WHAT'S NEW FOR 2006
The Tax Relief and Health Care Act of 2006 has extended certain tax provisions which would otherwise have expired at the end of 2005. These include the state and local sales taxes deduction, tuition and fees deduction, educator expenses adjustment, and certain work credits. This act also liberalizes rules for health savings accounts (HSA�s).� Other new legislation takes effect in 2006 as a result of the Pension Protection Act of 2006, Tax Increase Prevention and Reconciliation Act of 2006, and the Energy Tax Act of 2005. Highlights of this new legislation include: new tax credits for residential energy efficiency improvements, alternative motor vehicle credit, tax-free IRA distributions for charitable purposes, stricter rules for charitable contributions, increased alternative minimum tax (AMT) exemption, Kiddie tax for children under 18, and changes to the foreign earned income and housing exclusion rules.
Tax Rate Reduction - 2006 Individual Marginal Brackets
Let�s explain marginal tax rates again this year.� We will use an example of a married couple with $100,000 in taxable income.� The first $15,100 is taxed at 10% (=$1,510), the next $46,200 of income needed to reach $61,300 is taxed at 15% (=$6,930) and the final $38,700 to reach $100,000 is taxed at 25% (=$9,675).� Thus, your total federal income tax would equal $18,115 and your effective tax rate would equal 18.1% ($18,115/$100,000).� Your effective tax rate is listed on the invoice letter provided to you each year.� Also, please note that your effective tax rate % is reduced for the child tax credit and for net long-term capital gains/qualified dividends that are taxed at a lower rate.� Finally, the 7.65% or 15.3% Social Security and Medicare tax paid on your W-2 wages and self-employment income, respectively, is not included in your effective tax rate.� You may want to add this percentage to determine your �real� tax rate.
Standard Deduction in 2006
The standard deduction was increased from $5,000 single and $10,000 married in 2005 to:
For dependants filing a separate tax return, the standard deduction is $850 or $300 plus earned income.
The 2006 exemption amount increased $100 to $3,300 per exemption from $3,200 in 2005.�
Itemized Deductions Phaseout in 2006
The itemized deduction phaseout threshold increased from $145,950 in 2005 to:
Reduction in Phaseout of Personal Exemptions & Itemized Deductions!
Beginning in 2006, a higher-income taxpayer's personal exemption amount will be reduced by only 66.6% of the amount that would have been computed in previous years.� A higher-income taxpayer's itemized deductions (other than those for medical expenses, investment interest, and casualty losses) are reduced if his adjusted gross income (AGI) exceeds $150,500 ($75,250 for married filing separately).� Beginning in 2006, a taxpayer will lose only 66.6% of the amount he otherwise would lose under prior year reduction computations.
Child Tax Credit
The child tax credit is $1,000 (same as last year) for each child under age 17.� The phaseout threshold is $110,000 married and $75,000 for single and head of household.
Child Care and Dependent Care Expenses
For 2006, the maximum qualified care expense remains at $3,000 for one person and $6,000 for two or more persons.� The maximum dependent care credit is 35% of qualified care expenses.
Itemized Deductions - Sales Tax Deduction
The Tax Relief and Health Care Act of 2006 has extended the state and local sales tax deduction which would otherwise have expired at the end of 2005.� This allows taxpayers to deduct sales tax paid as an itemized deduction on Schedule A instead of the deduction for state and local income tax paid. Taxpayers may deduct actual sales tax paid or use IRS tables. This provision is effective through 2006.
Tax Law Changes for IRAs and other Retirement Plans
The Pension Protection Act of 2006 made a host of changes to pension plans.� It made permanent the credit for qualified retirement savings contributions.� For 2006, the rules in determining the limit on deductions where there is a combination of plans are relaxed.� A provision of EGTRRA allows contributions to 401(k) and 403(b) plans to be designated as Roth contributions.� For tax years beginning after 2006, the income limits for deductible contributions to traditional IRAs and Roth IRAs will be indexed for inflation and all or a portion of a taxpayer's refund may be directly deposited into an IRA.� Effective for post-2006 distributions, nonspouse beneficiaries are allowed to make rollovers of inherited qualified plans to their own IRAs.� Previously, only spouses were allowed to roll over qualified distributions into inherited IRAs.�
Charitable Donations of IRA Distributions
For tax years beginning in 2006 and 2007, IRA distributions (up to $100,000) made directly by the trustee to a charity generally are excluded from income if the taxpayer is at least age 70 1/2.� The distribution must be made directly by the IRA trustee to the charitable organization.� No double benefit is allowed. The amount excluded from income is not allowed as a charitable deduction on Schedule A.
