of pocket medical expenses greater than 7.5% of your adjusted gross income can be deducted. As dental practice owners, you can avoid the 7.5% adjusted gross income problem by paying the premiums through your business. Remember that with long-term care insurance you are allowed to pick and choose for whom you buy coverage. It can be just for you or it can include key employees. If your business is a C-corporation, all of the premiums can be deducted without limit.
- Health savings accounts. The maximum deductible contribution to health savings accounts (HSA) has increased to $5,450 for family coverage and $2,700 for individual coverage. HSAs allow a lower cost, high deductible health insurance policy to be combined with a tax deductible, tax deferred investment account. This could potentially allow a significant increase in the amount of retirement savings.
- Estate and Gift Taxes
- Estate tax exemption. In 2005, the maximum amount that could be passed at death to a nonspouse free of estate taxes was $1.5 million. For 2006, that amount has increased to a maximum of $2 million. An unlimited amount has always been allowed to your spouse free of estate taxes; therefore, many people make the mistake of leaving everything to their spouse thinking there is no tax liability. A major tax problem arises, however, upon the death of the second spouse. Therefore, if your net worth including life insurance exceeds $2 million, you should consider advanced estate planning to make certain the least amount of taxes are owed at the time of the death of the remaining spouse of a married couple.
- Annual gift tax exclusion. The annual gift tax exclusion amount increased from $11,000 to $12,000 per donee. It is possible to gift-split with your spouse and give a total of $24,000 to any, and as many, individuals as you wish.
- Social Security wage limit. For 2006, the employer and employee will continue to pay 6.2% each for social security tax (old age, survivors, and disability insurance) and 1.45% each for Medicare tax (hospital insurance). The maximum amount of 2006 wages subject to the social security tax has increased to $94,200 (from $90,000 in 2005). For Medicare tax, all covered 2006 wages are subject to the tax.
- New retirement plan available. Businesses can now offer employees a new savings vehicle in 2006. The Roth 401(k) plan allows employees to contribute after-tax dollars. It is very similar to the Roth IRA in that the earnings accumulate tax-free and qualified distributions are paid out tax-free. The major advantage of a Roth 401(k) over the Roth IRA is that the Roth 401(k) allows participants to use the traditional 401(k) limits ($15,000 plus an additional $5,000 catch-up contributions for participants age 50 or older).
- Business equipment expense. Typically, when business equipment is purchased, the cost of the equipment must be amortized over the expected life of the equipment. Small businesses receive a tax break that has been increased for 2006. Now up to $108,000 of business equipment can be purchased and immediately fully expensed. This tax benefit phases out once $430,000 of assets are put into service for the year.
Another major focus for Congress was to provide energy tax breaks by passing the Energy Tax Incentives Act of 2005. This act includes incentives for more energy efficient homes and for purchasing a hybrid car. The incentives come in the form of tax credits, which reduces your tax liability dollar for dollar compared with deductions that reduce your taxable income. Both credits and deductions provide tax relief but by no means are they equal. For example, if you receive a tax deduction for $1,000 and your tax rate is 35%, then your total tax saving is $350. Conversely, if you receive a tax credit of $1,000, then your total tax savings is $1,000. The other advantage to these energy tax credits is that they are not phased out for higher income individuals.
- Hybrid vehicles. The hybrid vehicle purchase credit is a significant tax savings. Depending on the hybrid vehicle fuel efficiency, the tax credit can be as much as $3,400. But there is a cap on this credit and the credit will start to phase out for a manufacturer’s line of hybrids once it sells its 60,000th hybrid.
- Solar energy. Another incentive from the Energy Tax Incentives Act is the solar energy credit. Homeowners are able to receive a credit for 30% of the cost of solar units put into use in 2006 that are used to heat air or water. There is also a small credit for energy-saving home improvements. This credit is for 10% of the cost of installing energy efficient skylights, outside doors, and high efficiency water heaters, furnaces, and central air conditioning systems. The maximum credit is $500 for the improvement and no more than $200 can be applied for energy efficient windows. Businesses can also receive a 30% credit for installing solar heating units and fuel cells.
To maximize your tax benefits for 2006, it is best to begin planning early in the year. Consult your financial advisor before acting on this advice.
Stewart H. Welch, III, CFP, AEP, is the founder of THE WELCH GROUP, LLC, which specializes in providing fee-only wealth management services to affluent retirees and healthcare professionals throughout the United States. He has been recognized by Money, Worth, Mutual Funds Magazine, and Medical Economics as one of the top financial advisors in the country. Visit his Web Site www.welchgroup.com.
Stewart H. Welch, III, CFP, AEP