Individual Tax Law Changes For 2006

Each new year usually brings several changes in the federal tax laws that affect individual taxpayers. Some are recurring — for instance, the inflation-based increases in the income-tax brackets. Others are due to new laws passed in the previous year. And still others are the result of delayed effective dates for laws enacted in years past.

For tax year 2006, there are a number of changes that may have an impact on your planning and your income-tax return to be filed in 2007. Here is a brief rundown of the more important changes.

Personal Exemption Phaseout

If your adjusted gross income (AGI) exceeds a certain threshold amount, the $3,300 personal exemption amount you can claim for yourself and your dependents begins to be phased out. The 2006 threshold amounts are: $225,750 for married joint filers, $188,150 for a head of household, $150,500 for unmarried filers, and $122,875 for married-separate filers.

The 2006 change: Due to a 2001 law, for 2006 this personal exemption phaseout is reduced so that it will be only two thirds of the normal phaseout.

Example: Assume a married couple with three children has 2006 joint AGI that triggers the personal exemption phaseout. Normally, with their AGI, the amount they could claim as personal exemptions would be reduced by $3,300. But, due to this new provision, their personal exemptions will only be reduced by $2,200.

Itemized Deduction Reduction

Similarly, your itemized deductions (for example, state/local taxes and mortgage interest paid) are reduced starting when your AGI exceeds $150,500 ($75,250 for married separate filers). As with the personal exemption phaseout, for 2006 the reduction in itemized deductions is scaled back so that you will lose only two thirds of the normal amount.

Retirement Plan Limits

Certain retirement plan limits increase for years beginning after 2005.

·        For 401(k), 403(b), salary reduction SEP, and 457 deferred compensation plans, the deferral limit rises from $14,000 to $15,000.

·        For those same plans, the catch-up contribution limit (for those at least age 50) rises from $4,000 to $5,000.

·       The IRA catch-up contribution limit increases from $500 to $1,000.

·       The SIMPLE plan catch-up contribution limit rises from $2,000 to $2,500.

In addition, starting in 2006, 401(k) and 403(b) plans can (but do not have to) allow plan participants to make after-tax Roth contributions, with no income restrictions. (In contrast, higher-income taxpayers cannot contribute to Roth IRAs.) If all requirements are met, earnings on the Roth contributions will avoid tax when distributed.

If you are an active participant in a retirement plan at work and contribute to an IRA, you are not allowed a tax deduction for your IRA contribution if your modified AGI exceeds a certain amount. In 2006, this amount increases for married joint filers and qualifying surviving spouses to $85,000 from $80,000 in 2005.

Residential Energy Credits

Two new residential energy credits are available for certain energy savings expenses, starting in 2006.

The nonbusiness energy property credit allows you to claim a lifetime tax credit (i.e., a direct offset against tax) of up to $500 for making qualifying energy saving improvements to your home. The residential energy efficient property credit allows an annual tax credit of up to 30% of the amount paid during the year for qualifying energy efficient property such as photovoltaic (solar power) property, solar water heating systems, or fuel cell property. Both credits are available through 2007. Several requirements and limits apply.

Alternative Motor Vehicle Credit

If you buy a hybrid or lean burn vehicle in 2006, you may be entitled to a credit of up to $3,400 (depending on how fuel-efficient the vehicle is). This credit replaces tax deductions available for certain vehicles placed in service before 2006.

Estate Taxes

The top federal estate-tax rate has dropped to 46% (from 47%) for 2006. The exemption equivalent amount of estate value that is free from the estate tax has increased to $2 million from $1.5 million.

Expired Provisions

Several favorable tax provisions expired at the end of 2005. Currently, Congress is considering some of these items for reinstatement.

·        Decreased AMT exemption amount. Higher exemption amounts used in computing the alternative minimum tax expired at the end of last year, so the old lower exemption amounts are in effect for 2006 (unless Congress reinstates the higher amounts).

·        Educator expenses. This above-the-line deduction for certain educator’s expenses is no longer allowable.

·        Higher education tuition deduction. The above-the-line deduction for tuition and fees paid isn’t available after 2005.

Need Tax Help?

These changes and others may have an impact on your 2006 planning. Our tax professionals can help you look at your 2006 tax picture now with an eye on the tax law changes that will affect your tax bill come April 2007. The earlier you plan, the easier it will be to cut your 2006 taxes.

The information provided in the newsletter has been obtained from sources believed to be reliable but its accuracy is not guaranteed.