Re: 2006 Tax Legislation - How the Tax Reconciliation Act Impacts Construction

Congress has just passed another tax cut package and the $70 billion dollar bill contains some important business tax breaks for the construction industry. While dividend and capital gains tax rate cuts in the new Tax Increase Prevention and Reconciliation Act have been getting a lot of attention, the business tax breaks are also very valuable. Our office wants to alert you to these tax incentives and how they could possibly help minimize your tax bill. 

Small business expensing. After 9-11, Congress raised the small business expensing threshold for businesses in New York to help them recover. In 2003, Congress increased the small business expensing limitation for all businesses nationwide and the increase was very generous. Instead of $25,000, small businesses could expense up to $100,000. The $100,000 amount was also indexed for inflation. However, the higher limitation was passed to be merely temporary. It was scheduled to expire in 2008. 

The Tax Reconciliation Act extends the more generous expensing limitation for two more years. Qualifying taxpayers can take advantage of this valuable tax break through December 31, 2009. 

For 2006, taxpayers can expense up to $108,000 of the cost of qualifying property such as heavy equipment, computers, and furniture. This deduction is reduced however by the amount that the cost of the property exceeds $430,000. Remember, the $100,000 amount is indexed for inflation; that's why it is $108,000 for 2006 and will be higher for 2007. If Congress had not extended the enhanced thresholds, the expensing limit would have dropped to $25,000 on a $200,000 cap after December 31, 2007. 

Domestic production deduction. There's a "sleeper" deduction that can be very valuable but hasn't received the attention it deserves in many cases. Two years ago, Congress created the new domestic production deduction, also known as the Code Sec. 199 deduction (after the section of the Tax Code that describes the deduction). Congress created this new deduction because it had to repeal the old tax benefits for exporters, which the World Trade Organization declared was an illegal trade subsidy. The new domestic production deduction is much broader, covering many construction-related businesses. 

The maximum deduction is nine percent of lesser of the taxpayer's qualified production activities income or taxable income for the tax year without regard to Code Sec. 199 or in the case of individuals, adjusted gross income. The maximum deduction is phased-in over five years. For tax years beginning in 2005 and 2006, the deduction is three percent. For 2007, 2008 and 2009, the deduction is six percent. In 2010 and thereafter, the deduction is nine percent. 

The deduction cannot exceed 50 percent of the W-2 wages paid by the taxpayer. Under the new tax law, effective for tax years beginning after May 17, 2006, only wages allocable to domestic production gross receipts are included for purposes of computing the Code Sec. 199 deduction limitation. While the new law allows the old rules to apply for 2006 calendar year taxpayers, fiscal year taxpayers with tax years beginning after May 17, 2006 are not as lucky. By next year, when the deduction grows larger, the W-2 wage restriction will be imposed by the new law on all businesses and will prove to be a slightly greater limitation on taking the "full" deduction. 

Tax shelters. The IRS has been very aggressive in combating tax shelters and the new law gives the IRS some more tools to use. Tax exempt organizations that facilitate shelters and abusive transactions will be sanctioned with hefty penalties. The new law also codifies proposed earnings stripping regulations to curb shelters. We can expect more anti-shelter legislation in the future. 

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As you have read, the new Tax Reconciliation Act impacts many construction-related taxpayers. Many of the provisions build-on earlier tax incentives. It's important to carefully weigh the tax benefits of each and every provision and how they interact with each other and prior tax cuts. We will naturally be taking these tax benefits into account as we plan for our clients' current year ends to help produce the best results possible when 2006 tax returns are filed next year.