Your Taxes: What's New for 2006
Don't overlook these changes in the law that might save you money.
By Joan Pryde, Senior Tax Editor, the Kiplinger letters
January 24, 2007
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With apologies to Bob Dylan, the tax laws they are a-changin'. Constantly. And keeping up with the ever-altering landscape is essential if you hope to hold down your tax bill to the legal minimum. Some changes -- such as inflation adjustments that increase the standard deduction and exemption amounts and widen the tax brackets -- are hard to miss. Other changes are sometimes all-too-easy to overlook.
Probably the biggest changes are the ones made so late last year that they don't even appear on 2006 tax forms. Congress renewed the deductions for state sales tax, college tuition and educators' expenses in December, but only after IRS finalized the 1040. So if you're planning to take any of these write-offs, you'll need to follow some special filing instructions to reap the benefits.
Plus, if you normally like to be an early filer, you may have to slow things down this year. IRS says it won't be ready until February 3 to process returns with any of the three revived deductions. If you're claiming one or more of those write-offs and you try to file electronically before then, IRS won't accept your return. If you send in a paper return, IRS will put it aside until that date, which increases the chance your forms will be misplaced. Better to hold on to that return until February. (See Don't Delay Tackling Your Return for more information about the processing delay and how to claim the three revived tax deductions.)
Other 2006 changes that might save you money:
Phone tax refund. IRS's loss is taxpayers' gain -- literally. The government has stopped collecting the 3% federal excise tax on long-distance calls, after it lost a series of court cases challenging the legality of the tax, which was based on time and distance of calls. Taxpayers argued -- successfully -- that the tax can no longer be levied because most calling plans now aren't based on distance. Taxpayers are entitled to a refund of taxes paid between March 1, 2003, and August 1, 2006 (the date the tax died). You can either claim a "standard" credit on your return of between $30 and $60, depending on your filing status, or total up the actual tax you paid and take a credit for that amount. You'll find a line on your return to claim your credit. Businesses and exempt organizations can also get a credit, but only for actual tax paid. IRS has no standard credit amounts for them to use. For more information, see Ring up Savings on Your 2006 Tax Return.
Hybrid car credit. If you purchased a hybrid vehicle during 2006, you can claim a credit of up to $3,400, depending on which make and model you bought. This replaces the $2,000 clean-fuel tax deduction and is a bigger tax saver because it reduces your tax liability dollar for dollar. The full credit is limited, however, to the first 60,000 vehicles each auto manufacturer sold after January 1, 2006. This cap already affects Toyota and Lexus hybrids: Those purchased after September 30, 2006, receive half the credit available for those bought earlier in 2006. For example, if you bought a Toyota Prius before October 1, your credit is $3,150, but a purchase in the fourth quarter gets you a credit of only $1,575. When you're filing your return, don't bother trying to find the line on the 1040 for the hybrid credit: It doesn't exist. You must calculate the credit on Form 8910 and then enter the amount on line 55c of the 1040.
Residential energy credits. Energy-saving improvements you made to your primary home last year may save you on taxes. For 2006, you can take a tax credit equal to 10% of the cost of skylights, outside doors, windows and pigmented roofs. Also eligible are high-efficiency furnaces, water heaters and central air conditioners. The credit is capped at $500, and no more than $200 can be from windows. There's also a 30% credit for solar units used to heat air or water. The maximum credit you can take for them is $2,000 each for furnaces and water heaters.
Higher income limits for deductible IRAs. The phase-out zones for traditional IRA write-offs are higher for joint return filers in 2006 than they were in 2005. If you are covered by a retirement plan at work, you can take a full IRA deduction if your modified adjusted gross income is $75,000 or less if you are married filing jointly (up from $70,000 in 2005). For singles and heads of household, the phase-out starts at $50,000, just like last year.
A tougher "kiddie" tax. Congress upped the ante for the kiddie tax. Starting in 2006, until the year that a child reaches age 18, any unearned income over $1,700 will be taxed at the parents' marginal rate, not the child's. Before the change, the rule applied only to children who were younger than 14.
Deduct more long-term care premiums. You can include more of your long-term care insurance premiums in your deductible medical expenses. Taxpayers 71 years old and older can claim as much as $3,530 (per person on a joint return). Filers ages 61 to 70 can claim $2,830. Those 51 to 60 can deduct up to $1,060. The write-off is up to $530 for policy owners ages 41 to 50. Younger people can deduct up to $280.
Bigger adoption credit. The top tax credit to offset the expenses incurred when adopting a child is higher for 2006 than in earlier years. If you qualify, the credit can be as high as $10,960.
Foreign earned income exlcusion increases. The foreign earned income exclusion is increased to $82,400 for 2006 (up from $80,000). At the same time, the maximum housing cost exclusion is reduced substantially. And, in a tricky calculation, earnings above these exclusions are taxed at higher rates instead of starting out in the lowest bracket. Be careful if you're treading in these waters.
Increased Section 179 deduction. The maximum amount a business can deduct in lieu of depreciation increases from $105,000 to $108,000 for assets place in service in 2006. This is often called the "expensing" deduction because it lets you deduct all at once business costs that otherwise would be written off over several years.
Standard mileage rates. The standard rate for business driving in 2006 is 44.5 cents a mile, up 4 cents a mile from the beginning of 2005 and down 4 cents from the rate allowed after Hurricane Katrina. The 2006 rate for medical and moving related driving is 18 cents a mile. You get to write off 14 cents a mile for driving you did for charity, except for driving related to Katrina relief. Those miles earn you 44.5 cents a mile.
A reduced squeeze on itemized deductions and personal exemptions for high-income taxpayers. Good news for higher-income taxpayers who have seen the value of their itemized deductions and personal exemptions reduced as their income rises above certain threshold. For 2006, the trigger point for squeezing deductions is when adjusted gross income exceeds $150,500, regardless of filing status. In 2005, affected taxpayers lost these write-offs at a rate of 3% of the amount by which their AGI exceeded the trigger point. For 2006 and 2007, the cut back is just 2%. It falls to 1% for 2008 and 2009. Then this phase-out disappears. For 2006, the reduction in personal exemptions begins at higher levels ... $225,750 of adjusted gross income for marrieds filing jointly, $188,150 for heads of households and $150,500 for singles. In 2005, this squeeze could wipe out the entire value of exemptions. For 2006, the value can be reduced no lower than $1,100.
Nontaxable combat pay allowed for earned income credit. You can include nontaxable combat pay in the calculation of earned income for the earned income credit. This provision was previously set to expire at the end of 2005 but has been extended to include 2006 and 2007.
Estate tax exemption. In 2006, the federal estate tax exemption rose to $2 million up by $500,000 from 2005. It's scheduled to stay at $2 million for 2007 and 2008, too.