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More Tax Changes: The Tax Relief and Health Care Act of 2006

President Bush signed the Tax Relief and Health Care Act into law in late 2006. The new law, which offers $45.1 billion in tax breaks and adds more than 200 changes to the Tax Code, extended several tax provisions that were scheduled to expire, resurrected several tax provisions that had already expired and added a few surprises.

For instance, the new law retroactively restored some popular expired tax cuts to the beginning of 2006. Those included the deduction for state and local sales taxes, the higher education tuition deduction, the teacher's classroom expense deduction and the research tax credit.

The new law also enhanced some important incentives, bolstered Health Savings Accounts, extended some expiring energy credits and includes miscellaneous tax relief, including a refundable credit worth up to 20 percent to certain taxpayers with long-term unused AMT credits who have AMT income from incentive stock options.

Here's a recap of some of the provisions that were extended:

Deduction of state and local general sales tax: The American Jobs Creation Act of 2004 allowed taxpayers to deduct either state and local income taxes or state and local general sales taxes as an itemized deduction, according to the CCH Tax Briefing. This deduction expired on Dec. 31, 2005. However, the popularity of the deduction, especially among residents of states without an income tax, did not go unnoticed on Capitol Hill. Thus, the new law extends it through 2007. According to CCH , taxpayers can calculate their deduction either by saving receipts or using the Optional State Sales Tax Tables in IRS Publication 600.

According to CCH, taxpayers may alternate from year to year between sales tax and state income tax deduction. Similarly, in taking the sales tax deductions, alternating from year to year between using the IRS sales tax tables and the actual expense method is permitted, CCH reported. In some cases, taxpayers may want to consider timing the purchase of big-ticket sales tax purchases to achieve the best possible tax break.

Higher education tuition deduction: The new law extends the popular above-the-line higher education tuition deduction through 2007. For 2006, and again in 2007, a $4,000 above-the-line education deduction is available each year to single taxpayers with adjusted gross incomes (AGI) of $65,000 or less ($130,000 for joint filers). For those single taxpayers with incomes between $65,001 and $80,000 ($130,001 to $160,000 for joint filers) a $2000 above-the-line education deduction is available. These are the same levels set for the deduction in 2004 and 2005.

Teacher's classroom expense deduction: Teachers and other education workers can deduct, above the line, up to $250 of certain out-of-pocket classroom expenses such as paper, pens, glue and scissors, software and books. The position can be with any class from kindergarten through grade 12 as long as the work covers at least 900 hours during the school year. This deduction, which recognizes that many education professionals purchase classroom supplies with their own money, was claimed by more than 3 million taxpayers in 2005.

Work opportunity tax credit and welfare-to-work tax credit: Congress created the Work Opportunity and Welfare-to-Work tax credits to give employers tax incentives to hire economically disadvantaged individuals. According to CCH , the new law retroactively renews the two popular credits for 2006 and for 2007, combines them, with enhancement, into one credit.

Energy extenders: The new law also extends for one year a host of energy related tax provisions scheduled to expire at the end of 2007 under current law, such as the credits for residential energy efficient property and new energy efficient homes, and the deduction for energy efficient commercial buildings. Other extenders include:

• Research tax credit;
• Election to treat combat pay as earned income for purposes of the earned income credit; and
• Archer medical savings accounts (Archer MSAs).

Health savings accounts (HSA): The new law enhances the use of health savings accounts (HSAs). Unlike the extenders, the HSA enhancements are permanent and most take effect for tax years beginning after 2006, according to CCH. For instance, 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 new law also allows employees a one-time, once-in-a-lifetime, rollover of funds from their IRAs into an HSA. The election to make the rollover is irrevocable. The change is designed to give employees quicker access to their funds for medical expenses. The provision applies to tax years beginning after Dec. 31, 2006.

The bill also has a number of tax provision that offer even more tax relief to a wide variety of taxpayers. Those include, according to CCH :

• 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; and
• An itemized mortgage insurance premium deduction available on qualified residences, with phase-out starting at $100,000 AGI, for 2007 only. The premium must be paid or accrued with respect to a mortgage insurance contract issued after Dec. 31, 2006.

And last, the bill also increases the penalty for filing a frivolous tax return from $500 to $5,000.

January 2007 – This column was authored in cooperation with Financial Planning Association.