Higher Taxes for You in 2006?

If Congress does not act, income taxes will rise for many of us in 2006. As we go to print, Congress had not stirred itself to extend a number of popular and important tax breaks that will expire at the end of 2005. Congressional tax leaders weren’t even sure that they would be able to bring legislation to the floor by the end of the session.

Two major tax breaks that might expire are those that protect taxpayers from the alternative minimum tax.

We have covered the AMT at length in past visits. This is a separate tax system that ensures taxpayers do not benefit from taking “too many” tax breaks. You compute both the regular income tax and the AMT, and then pay the higher tax. Taxpayers living in high tax states, especially those who have a lot of exemptions or itemized deductions, are among the taxpayers most likely to be snared by the AMT. Details about the AMT and how to avoid it are in the Tax Watch section of the Archive on the members’ web site.

One AMT provision at risk allows many personal tax credits to be used in computing the AMT. Those credits will be lost, and taxes increased for many, if Congress does not act. The other provision increased the exemption amount that is used to compute the AMT. The loss of these two items is estimated to increase to 21 million the number of Americans subject to the AMT in 2006.

The deduction for state and local sales taxes also would expire. This itemized deduction was resurrected in 2003 but only for the 2004 and 2005 tax years. It especially benefits taxpayers who itemize deductions and who live in states with high sales taxes and low or no income taxes, such as Florida and Texas.

Taxpayers who benefit from the sales tax deduction should consider accelerating into 2005 any large purchases they were considering for 2006, such as automobiles. That would ensure the sales taxes could be deducted in 2005, while they might not be deductible in 2006. But beware: The extra sales tax deduction might trigger the AMT. Do the calculations for both taxes before deciding what to do.

Elementary and secondary school teachers also will lose a deduction of as much as $250 for out-of-pocket expenses for purchases of classroom supplies. The deduction can be taken without itemizing expenses.

Also on the table are items that do not need to be extended yet. Many in Congress hoped to extend the provisions of the 2001 and 2003 tax laws that are set to expire from 2008 to 2010. These include the lower rate on capital gains and dividends, the current tax rates and brackets, and the estate tax elimination, among others. Failure to extend these makes longer-term planning difficult.

Congress might act in the last days of this session on at least some of these items. If it doesn’t, many of us should be prepared for income taxes to increase in 2006.