On December 20, 2006, President Bush signed into law the Tax Relief and Health Care Act, a long-awaited tax bill that extends popular tax breaks that had expired in 2005 or were set to expire in 2006. In addition, this measure also enhances certain tax breaks for Health Savings Accounts (HSAs) and provides a measure of relief for individuals hit by the alternative minimum tax (AMT) after exercising incentive stock options (ISOs).Deduction for State and Local Sales Taxes
The American Jobs Creation Act of 2004 made it possible for taxpayers who itemize their deductions to deduct state and local sales taxes instead of state and local income taxes, but this option expired on December 31, 2005. The new reform allows this deduction through 2008. This option holds the most benefit for residents in states with no income tax or for those living in states with low income tax rates but high sales tax rates, provided their earning and spending make the numbers work.
There are two ways to determine the amount of your deduction: 1) calculate the actual amount of sales tax you paid, which would require your having saved receipts to substantiate the amount of your deduction in the event of an audit; or 2) use a standard IRS table, which will figure an amount based on your adjusted gross income, dependents, filing status, and state of residence.Higher Education Tuition Deduction
An above-the-line deduction worth $4,000 is available to individuals paying qualified higher education expenses. To qualify, single filers must have adjusted gross incomes (AGIs) of $65,000 or less, while joint filers must have AGIs of $130,000 or less. A $2,000 deduction is available to single filers with AGIs under $80,000 and to joint filers with AGIs under $160,000. If you claim either the Hope Credit or the Lifetime Learning Credit, you may not take this deduction.Teacher's Classroom Expense Deduction
Teachers, counselors, principals, and classroom aides may be eligible for a $250 above-the-line deduction for out-of-pocket classroom expenses. Qualified supplies include books, paper, pens, art supplies, computer equipment, software, and athletic equipment.Energy Efficiency Incentives
Extending certain provisions of the Energy Policy Act of 2005, this new measure renews some tax incentives through 2008, including the following:
- The deduction for energy-efficient
commercial building property.
- The business credit for energy-efficient new homes.
- The credit for residential photovoltaic property, solar water heating, and fuel cell power plants.
- The credit for business installation of qualified fuel cells, stationary microturbine power plants, and solar energy property.
- The renewable electricity production credit.
- The issuance of clean renewable energy bonds (CREBs).
- The reduced excise tax on methanol or ethanol fuel derived from coal.
This energy reform does not, however, extend or enhance tax breaks for hybrid cars, and some models are no longer eligible for the maximum tax credit. Toyota, having sold more than 60,000 fuel-efficient vehicles, has exceeded a limit set by the Energy Policy Act of 2005. The tax credit for Toyota models will eventually phase out, as will the credit for hybrids produced by other manufacturers once they sell 60,000 fuel-efficient vehicles.Health Savings Accounts
In a nod to health care reform, the new legislation permanently enhances tax incentives for Health Savings Accounts (HSAs). Employees who have a health Flexible Spending Arrangement (FSA) or a Health Reimbursement Arrangement (HRA) can make a one-time, direct transfer to an HSA through December 31, 2011. Furthermore, beginning in 2008, employees can make a one-time transfer from an Individual Retirement Account (IRA) to an HSA. The amount is limited to the maximum deductible contribution amount of the high-deductible health plan (HDHP), based on the employee's coverage.
In addition, contributions to an HSA are no longer limited to the annual deductible of the HDHP. As a result, in 2008, the maximum contribution for self-only coverage is $2,850, and for family coverage is $5,650.Alternative Minimum Tax Reform
Many unsuspecting taxpayers who exercised incentive stock options (ISOs) have been hit by the alternative minimum tax (AMT). Through December 31, 2012, taxpayers with AMT income may claim a refundable credit worth up to 20% of their unused, long-term AMT credits. The credit phases out for higher-income taxpayers.Business Incentives
Delivering good news to business owners, this latest reform continues the Research and Experimentation (R&E) credit, which rewards companies for technological innovations and improvements. The R&E credit applies to qualified costs incurred in 2006 and 2008, and for tax year 2008, favorable modifications may apply. The credit generally applies to 20% of qualified research expenses above and beyond a base amount. Taxpayers may claim the alternative incremental credit (AIC), which uses a stated percentage of qualified R&E expenses that exceed the taxpayer's average research expenditures over four years. Thanks to the latest reform, the stated percentage amounts used to calculate the AIC will be higher in 2008. This legislation also creates a new alternative simplified credit, which equals 12% of the qualified expenses that exceed 50% of the average research expenses for the three preceding tax years. The credit drops to 6% if the taxpayer has no research expenses in any of the three preceding tax years.
Also getting a boost are the Welfare-to-Work (WtW) credit and the Work Opportunity Tax Credit (WOTC), which provide tax incentives for businesses to hire poor workers. This reform renews both credits for 2006 and then consolidates the two credits into one for 2008, raising the age limit for food stamp recipients from 25 to 40 and easing the eligibility requirements for ex-felons. For most target groups, the credit equals 40% of qualified first year wages, which cannot exceed $6,000.
This tax relief act also continues through 2008 the New Markets Tax Credit for equity investments in economically distressed communities. In addition, the following provisions have been extended through 2008:
- Accelerated depreciations for qualified leasehold and restaurant improvements.
- Expensing of brownfields remediation costs, now applicable to sites contaminated by petroleum products, in addition to areas contaminated by industrial waste and toxins.
- Authority to state and local governments to issue Qualified Zone Academy Bonds (QZABs) for educational improvements in high-poverty areas.
- Deductions of corporate charitable gifts of technology and computer equipment to schools and public libraries. For 2006 and 2008, equipment assembled by the donor qualifies.
The Tax Relief and Health Care Act of 2006 will cost an estimated $45 billion over 10 years. For specific guidance on what provisions may affect your tax situation, give us a call.