CHANGES IN TAX LAW INCLUDE
INCENTIVES FOR ENERGY-EFFICIENCY
AND RETIREMENT SAVINGS
In January 2007, the Internal Revenue Service announced several tax law changes, including incentives designed to promote household energy efficiency and retirement savings, as well as new rules governing charitable donations.
Tax Credits Promote Energy Efficiency
Taxpayers may claim a ten-percent credit for certain energy-efficient improvements made to their principle residence, including insulation, exterior windows, exterior doors, water heaters, heat pumps, central air conditioning, furnaces, and hot water boilers. The credit is based on the cost incurred to make such improvements, and is limited to a total credit of $500. Certain dollar amounts apply, depending on the specific improvement. For example, credits for energy-efficient windows are limited to $200. See Form 5695 for more information.
New Contribution Limits for IRAs, Special Treatment for Active-Duty Military
The IRS also announced several changes related to tax treatment of IRAs and other retirement plans. Starting with the 2006 tax year, the contribution limit for Roth and traditional IRAs has increased to $5,000 for those aged 50 or over. This represents an increase of $500. For those under 50, the limit remains unchanged at $4,000. The $10,000 phase-out range for IRA deductions for those covered by a retirement plan begins at incomes of $75,000 if married filing jointly or as a qualifying widow(er), up from $70,000 in 2005. For a single person or head of household, the phase-out range remains unchanged, and begins at $50,000. The range remains unchanged for married persons filing separate returns, and begins at $0.
The elective contribution limit for employees who participate in 401(k), 403(b) and most 457 plans has increased to $15,000. The limit remains at $10,000 for SIMPLE plans. The catch-up contribution limit for persons aged 50 or older has increased to $5,000 for 401(k), 403(b) and 457 plans and to $2,500 for SIMPLE plans. Beginning in 2006, 401(k) and 403(b) plans may create a qualified Roth contribution program allowing participants to choose to have part or all of their elective deferrals to the plan designated as after-tax contributions.
Members of the military serving in Iraq, Afghanistan and other combat zones may count tax-free combat pay when calculating how much they may contribute to a Roth or traditional IRA. This change was made because taxpayers usually were required to have taxable earned income in order to make contributions into an IRA, thus members of the military whose earnings came from tax-free combat pay were often barred from making such contributions. This change is retroactive to 2004, and eligible taxpayers have until May 28, 2009 to make contributions for 2004 and 2005. Taxpayers who have already filed returns for 2004 and 2005 and choose to make these special back-year contributions to a traditional IRA must report them on an amended return using Form 1040X, along with, in some cases, Form 8606. See IRS News Release IR-2006-129 for more information.
Military reservists and members of the National Guard who have been called to active duty may receive payments from their individual retirement accounts, 401(k) plans and 403(b) tax-sheltered annuities without being subject to the typical ten-percent early-distribution tax that applies to most retirement distributions received before age 59 ½. For such taxpayers, the ten-percent tax is waived for at least 180 days or for an indefinite period. Reservists activated after September 11, 2001 and prior to December 31, 2007 qualify for this relief. Although the ten-percent early-distribution tax does not apply, regular income taxes continue to apply to these payments in most cases. For more information, see IRS News Release IR-2006-152.
New Rules for Charitable Contributions
Clothing and household items donated to charity after August 17, 2006, must be in good used condition or better in order to qualify as deductible. However, a taxpayer is permitted to claim a deduction of more than $500 for any single item, regardless of its condition, if the taxpayer includes a qualified appraisal of the item with his or her tax return.
To deduct any charitable donation of money, taxpayers must provide copies of bank records or written communication from the recipient showing the name of the organization and the date and amount of the contribution. Although taxpayers are already required to keep records to support such deductions, this new provision is designed to provide greater certainty in determining what may be deducted as a charitable contribution. This provision applies to contributions made in taxable years beginning after August 17, 2006. For taxpayers that file returns on a calendar-year basis, including most individuals, the new provision applies to contributions made beginning in 2007.
An IRA holder, aged 70 ½ or older, may directly transfer up to $100,000 per year to an eligible charity on a tax-free basis. This option is available in tax years 2006 and 2007. Eligible IRA holders may take advantage of this provision whether or not they itemize their deductions. Funds must be contributed directly by the IRA trustee to the eligible charity. Transferred amounts are counted in determining whether the holder has met the IRAs required minimum distribution rules. For more information on these changes and tips for donating to charity, see IRS News Release IR-2006-192.
Kiddie Tax Age and Income Changes
Children under 18 who receive taxable investment income may be required to calculate their applicable tax using their parents' higher marginal rates. This does not apply to a married child who files a joint return. In the past, the so-called "kiddie tax" only applied to children under the age of 14. Also, the amount of taxable investment income a child can have without being taxed at their parent's rate rises to $1,700, up from $1,600. The rest of the child's taxable income - earned income plus unearned income minus the standard deduction - is taxed at the child's regular rates.
One Year Increase in the AMT Exemption
For tax year 2006, the alternative minimum tax exemption rises to $62,500 for a married couple filing a joint return, up from $58,000 in 2005, and to $42,500 for singles and heads of household, up from $40,250. Under current law, these exemption amounts will drop to $45,000 and $33,750, respectively, in 2007.
Standard Mileage Rates Adjusted for 2006
The standard mileage rate for business use of a car, van, pick-up or panel truck is 44.5 cents a mile. The standard mileage rate for the cost of operating a vehicle for medical reasons or as part of a deductible move is 18 cents a mile. The standard mileage rate for using a car to provide charitable services solely related to Hurricane Katrina relief is 32 cents per mile. Otherwise, the rate for providing services to charitable organizations is set by law and remains at 14 cents a mile.
Personal exemptions and standard deductions have risen, tax brackets have widened and more than three dozen individual and business tax provisions have been adjusted for inflation. See "2006 Inflation Adjustments Widen Tax Brackets, Change Tax Benefits" for a complete list of these changes.
Popular items adjusted include the following:
The value of each personal and dependency exemption is $3,300, up $100 from 2005. Most taxpayers can take personal exemptions for themselves and an additional exemption for each eligible dependent. An individual who qualifies as someone else's dependent cannot claim a personal exemption, and personal and dependency exemptions are phased out for higher-income taxpayers.
The standard deduction is $10,300 for married couples filing a joint return and for qualifying widow(er)s, a $300 increase over 2005. The standard deduction is $5,150 for singles and married individuals filing separate returns, up $150; and $7,550 for heads of household, up $250. Higher amounts apply to blind people and senior citizens. The standard deduction is often reduced for a taxpayer who qualifies as someone else's dependent. Nearly two-thirds of all taxpayers claim the standard deduction rather than itemizing deductions such as mortgage interest, charitable contributions, and state and local taxes.
The maximum earned income tax credit is $4,536 for taxpayers with two or more qualifying children, $2,747 for those with one child and $412 for people with no children. Available to low and moderate income workers and working families, the EITC helps taxpayers whose incomes are below certain income thresholds, which rises to $38,348 in 2006 for those with two or more children, $34,001 for people with one child and $14,120 for those with no children. One in six taxpayers claim the EITC, which, unlike most tax breaks, is refundable, meaning that people can get it even if they owe no tax and even if no tax is taken out of their paychecks.
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Last updated 12-Nov-2015.