TAX RELIEF AND HEALTH CARE ACT OF 2006

As one of its last official acts, the 109th Congress recently passed the Tax Relief and Health Care Act of 2006, a wide-ranging measure that preserves a variety of popular tax breaks for families and businesses, and includes new tax breaks as well. The new law is almost overwhelming "good news" for taxpayers, particularly because it retroactively restores and extends key tax breaks that went off the books at the end of 2005. These include the election to deduct state and local general sales tax, the deductions for higher education expenses and for schoolteachers' books and supplies, and the research credit.

However, the new law also will prove to be a challenge when the time comes to file 2006 returns. That's because the IRS had to send key forms and schedules for the 2006 year off to the printer before the new law extended these tax breaks. The IRS has said it will not reprint forms and schedules to reflect the new law, but will, instead, issue supplementary instructions. In other words, filing 2006 returns could be a real challenge for the uninformed, and refunds could be delayed because the IRS will have to retool its computers and procedures to reflect the new law's changes.

New Law Changes Affecting Individuals

Here's a summary of the most widely applicable tax breaks for individuals that have been restored and/or extended, and for how long:

The tax deduction for qualified higher education expenses is restored for 2006 and extended through 2007. It allows individuals to deduct up to $4,000 (depending on their income) of higher education expenses instead of claiming the Hope or Lifetime Learning tax credits. The deduction is taken "above-the-line" (that is, it is subtracted to arrive at adjusted gross income), so it may be claimed by all individuals regardless of whether they itemize their deductions.

The tax break allowing individual taxpayers to elect to take an itemized deduction for state and local general sales taxes instead of the itemized deduction permitted for state and local income taxes is restored for 2006 and extended through 2007. You have two options for determining deductible sales tax: (1) actual sales tax paid if receipts are maintained for IRS verification; or (2) approximate sales tax paid as estimated in tables provided by the IRS plus sales tax on certain additional items (such as a boat or car) that may be added to the table amount. The IRS said it will be issuing a separate publication carrying optional sales tax tables for the 2006 tax year; these tables will not be in the Form 1040 instructions.

The tax break permitting elementary and secondary school teachers and certain other school professionals to deduct up to $250 of out-of-pocket costs incurred to purchase books, supplies and other classroom equipment is restored for 2006 and extended through 2007. This deduction is claimed "above the line."

The 30% tax credit for the purchase of residential solar water heating, solar electric equipment and fuel cell property is extended through Dec. 31, 2008. The maximum credit depends on the type of energy efficient property that you buy.

The election to have excluded combat pay counted as income for purposes of calculating the earned income tax credit (EIC) is extended through 2007. This election could result in an otherwise eligible taxpayer claiming the EIC, a refundable credit, even if he or she doesn't have any other earned income.

The tax break allowing first-time homebuyers in the District of Columbia to claim a tax credit of up to $5,000 on the purchase price of the home is restored for 2006 and extended through 2007.

New contributions to Archer medical savings accounts (Archer MSAs) may be made through 2007. New contributions may be made after 2007 only by or for individuals who previously had Archer MSAs, and employees who are employed by a participating employer. Individuals may make tax-deductible contributions to an Archer MSA to pay for health care expenses. The distributions are tax-free if used to pay for eligible medical expenses.

The Tax Relief and Health Care Act of 2006 also includes these new tax breaks for individuals:

For the 2007 tax year only, there's a new itemized deduction for the cost of premiums for mortgage insurance on a qualified residence. The deduction is phased-out for taxpayers whose adjusted gross income exceeds $100,000.

After 2006, a limited relief provision helps individuals who wound up with AMT (alternative minimum tax) problems because of their exercise of incentive stock options. The relief provision, which is complex, allows individuals to take advantage of a refundable credit with respect to certain long-term unused alternative minimum tax (AMT) credits existing before Jan. 1, 2013.

The new law includes many changes for health savings accounts (HSAs), including: allowing one-time rollovers from health flexible spending accounts (FSAs) and health reimbursement arrangements (HRAs) into HSAs (after the enactment date of the new law and before 2012); repeal of the annual plan deductible limit on HSA contributions (after 2006); expanded contributions limit for part year coverage (after 2006); and allowing one-time rollovers from IRAs into HSAs (after 2006).

New Law Changes Affecting Businesses

Here's a summary of the most widely applicable business-related tax provisions that have been restored and/or modified and extended, and for how long:

The research and development (R&D) credit is restored for 2006 and extended for 2007. In addition, for tax years ending after 2006, the new law enhances the credit by (1) increasing the rates of the alternative incremental credit and (2) creating a new alternative simplified credit that does not use gross receipts as a factor (so that newer businesses can access the credit).

The work opportunity tax credit (WOTC), which is a credit for wages paid by employers who hire individuals from certain targeted groups, and the welfare-to-work tax credit, which is a credit for wages paid by employers who hire long-term family assistance recipients, are extended in their current form for workers hired in 2006 and combined and modified for those hired after 2006 and before 2008.

The election to expense (currently deduct) environmental remediation costs associated with cleaning up certain hazardous sites is restored for 2006 and extended for 2007, and for post-2005 expenses, the definition of an eligible contaminated site is expanded to include sites contaminated by petroleum products.

The accelerated writeoff for certain leasehold improvements and restaurant property (depreciation over 15 years instead of 39 years) is restored for 2006 and extended through 2007.

The bonus 50% first-year depreciation break that was included in the Gulf Opportunity Zone Act of 2005 is modified by extending the placed-in-service deadline for certain property used in certain highly damaged areas within the Gulf Opportunity Zone.

The tax credit for builders of new energy efficient homes is extended through 2008. The credit applies to manufactured homes meeting a 30% energy reduction standard and other homes meeting a 50% standard.

The deduction for energy efficient commercial buildings meeting a 50% energy reduction standard is extended through Dec. 31, 2008.