SMATAX | Tax Services

Client Corner

»Tax News
Client Corner :: Newsletter

January 2007: Tax Law Changes Effecting Individuals for 2006 and Beyond

Homeowner Energy Credits For Tax Years 2006 and 2007
The credit per improvement is:

  • 10% of the cost of energy efficient building envelope components. These consist of insulation materials or systems that reduce heat loss/gain; exterior windows (including skylights); exterior doors; and certain metal roofs with special coatings designed to reduce heat gain. You must be the first user of the equipment, which must be expected to last for at least five years.
  • Up to $300 tax credit for the cost of energy-efficient building property (electric heat pump water heater, electric heat pump; geothermal heat pump, central air conditioner and natural gas, propane, or oil water heater meeting specific energy efficiency standards).
  • Up to $150 credit for a natural gas, propone, or oil furnace or hot water boiler.
  • Up to $50 credit for an advanced main air circulating fan.

Your overall lifetime tax credit for all of the above improvements is $500, and only $200 of this credit amount may be for buying and installing energy-saving windows. The tax credits for energy efficient improvement will only be available for equipment placed in service in 2006 and 2007.

Keep in mind that you probably will not have to determine for yourself whether a home improvement creates or saves enough energy to qualify for a tax credit under the new law's complex and technical rules. In all likelihood manufacturers will certify, in the materials that come with their products, whether equipment and materials create or save enough energy to qualify for a tax credit. You will have to determine whether your use of the equipment qualifies you for tax breaks, and how to make the best use of them.

Useful Websites:

Highlights of the Tax Increase Prevention and Reconciliation Act of 2005-TIPRA

Alternative Minimum Tax Relief
The AMT exemption amount increases are kept in affect for 2006. The use of certain nonrefundable personal credits is permitted for AMT purposes in 2006. These credits include the dependent care credit, the credit for the elderly and disabled, the credit for interest on certain home mortgages, the Hope credit for certain college expenses and the Lifetime Learning credit. These adjustments to AMT will keep 15 million taxpayers from being effected by AMT during tax year 2006. AMT does not affect everyone, but if you are affected by AMT, tax planning may have increased importance.

Dividend and Capital Gains Rate Cuts
The 15% qualified dividend and long-term capital gain rates are extended through tax year 2010. 5% rates apply to taxpayers in the 10-15% regular income tax brackets. The rates were previously set to expire in 2008. Extending the rates allows for better long-term tax planning.

Capital assets include stocks, bonds, real estate, etc. To qualify for a long-term capital gain the asset must be held for 1 year and 1 day. If the holding period is less than 1 year, the asset will be taxed as ordinary income (regular income tax rates will apply).

Section 179 Business Expensing
IRS code section 179 allows for the expensing (deducting) of qualifying property (business equipment, Vehicle over 6,000 pounds GVWR, etc.). TIPRA extended the higher amounts for section 179 expensing through 2009. Without the extension the maximum amount of section 179 expensing would have dropped from $108,000 to $25,000. Vehicles over 6,000 pounds gross vehicle weight, but less than 14,000 pounds gross vehicle weight are still limited to $25,000 of section 179 expensing. If the election to deduct an item using section 179 is not made the item must be depreciated over its useful life.

Roth IRA Changes
TIPRA eliminates the $100,000 adjusted gross income ceiling for converting a traditional individual retirement account (IRA) to a Roth IRA, for tax years after 2009. A conversion is treated as a taxable distribution, but is not subject to the 10-percent early withdrawal penalty. Taxpayers who convert in 2010 can elect to recognize (be taxed) the conversion income in 2010 or average it over the next two years.

Contributions to a Roth IRA are not deductible, but the earnings are permanently tax-free. Roth IRAs have no required minimum distribution at age 70½.

This provision does not extend to 401(k) plans. However, nothing would prevent Roth IRA conversions of traditional IRAs that have received proceeds of 401(k) balances when an individual leaves employment.

Kiddie Tax Changes
The Kiddie Tax rules require a child's unearned income, such as dividends and interest, to be taxed at the parents' tax rate, which is usually a higher rate. Under current law, the kiddie tax applies if the child is under age 14, the child has net unearned income over $1,700, and the parent can claim the child as a dependent. TIPRA raises the age limit to under 18.

