Last-Minute Tax Law Extends Deductions
This year more than ever it is advisable to read the instructions carefully and check the IRS’s web site before filing 2006 tax returns. If you use tax preparation software, be sure to download the free updates before completing your returns. Take these precautions because Congress slipped through a new tax law before it adjourned in 2006, and the President signed it on December 22. Some of the provisions affect returns for 2006.
The main purpose of the new law was to extend tax law sections that were slated to expire at the end of 2006 or already expired at the end of 2005. The changes also will affect the tax filing season. Returns that are filed in January 2007 and were affected by the changes won’t be processed until early February, because the IRS has to rewrite computer programs to incorporate the changes. Because the IRS sent tax forms to the printers in November, printed forms do not reflect the changes in the law.
The major change is an extension of the option to deduct state and local sales taxes instead of income taxes. This helps taxpayers in states without income taxes, such as Florida and Texas. Remember you can deduct these expenses only if you itemize deductions on Schedule A.
Also extended is the deduction for qualified higher education tuition and fees in lieu of taking the Lifetime Learning and Hope tax credits.
For teachers, their above-the-line deduction of up to $250 for teaching-related supplies is extended.
Because tax forms already were printed when the new law was enacted, the IRS had to develop some make-shift rules for taking the extended tax breaks. For example, the sales tax deduction can be claimed on line 5 of Schedule A for “State and local income taxes.” Enter “ST” on the dated line to the left of the line, and enter the amount of your deduction on the line.
A number of business tax breaks also were extended.
Each of these provisions was extended for only one year through the end of 2007, so the process of trying to extend the provisions will begin again in a few weeks. Some energy tax breaks were extended through 2008.
The new law also made changes in Health Savings Accounts. These are the accounts that can be used for anyone whose health coverage is through a high deductible plan or policy. There are deductions for contributions to the accounts by individuals. Investment earnings of the account are not taxed, and distributions from the accounts are tax free if used for qualified medical expenses.
In the new law, the annual contribution limit is increased to $5,650 for an individual with family coverage and $2,850 for someone with individual coverage. The limit will rise with inflation each year. The old limit was equal to the minimum deductible required on a qualifying insurance policy. The contribution limit also is not pro rated when the taxpayer qualifies for an HSA for less than the entire year.
Another provision to make HSAs more attractive is that flexible spending accounts can be rolled into an HSA one time. This is helpful to taxpayers who are not able to spend all their money in an FSA before the deadline. FSAs have a “use it or lose it rule.” Money that an employee deferred into an FSA is lost if not spent by the deadline.
A similar provision will allow, after 2006, a one-time transfer of funds from an IRA to an HSA.
Another change in 2006 tax returns that was not in the new law but still is important is that you will be able to claim a refund for the long distance telephone excise tax that was collected illegally by the IRS over the last three years. The IRS agreed in Spring 2006 that it should stop collecting the tax, and since then has established procedures under which people and businesses can claim refunds on their 2006 returns. In general, you can claim a refund for the actual amount of telephone taxes paid. Or you can claim the IRS’s safe harbor amount. For most individual taxpayers, the refund will be about $60. Instructions for claiming your refund are with tax returns and on the IRS web site.
The bottom line for the 2006 tax filing season is that it is best to use computers and electronic filing for returns affected by the changes. Also, check the IRS’s web site at www.irs.gov for special instructions on reporting the changed provisions.
A final change to keep in mind is that taxpayers who use Direct Deposit of their refunds can split the refund between up to three financial accounts, including IRAs. You can send part of your checking account, part to savings, and part to the IRA.
