Special Report

20 Things You Need to Know About the 2006 Tax Laws

Every year, notable changes to federal tax law occur. Here are 20 changes that take effect starting with the 2006 tax year - changes you should know about before your return is prepared. (See disclosure endnotes*)

Most of these changes relate to the sweeping tax cuts approved by Congress and President Bush in 2002. Others reflect the impact of rising energy costs and the recovery from Hurricane Katrina.

Several new tax law changes affect retirement savings plans.

In particular, they affect IRAs and pension plans.

1a) Traditional IRA income limits have increased another $5,000.

If you were covered by a retirement plan in 2006 you can take an IRA deduction if your modified adjusted gross income (AGI) is less than $85,000 (married filing jointly) or $60,000 (single or head of household).

1b) IRA contribution limits have increased.

If you were age 50 or older in 2006, you may be able to deduct up to $5,000 as a traditional or Roth IRA contribution. (That $5,000 limit allows a $1,000 catch-up contribution.)

1c) At age 70-1/2 or older, you can now make a qualified charitable deduction directly from your IRA to a qualified charity.

This distribution does not count as income.

1d) Limits on elective deferrals for qualified retirement plans and SIMPLE plans have increased.

• The maximum amount of elective deferrals contributable to a qualified plan is $15,000 ($20,000 if you are 50 or older).

• The maximum amount of elective deferrals contributable to a SIMPLE plan is $10,000 ($12,500 if you are age 50 or older).

1e) 401(k) and 403(b) plans can now include a designated Roth IRA contribution program.

Employee contributions to these add-on accounts are treated as elective deferrals, yet they must be included in income. Qualified distributions from these Roth accounts are not considered income.

1f) The following changes affect members of the U.S. Armed Forces and former public safety employees.

• For purposes of taking an IRA deduction, earned income includes any non-taxable combat pay received by a member of the U.S. Armed Forces.

• If you were a qualified reservist called to active duty for more than 179 days, the additional 10% tax on early distributions does not apply to distributions issued to you after September 11, 2001.

• If you were a public safety employee who separated from service after age 50, the additional 10% tax on early distributions does not apply to distributions you received from qualified governmental plans after August, 17, 2006.

Deduction limits have increased for
Health Savings Accounts (HSAs) and
Archer Medical Savings Accounts (MSAs).

For HSAs:

• 2006 maximum deduction - $2,700 ($5,450 for family coverage)

• 2006 maximum additional deduction for individuals age 55 or older - $700

• Minimum annual deductible of a high deductible health plan - $1,050
($2,100 for family coverage)

• Maximum annual deductible and other out-of-pocket expenses limit - $5,250
($10,500 for family coverage)

For Archer MSAs:

• Minimum annual deductible of a high deductible health plan - $1,800
($3,650 for family coverage)

• Maximum annual deductible of a high deductible health plan - $2,700
($5,450 for family coverage)

• Maximum out-of-pocket expenses limit - $3,650 ($6,650 for family coverage)

More changes to the ever-changing estate tax laws.

• The estate tax exemption has increased to $2 million for 2006.

• The maximum estate and gift tax rate edges south to 46% for 2006 (it will be 45% for 2007).

• The annual exclusion for gifts of present interests made to a donee during the calendar year is now $12,000.

• The annual exclusion for gifts made to spouses who are not U.S. citizens is now $120,000.

• The generation-skipping transfer (GST) lifetime exemption has increased to $2 million for 2006.

The IRS has raised the exemption amounts for the Alternative Minimum Tax (AMT).

Originally designed to tax the ultra-rich, the AMT (never indexed to inflation) now forces many middle-class taxpayers to do their taxes twice. The good news: the exemption amounts for TY 2006 have risen.

• Single - $42,500

• Married filing jointly or surviving spouse - $62,550

• Head of household - $42,500

• Married filing separately - $31,275

The standard deduction has increased for 2006.

The IRS has increased the basic standard deduction by about 3% for 2006. The new standard deductions are:

• $7,550 for head of household (was $7,300 in 2005)

• $10,300 for married filing jointly or surviving spouse (was $10,000 in 2005)

• $5,150 for married filing separately (was $5,000 in 2005)

• $5,150 for single people (was $5,000 in 2005)

As for adults who qualify as dependents, their standard deduction may not exceed a) $850 or b) the sum of their earned income + $300, whichever is greater.

The IRS has raised the amount of income subject to Social Security and Medicare tax.

For the 2006 tax year, the amount of wages subject to SSI tax has increased to $94,200 (it was previously $90,000). All covered 2006 wages are subject to Medicare tax.

The "kiddie tax" is rising.

Sometimes, high-income households will channel unearned income through minor children to reduce overall taxes. This tactic has now become a little less advantageous.

7a) Under the old rules, once the child turned 14, all unearned income was taxed at the child's rate.

But now, if a child is younger than 18, the parents' higher tax rate applies on that child's unearned income.

7b) Previously, a minor child could receive up to $850 in unearned income tax-free, with every dollar after the first $850 getting taxed at 15%.

But for 2006, things have changed: the first $850 of unearned income is still tax-free, but only the next $850 over that will be taxed at 15%. Any unearned income over $1,700 will be taxed at the parents' income tax rate.

Of course, this tax doesn't apply to any income your teenager earns. It only applies to dividends, interest income and income from non-employment sources.

You'll need to document charitable contributions you made after August 17, 2006.