Highlights of the Pension Protection Act of 2006

Pension Contribution Limits Made Permanent

  • Permanent higher dollar amount for IRA contributions ($4,000 in 2006);
  • Permanent higher dollar limits on defined contribution plans ($44,000 in 2006), elective deferrals (including $15,000 in 2006 for 401(k) plan deferrals), SIMPLE plan contributions ($10,000 in 2006) and compensation that may be taken into account under a plan;
  • Permanent increases in the annual benefit limit under a defined benefit plan ($175,000 for 2006);
  • Permanent catch-up contributions for wiser (formerly older) workers ($1,000 after 2005 for IRAs, $2,500 for SIMPLE plans, $5,000 for 401(k) plans;
  • Permanent Roth 401(k)s and 403(b)s;
  • Permanent start-up tax credit for new small employer-sponsored plans (maximum $500/year for each of the first three years);

Section 529 College Savings Plans
The Section 529 college savings plans have been made permanent. The new law adds stricter rules related to the operation of Section 529 plans to prevent abuse.

Charitable Donations Substantiation Requirements Have Been Tightened

Non-Cash Donations
Under the new law, no deduction is allowed for used clothing and household items unless the items are in "good" condition. This change is effective for donations made after August 17, 2006.

Note: According to the IRS, individuals reported non-cash donations valued at $36.9 billion on Form 8283 in tax year 2003. Clothing represented 48 percent of donations reported on Form 8283.

Advice: Keep detailed records of all items donated to charity. Under the new rules, having a picture record of items donated would be advisable.

Cash Donations
In a major change, no deduction is allowed for any contribution of cash, check or other monetary gift unless the donor can show a bank record or a written communication from the charity indicating the amount of the contribution, the date the contribution was made, and the name of the charity. The new recordkeeping requirements appear to give taxpayers absolutely no leeway. Cash donations, regardless of amount, must be substantiated either by a cancelled check or a bank record. Donations made by debit or credit card can be substantiated by the taxpayer's bank statement.

Useful Website:

Highlights of the Tax Relief and Health Care Act of 2006

Sales Tax
The optional sales tax deduction has been extended through 2007.

Higher Education Tuition Deduction
The tuition and fees (above-the-line) deduction has been extended through 2007. A $4,000 above-the-line education deduction is available to single taxpayers with adjusted gross income of $65,000 or less ($130,000 for joint filers). A $2,000 above-the-line education deduction is available to single taxpayers with adjusted gross incomes up to $80,000 ($160,000 for joint filers). Only higher education tuition and fees are eligible for the deduction. The hope and lifetime learning credits cannot be taken in the same year for the same student.

Teacher's Classroom Expense Deduction
The educator expense deduction has been extended through 2007. Teachers and other education workers can deduct, above the line, up to $250 of certain out-of-pocket classroom expenses. Instructors, counselors, principals, and classroom aides, as well as teachers, who work at least 900 during the school year are eligible for the deduction. Educator must work in a kindergarten, elementary or secondary school through Grade 12.

Health Savings Account Enhancements
The HSA changes are permanent. Employees with a health flexible spending account (FSA) or a health reimbursement account (HRA) will be allowed to make a one-time transfer of the balance in their FSA or HRA to an HSA. The maximum transfer amount is the lesser of the balance as of the date of transfer or September 21, 2006. The transfer must be made before January 1, 2012.

A one-time, once-in-a-lifetime, rollover of funds from their IRA into an HSA is now permitted. The IRA rollover cannot exceed the maximum contribution limit for the year. The limits on deductible annual contributions have been repealed.

Mortgage Insurance Deduction (2007 only)
Premiums paid or accrued for qualified mortgage insurance by a taxpayer during the taxable year in connection with acquisition indebtedness with respect to a qualified residence of the taxpayer shall be treated for purposes of this section as interest which is qualified residence interest. The deduction will decrease as AGI exceeds $100,000 and at $110,000 AGI (married filing joint $50,000 and $55,000) the deduction is phased out completely. Appears to apply only to taxpayers who acquire the debt in 2007.

AMT relief for taxpayers subjected to AMT on ISO's (MCI Worldcom)
A refundable credit worth up to 20 percent for the next five years, to certain taxpayers with long-term unused AMT credits who have AMT income from incentive stock options.