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What the New Tax Bill Means

Posted On: 2006-08-14
Length: 4:55

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Albert Einstein is supposed to have said, "The hardest thing in the world to understand is income tax." Well, if he couldn't understand it, what chance do you and I have? Well, we'll try to shed some light on the subject in this Fidelity Personal Finance podcast and explain what the new tax bill may mean for you by providing an update on the latest tax law changes.

The new tax bill signed by President Bush in May covers a range of financial matters for investors and taxpayers alike. While it doesn't cut any taxes, it does extend lower tax rates that were scheduled to go away. It temporarily stops the alternative minimum tax, or AMT from impacting more Americans, and it eliminates income limits for Roth IRA conversions. The not-so-good news, the kiddie tax kicks in at a higher age, which could have implications for taxpayers saving for college. For a rundown of the latest tax changes and how they could affect your finances, let's start with the extension of low capital gains and dividend tax rates. The tax act extended preferential tax rates that apply to long-term capital gains and certain qualified dividends through 2010. These rates were scheduled to expire the end of 2008, which would have returned the maximum long-term capital gains tax rate to 20%, and the maximum tax rate on qualified dividends to 35%. This bumps up to 39.6% starting in 2011. For taxpayers in the top four tax brackets, the tax rate on long-term capital gains and qualified dividends will be 15% for all years through December 31, 2010. And for taxpayers in the lowest two tax brackets, which are 10% and 15%, it'll be 5% through 2007, and 0% from 2008 through 2010.

Many financial experts welcome the changes. According to one, John G. F. Bonnanzio, these low rates fit our approach to investing, because it encourages our clients to think long term. John is group editor of independent newsletters Fidelity Insight and Funds Net Insight. The extension may make it attractive for wealthy families to give appreciated assets up to the annual gift tax exclusion limit, which is $12,000 in 2006, or $24,000 for married couples who gift-split to children who are age 18 or older, but still in the lowest tax brackets. Any appreciation after the date of the gift should not be subject to gift taxes, so you might consider gifting securities that you believe have a lot of growth potential. When the child sells the securities, he or she will be responsible for the income taxes on any realized gains. If the child remains in the lowest two tax brackets when the assets are sold, and the assets are sold from 2008 through 2010, any long-term capital gains should be federal tax free. The strategy can help fund college tuition payments, or potentially create a substantial college graduation gift to help a young adult get started in life.

Now let's turn to the alternative minimum tax...

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