This year's tax changes are mostly due to the Tax Increase Prevention and Reconciliation Act of 2005, which extends many provisions and changes others; also the Energy Tax Incentives Act of 2005 creates many new tax credits; and the Pension Protection Act of 2006 makes many changes to the pension provisions as well as providing changes to charitable contributions and extending some expiring provisions.
The following represent just a few of the important tax items which may apply to you:
Increase in Standard Deduction to $5,150 for Single and Married Filing Separately taxpayers; $10,300 for Married taxpayers filing jointly; $7,550 for Head of Household taxpayers.
The personal exemption has been increased to $3,300 for 2006.
The phase-out of the personal exemptions has been reduced starting in 2006 by 1/3, regardless of AGI (AGI phase-out thresholds are $150,500 for Single filers; $188,150 for HOH filers, $225,750 for Married Filing Joint, and $112,875 for Married Filing Separately).
Section 179 deduction has been increased by the IRS to $108,000 for business assets purchased in 2006, and remains at $25,000 for California.
The Standard Business Mileage rate for 2006 is 44.5 cents per mile; 18 cents per mile for medical and moving mileage; and 14 cents per mile for charitable mileage (32 cents per mile for Katrina charitable work).
IRA deduction this year remains the same at $4,000, but the age 50 & over deduction has been increased to $5,000 (an extra $1,000).
401(k) contributions have increased to $15,000, with an extra $5,000 for those taxpayers 50 & over.
The Tuition and Fees Deduction has expired unless Congress extends it before year-end.
The Kiddie Tax threshold increases to $1,700, but it now applies to children under age 18 (before it was age 14). Parents may include the child's gross income on their tax return when the child's gross income is over $850 but less than $8500, but only if there is no earned income (W-2, etc.) or Schedule D transactions.
Social Security benefits are limited for workers under 65 who earn over $12,480 in 2006.
Nanny Tax law states that FICA must be withheld if wages for domestic service workers are $1,500 or more for 2006; FUTA must be paid to the IRS if $1,000 is paid to all household workers in any calendar quarter of the current year or the prior year.
Foreign Earned Income Exclusion for 2006 is $82,400, and $11,537 is the maximum housing exclusion for foreign housing costs.
Gift Tax Exclusion for 2006 has increased to $12,000 before a gift tax return has to be filed and the amount tracked toward a lifetime exclusion of $1,000,000.
Energy Policy Act of 2005 takes effect for the 2006 tax year, which gives several new tax breaks to individuals and businesses that invest in energy efficient improvements to their homes/buildings. These credits are for installing qualified energy efficiency improvements such as certain insulation material, exterior windows, exterior doors, and specific types of metal roofing. Other residential energy property expenses that qualify are certain types of water heaters, geothermal heat pumps, central air conditioners, furnaces, and main air circulating fans. These credits are reported on Form 5695, which is new this year.
Contractors who build Energy Efficient Homes can qualify for special credits in 2006, and must use Form 8908 to claim those.
Hybrid Vehicles placed in service in 2006 may qualify for new alternative motor vehicle credits, and take the place of the prior qualified clean-fuel vehicle deduction. These credits depend upon date the manufacturer sold the first 60,000 vehicles of that model. For a complete listing of vehicle makes and models and the amount of credit available, check out 0. Any credits for this are calculated on Form 8910.
Tax Increase Prevention and Reconciliation Act (TIPRA, passed 5/17/06) makes changes to AMT, 1099-INT reporting, Capital Gains rates, Musical Compositions sales and copyrights, the Kiddie Tax, Roth IRA conversions, OIC Deposits, and Section 179 deductions for business assets.
Alternative Minimum Tax exemptions were increased for each filing category and the taxpayers with income between $100,000 and $500,000 are hardest hit by AMT. It is expected that in 2010, 90% of these taxpayers will pay AMT under today's laws.
Capital Gains Rates of 5% and 15% will now stay the same through 2010. This also applies to capital gains treatment of qualifying dividends (unless the taxpayer elects to treat qualified dividends as investment income for purposes of the investment interest deduction).
Nondeductible IRA Tax Planning Tip: For taxpayers whose income is too high to currently contribute to a Roth IRA, they could make nondeductible contributions to a traditional IRA for the next few years; then in 2010 roll the traditional IRA into a Roth IRA and take advantage of an election to pay the tax over a 2-year period. The majority of the account would have already been taxed, which would create a smaller tax bite at conversion.
Computer software may be expensed (does not need to be capitalized) for business purposes for tax years before 2009.
Pension Protection Act of 2006 deals largely with pension plan administration, but also deals with Charitable Contributions. Starting in 2006, using Form 8888, taxpayers can ask the IRS to contribute their refund directly into an IRA account.
Nonspouse Beneficiaries will now be able to establish a rollever IRA in the beneficiary's own name for purposes of receiving required distributions, so they can be spread over a period of several years.
IRA distributions to charity after taxpayer has reached age 70 ½ are tax-free, not to exceed $100,000. That distribution/contribution counts toward the required minimum distribution for the year. There are several tax advantages to this new law: the taxpayer does not have to itemize deductions in order to benefit from the charitable donation; this reduces his/her AGI; less social security may be taxable.
Non-Cash Contributions to Charity will be strictly limited to items in "good, used condition or better". If the item exceeds $500 in value, there must be a qualified appraisal of the property donated. For personal property donated worth over $5,000 (other than publicly traded securities), there is a new recapture provision dealing with the sale of that property within 3 years. These new rules apply to contributions made after August 17, 2006.
