Senate passes final tax bill
The next stop for the controversial $69B bill is President Bush's desk. His signature is expected next week.
By Jeanne Sahadi, CNNMoney.com senior writer

NEW YORK (CNNMoney.com) - The Senate on Thursday passed a GOP-supported final tax reconciliation bill that extends the reduced tax rates on capital gains and dividends, and prevents millions of households from falling prey to the alternative minimum tax (AMT) in 2006.

The bill also includes a provision that will make Roth IRAs available to high-income taxpayers.

HOW MUCH WILL YOU SAVE?
Here's an estimate of the average savings that the tax reconciliation bill will yield for different income groups.
Income groupSavesReduces tax liability by:
$20K-$30K$100.4%
$50K-$75K$1121.0%
$75K-$100K$4062.3%
$100K-$200K$1,3954.4%
$200K-$500K$4,5275.9%
Over $1 million$42,7664.5%
Source: Urban-Brookings Tax Policy Center
AMT relief
Provision and impact
Boost exemption levels for joint filers to $62,550, from $58,000
Shield 15 million taxpayers from AMT in 2006

The measure passed mostly along party lines by a vote of 54 to 44. It was protected from filibuster and only required a simple majority to pass.

The next and last step in making the bill's provisions law is President Bush's signature, which is virtually guaranteed as the White House has been urging lawmakers to extend the lower investment tax rates.

After months of debate and delays, Republican tax writers this week reached official agreement on the provisions of the bill, which is now estimated to cost $69 billion over 10 years by the bipartisan Joint Committee on Taxation.

With the exception of some popular provisions like AMT relief, many elements in the reconciliation bill have been sharply criticized by Democrats and some moderate Republicans. They contend some of the tax breaks, especially the extension of the investment tax rates, are too costly and benefit too few taxpayers - namely, upper-income ones.

Democrats also have objected to the removal of an extension for tuition deduction, which they say could have been paid for if tax writers had left in a provision that would have reduced a key tax break for oil companies, which would have raised $4.3 billion in revenue. The final bill does include a smaller provision pertaining to oil companies that would raise $189 million over 10 years.

But the tuition deduction will be included in a second tax bill, Senate Finance Committee Chairman Charles Grassley, R-Iowa, has said, and that bill "will be finalized and voted on as soon as possible," he said Thursday. Other expiring provisions that were taken out of the reconciliation bill but are likely to be included in that second bill are an extension of the state and local sales tax deduction and a deduction for teachers who buy supplies for their classrooms.

Here is a summary of some of the approved reconciliation bill's main provisions and how they'll affect your wallet:

Extend reduced capital gains and dividend rates

The bill will extend for two years the 15 percent rate on long-term capital gains and dividends. For low-income taxpayers, that rate will be 0 percent.

Currently scheduled to expire at the end of 2008, the reduced rates will run through 2010. After 2010, the rates are scheduled to revert to 20 percent for long-term capital gains - 10 percent for those in the lowest tax bracket - and one's top income tax rate for dividends.

The JCT estimates the provision will cost $50.8 billion over 10 years.

Proponents of the measure say the reduced rates put more money back in taxpayers' pockets and encourage investment, which in turn spurs job growth and other economic benefits, which can boost tax revenue.

Critics question the correlation between lower investment income rates and economic growth and say the reduced rates primarily benefit high-income taxpayers since exposure to stocks for middle- and upper-middle income taxpayers tends to be through tax-deferred vehicles like 401(k)s.

The Urban-Brookings Tax Policy Center, for instance, estimates that a taxpayer with an income between $50,000 and $75,000 would save an average of $58 on his tax bill in 2009, or about 0.4 percent of what his total tax liability would have been if the rates weren't extended. But only 23 percent of that income group even have taxable investments -- the average tax cut they'd receive is $255, or about 2 percent of their tax liability.

By contrast, a taxpayer with income of $1 million or more would save an average of $32,111, or about 3.3 percent of what his tax liability would have been. If you just count those with taxable investments in that income group - 81 percent - the average tax cut they'd receive is $39,448, or about 4 percent of their tax liability.

For those with sizeable dividends in a taxable portfolio, the savings also can be impressive. Say you have a $300,000 portfolio of stocks and mutual funds, with an average dividend yield of 1.8 percent. Your annual dividends would total $5,400 and you'd owe $810 in income tax on them, based on a 15 percent rate. If the reduced rate wasn't extended and you're in the 28 percent tax bracket, you could owe up to $702 more depending on your adjusted gross income for a total of $1,512.

Provide greater AMT relief

Lawmakers will increase for tax year 2006 the AMT income exemption levels that were in effect for 2005. The new exemption levels will be $42,500 for single filers, up from $40,450, and $62,550 for joint filers, up from $58,000.

In addition, when calculating whether they're subject to AMT, taxpayers will be allowed to use all nonrefundable personal credits to offset AMT liability. Normally, these credits often end up being disallowed under AMT.

The JCT estimates that the provision agreed to by lawmakers will prevent an additional 15 million taxpayers from falling prey to the AMT in 2006.

Tax Policy Center estimates show the majority would come from households with income between $100,000 and $500,000, and their savings would range from $1,074 to $2,838.

The estimated cost of the provision over 10 years is $33.9 billion.

The AMT imposes a higher bill on taxpayers than the regular tax code.

The tax, originally intended for the wealthy, now threatens to catch tens of millions of middle-class taxpayers unless lawmakers continue to increase the AMT income exemption levels, since the original levels were never adjusted for inflation.

Increase Roth IRA eligibility

In order to keep the final reconciliation package under its $70 billion spending limit, lawmakers needed to add revenue raisers into the bill.

The most controversial is one allowing all taxpayers, not just those with modified adjusted gross income of $100,000 or less, to convert their traditional IRAs to Roth IRAs starting in 2010.

Proponents of the measure say it will raise revenue since IRA holders must pay taxes on their accounts when they make the conversion. By JCT estimates put out Tuesday, the conversions will yield an additional $6.4 billion in revenue between now and 2015.

But critics say that long-term the provision will be a revenue loser for two reasons: 1) the gains earned in those accounts would grow tax free, while in a traditional IRA they would have been taxed as income upon withdrawal; and 2) those making the conversion will be advised to pay their Roth taxes upfront using money from their taxable savings, the interest and dividends from which are taxed every year. By reducing their taxable savings, they also will be reducing Uncle Sam's take in future years.

Conversions won't make sense for all upper-income taxpayers. Much depends on your current income tax rate, your anticipated income tax rate in retirement and whether you can pay the up-front taxes on the conversion with money other than that earmarked for the Roth.

"Generally, if outside funds are available to pay taxes triggered by the rollover, conversion will make sense unless the taxpayer expects to be in a substantially lower tax bracket at retirement. When conversion makes sense, the long-term tax savings can be very dramatic," said Craig Janes, a partner at Deloitte Tax LLP, in a statement.

For instance, Deloitte estimates that a taxpayer with a $200,000 traditional IRA could generate an additional $170,000 in retirement income by making the conversion, if he is in the 33 percent tax bracket but expects to be in the 25 percent tax bracket when he retires. It also assumes he makes the conversion in 2010, retires in 2025 and gets an average annual return of 8 percent on his investments.

If, however, his income tax rate in retirement were 15 percent, the conversion could cost him $102,000 in retirement income.

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.