Increase of AMT Exemption and Expansion of Personal Credits
The Tax Increase Prevention and Reconciliation Act of 2006 increases the AMT exemption amount to $62,550 married and $42,500 for unmarried individuals (instead of dropping to $45,000 and $33,750).
Kiddie Tax Applies to Children Under Age 18
In 2006, a child under 18 is subject to tax on unearned income over $1,700 at his or her parent's highest marginal rate.� In previous years, a child was subject to the "kiddie tax" if he or she was under age 14.
Domestic Production Activity Rules
Effective for years beginning after May 17, 2006, for purposes of the 50% W-2 wage limit on domestic production gross receipts, taxpayers may only include amounts that are properly allocable to domestic production gross receipts, and the special limit on wages as allocated to partners or shareholders of pass-through entities is repealed.
New reporting Requirements for Tax-Exempt Interest
Under the Tax Increase Prevention and Reconciliation Act information reporting is required for interest paid on tax-exempt bonds after December 31, 2005. Two new boxes, box 8 for tax-exempt interest and box 9 for private activity bond interest have been added to Form 1099-INT.
Gift Tax Exclusion
The annual gift tax exclusion for 2006 is $12,000 per donee, an increase from $11,000 in 2005.
Tax Credit for Energy Efficient Improvements to Existing Homes
Although the Energy Tax Act was passed in 2005, many of its provisions began to take effect in 2006.� A taxpayer may claim a lifetime nonrefundable credit of up to $500 for making qualifying energy saving improvements to his or her existing main home.�� Improvements such as insulation, exterior doors and windows, and certain water heaters, air conditioners, etc. that meet specific energy efficiency standards qualify.� Also, certain solar power and photovoltaic equipment receives a higher credit.
Alternative Motor Vehicle Credit
The Energy Tax Act provides a new alternative motor vehicle credit consisting of the sum of four new tax credits for the purchase of alternative power vehicles:� 1) qualified fuel cell, 2) advanced lean burn technology 3) hybrid motor and 4) alternative fuel motor vehicle credit.� The alternative motor vehicle credit is allowed to the vehicle owner in the year placed into service, including the lessor of a vehicle subject to a lease.� This new credit replaces the deduction for clean-fuel vehicles which is no longer available.
Charitable Contributions - New Rules
In the case of a charitable contribution of money, regardless of amount, the donor must maintain a cancelled check, bank record or receipt from the donee organization showing the name, date of contribution, and dollar amount. This is effective for contributions made in tax years beginning after August 17, 2006.� Also, donations of food inventory which was formerly available only to C corporations is extended to all trades and businesses, effective for two years through 2007.�
Stricter Rules for Noncash Donations
Deductions for contributions of clothing and household items are prohibited unless the items are in good used condition or better.
Standard Mileage Rate
The standard business mileage rate per mile for 2006 is about the same as 2005.
The Maximum IRA contribution is $4,000 ($5,000 for taxpayers 50 years of age or older).� For taxpayers covered by a retirement plan, the IRA deduction may be taken if modified adjusted gross income is below $60,000 ($85,000 if married filing jointly).
Estimated Tax Payments
Estimated tax payments are not required if the taxpayer's total tax liability, reduced by any withheld tax, is less than $1,000.� For most taxpayers in 2006: If you owe more than $1,000, your required payment to avoid a penalty must be the lesser of (1) 90% of your 2006 tax, or (2) 100% of your 2005 tax.
Section 179 Depreciation Limit Increased to $105,000 & Includes Software
The Section 179 deduction was increased to $108,000 for 2006.� Off-the-shelf computer software placed in service in 2005 through 2007 now qualifies for Section 179 expensing.
Wage Base for Household Employees
For household employees paid less than $1,500, there is no federal requirement to report and pay taxes.
Capital Gains Tax & Qualified Dividend Tax Rates Remain Same
The long-term capital gains and qualified dividend tax rates remain at 15% for taxpayers with a marginal tax bracket above 15%.� Collectibles, including gold and silver bullion are still taxed at 28%.
Social Security Wages and Rates for 2006 & 2007
The maximum amount of wages subject to Social Security tax is $94,200 for $2006 and $97,500 for 2007.� The Social Security tax rate remains at 6.2%.� All wages are subject to Medicare tax of 1.45%.