New Roth 401(k) Plans are available in 2006. There is no current tax deduction for the contributions, but they allow the employee to receive a portion of his/her distributions tax-free at retirement. This new plan allows some high income taxpayers to contribute who would otherwise be over the threshold for a regular Roth IRA. This new type of account must be in a separate account, and any employer's match must go into the regular 401(k) account. The distributions for this type of account follow the 401(k) rules, and to receive the distributions tax-free the account must have been established for at least 5 tax years; the taxpayer must be over 59 ½.
Refund for Excise Tax on long-distance Telephone Service on the 2006 tax returns, on line 71 of the 1040. There is a standard amount of refund based upon the taxpayer's number of exemptions (1 exemption = $30, 2 exemptions = $40, etc.), or Form 8913 can be used to document actual calculations. This refund is for all excise taxes between February 28, 2003 and August 1, 2006. This is a refundable credit, which means that applicable taxpayers can file a 1040EZ-T to claim this refund even if they would not otherwise not required to file a tax return. Businesses must calculate their actual tax paid to determine the amount of the credit; if the refunded business expense was deducted as a telephone business expense, the refund in 2007 must be included in gross income.
Domestic Production Activities deduction for businesses, Section 199, is calculated on Form 8903 and reported on line 35 of the 1040. This had been new in 2005, and has been fine-tuned for 2006. This deduction applies to business that do construction, wholesale food, software development and sales; clothing manufacturing, water processing, production of newspapers and magazines, just to name a few. Only the income and expenses attributable to the production activity are included in this calculation. Both regular wages paid to employees and wages paid to leased employees count.
Definition of a Child which was revised in 2005 has been further defined for 2006. If a child is a qualifying child of more than one individual, the taxpayers can decide between them who will take the child; the IRS has come up with tie-breaker rules when two taxpayers use the same qualifying child on their returns. Those tie-breakers involve which one is the child's parent, the parent with whom the child resides for the longest period of the year, and if neither are parents, the taxpayer with the highest AGI.
Divorced and Separated Parents can claim the child for different purposes sometimes. The custodial parent generally takes the dependency exemption; however if that parent waives the exemption he/she can still claim the earned income credit, dependent care credit, and/or Head of Household filing status. Each exemption and credit must be evaluated by specific criteria provided by the IRS's new clarifications.
Health Savings Account Distributions are reported on Form 8889, and the tax treatment depends upon the reason for the distribution. Normal distributions used to only pay qualified medical expenses for the account beneficiary, spouse of account beneficiary, dependents, or someone who could have been claimed as a dependent but received $3200 in gross income. These distributions are excludable from gross income. If the distributions are not used for qualified medical expenses, they are included in taxable income plus subject to a 10% excise tax unless the account beneficiary has died, become disabled, or has turned age 65.
Partial Exclusion for Home Sale is allowed if the taxpayer both owns and lived in it as his/her personal residence for 2 out of the most recent 5 years and can prove to the IRS that the sale is due to unforeseen circumstances.
Split Refunds can be directly deposited into as many as 3 bank accounts by using Form 8888 starting in 2006; California refunds can be split into 2 bank accounts.
Private Debt Collection has begun for the IRS to more effectively collect money owed by taxpayers. There are three private companies authorized to collect federal debts, but only for cases in which the taxpayer has not disputed the liability. If a private company is assigned to collect from a taxpayer, they will first send a letter with the name of the collection company to that taxpayer. Subsequently, the taxpayer will receive a letter from that private company. All payment checks should still be written to the U.S. Treasury, and there are no exceptions.
Child Care Credit is disallowed for expenses for any child in kindergarten or higher; previously the disallowance of school expenses occurred at grade one or higher. After-school child care may still qualify if all the other requirements are met.
Domestic Partners that are registered in California may report different income on the federal return from their state return, as the community property law in California is not taken into account for federal purposes.
Prepaid Expenses can only be claimed in the taxable year in which the services are performed or the taxable year that the expenses are paid, whichever is later, whether the taxpayer is on a cash basis or an accrual basis.
Payroll Taxes can be paid by Credit Card starting in 2006, for the balance due on Form 941 and Form 940. However a credit card cannot be used to make federal tax deposits. The taxpayer may do so by calling 1-800-2PAYTAX. There will be a service fee charged for this service.
Form 944 is new for 2006, and was created for the purpose of allowing small employers to file their employment tax return annually instead of quarterly. This applies to those businesses whose annual liability for employer taxes and withheld federal income taxes is $1,000 or less.
Disclosure of Information regulations have been passed, which require written consent to be given before a tax return preparer discloses or uses the taxpayer's return information for any purpose. This consent must be provided each time a preparer is asked to provide tax return information, and must follow specific rules such as size of paper and 12-point type, as well as the nature of the disclosure or use. Certain mandatory language must be included with the consent. All consents must contain a warning about third party use of tax return information, as well as language as to what steps to take if the taxpayer feels his/her rights have been violated.
CALIFORNIA TAX LAW CHANGES
Dissolution of California corporations has been simplified by elimination of the tax clearance certificate requirement. This applies to all busineses other than partnerships and limited partnerships. The new process provides that the minimum franchise tax will not be assessed for a taxable year if the entiry files a final annual tax or minimum franchise tax return for the preceding taxable year; the entity did not conduct any further business in California; and the entity files documents for dissolution, surrender, or cancellation within 12 months of the due date of the final return without regard to extension. New forms and instructions are available on the Secretary of State's website.