If you want a deduction, that is. If you donated cash or property to a charity last year, you need a receipt to be safe in claiming the deduction. The IRS is getting strict about these deductions, so when you make a donation to charity in the future, keep a receipt (if you donate cash) and make a list and take photos of specific items (if you donate property).q

8a) Did you contribute cash to a non-profit group or qualified charity after
August 17, 2006?

Then you must document that charitable gift with a dated receipt or a dated bank record if you want to claim a deduction.

8b) Did you donate clothing or household items to a non-profit group or qualified charity?

You probably won't be able to claim a deduction, unless what you donated was in "good" or better condition.

Earned Income Credit amounts have increased.

Here are the new EIC limits. You may be able to take the credit for TY 2006 if you earn less than:

• $36,348 ($38,348 if married filing jointly) with more than one qualifying child

• $32,001 ($34,001 if married filing jointly) with one qualifying child

• $12,120 ($14,120 if married filing jointly) with no qualifying child.

9a) The adjusted gross income (AGI) limit for EIC has also increased.

You may be able to claim the credit if your AGI is less than the above income limits (in the category that applies to you).

9b) You can earn up to $2,800 in investment income for TY 2006 and still retain your eligibility for the EIC (another limit increase).

The exemption amount has increased $100.

It was $3,200; it is now $3,300. For tax year 2006, exemptions are phased out beginning at the following AGI levels:

• $112,875 for married persons filing separately

• $150,500 for single individuals

• $188,150 for heads of household

• $225,750 for married persons filing jointly or qualifying widow(er)

The IRS has adjusted mileage rates for rising energy costs.

These rates will increase again for TY 2007. Make sure you document your odometer readings, trip dates, and legitimate reasons for claiming these deductions.

11a) If you use a car for business purposes, the standard business mileage rate deduction for 2006 has risen to 44.5¢ per mile from 40.5¢ per mile.

(It will rise to 48.5¢ per mile for TY 2007).

11b) If you used your car to get medical care or to move, you can deduct 18¢ per mile for those trips, as opposed to 15¢ per mile last year.

(In 2007, this rate jumps to 20¢ per mile.)

11c) If you used a car to provide charitable services to a qualified charity, you can receive credit for your mileage at the rate of 14¢ per mile.

And if that charity was engaged in the relief effort related to Hurricane Katrina, you can take the standard mileage rate of 32¢ per mile.

If you've made your home more energy-efficient, you may be able to claim a tax credit.

If you've bought technology such as a solar water heater, photovoltaic equipment, or a fuel cell power source or micro-turbine to provide energy for your home, you may qualify for a tax credit.

State and local governments must now report interest paid on tax-exempt state and local bonds.

These interest amounts will be stated on a Form 1099-INT (Interest Income). You must also show these amounts on your tax return, for information only.

You can now split your tax refund among multiple bank, brokerage or credit union accounts.

In 2007, you can use the new Form 8888 to stipulate what percentage of your refund you want to go where via direct deposit.

The IRS has expanded the list of vehicles qualifying for the Alternative Motor Vehicle Credit.

The full list is at www.irs.gov/newsroom/article/0,,id=157557,00.html and includes most hybrid cars and SUVs. If you drove an alternative motor vehicle in 2006, you may be able to take up to a $3,400 deduction. (But starting in 2006, you can't take a deduction for a clean-fuel vehicle.)

Tax benefits for adoption have increased.

The adoption credit and the maximum exclusion from income of benefits under an employer's adoption assistance program have been increased $10,960.

Credits are available for clean renewable energy bonds or Gulf tax credit bonds.

If you held any of these bonds during TY 2006, you may be able to claim a credit.

Income limits have been increased for the education savings bond interest exclusion.

For 2006, your exclusion begins to be phased out when your modified adjusted gross income (MAGI) reaches $63,100 ($94,700 for joint filers) and is eliminated completely at $78,100 ($124,700 for joint filers). For 2005, the exclusion phased out between $61,200 and $76,200.

A reduction in phase-outs.

• Itemized deductions used to be reduced according to rising income levels. For tax year 2006, the deduction phase-out is reduced by one-third. By 2010, it will be gone entirely.

• Personal exemptions are also reduced by one-third in 2006

These tax provisions have expired for
tax year 2006.

• The deduction from adjusted gross income (AGI) for educator expenses. (If you have itemized these expenses, such a deduction may still be allowed.)

• The deduction for qualified tuition and fees. (You may be able to claim a credit for these expenses.)

• The District of Columbia first-time homebuyer credit (which applies to homes purchased after December 31, 2005).

• The itemized deduction for state and local general sales taxes.

* This Special Report is a summary of the 2006 tax law changes, and is not intended as a guide for the preparation of tax returns. The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting or tax advice or opinion provided by Scott E. Bordelon , CFP®, AAMS, Financial & Investment Management Advisors, Inc., Mutual Service Corporation and Peter Montoya Inc. to recipients. No information herein was intended or written to be used by readers for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Readers are cautioned that this material may not be applicable to, or suitable for, their specific circumstances or needs, and may require consideration of non-tax and other tax factors if any action is to be contemplated. Readers are encouraged to consult with professional advisors for advice concerning specific matters before making any decision, and Scott E. Bordelon , CFP®, AAMS, Financial & Investment Management Advisors, Inc., Mutual Service Corporation and Peter Montoya Inc. disclaim any responsibility for positions taken by taxpayers in their individual cases or for any misunderstanding on the part of readers. Scott E. Bordelon , CFP®, AAMS, Financial & Investment Management Advisors, Inc., Mutual Service Corporation and Peter Montoya Inc. assume no obligation to inform readers of any changes in tax laws or other factors that could affect the information contained herein.

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