Late tax changes create opportunity, confusion
Legislation designed to fix some pension, healthcare and energy problems ushered in a host of minor tax breaks -- and a handful of tax traps -- that will affect 2006 returns.
That could make filing returns more rewarding, but even more bedeviling than usual this year.
“Sales taxes, college tuition and out-of-pocket expenses for teachers are all deductible again, but they’re not on the tax return,” said Mark Luscombe, principal tax analyst with CCH Inc. “You’ll have to know the law and write them in.”
New rules also affect those donating to charity, children with investment income and those who bought hybrid cars and energy-efficient windows.
What changes should individuals filing 2006 returns watch for?
* Tuition. An expired deduction for those paying college tuition was reinstated in late December. But, like many of today’s tax breaks, this one is “means tested” -- if you make too much money, you may not qualify.
The tuition break allows singles earning less than $65,000 and couples earning less than $135,000 to write off as much as $4,000 in college bills.
A reduced deduction of $2,000 is allowed for singles earning more than $65,000 but less than $80,000, and for married couples earning more than $130,000 but less than $160,000.
Importantly, because this deduction is taken before the taxpayer’s “adjusted gross income” is computed, it can help individuals get a bigger bang out of other means-tested deductions and credits, such as the child tax credit.
The bad news: Because this break was reinstated so late in the year, it doesn’t show up on the 1040 form. The Internal Revenue Service suggests that taxpayers write it in on line 35 of the return, the space for “domestic production activities deduction,” which is a rarely used deduction for certain businesses and partnerships that make products in the United States.
One other suggestion: If you want this deduction, don’t file your return until mid-February. The IRS has to recode its computers to accept it and anticipates that tuition deduction claims will be rejected until that’s done.
* Classroom supplies. Teachers can deduct as much as $250 in out-of-pocket costs for classroom supplies. This deduction was also set to expire in 2006, but got a last-minute revival.
To claim it, write it on line 23, where it says “Archer MSA deduction” -- another rarely used line that was dedicated to Archer Medical Savings Accounts, which are being phased out in favor of Health Savings Accounts.
Again, if you’re claiming this deduction, don’t file until the middle of next month.
* Sales taxes. People with low incomes but high expenses might benefit from the sales tax deduction, which also got a last-minute revival. This is an “either-or” deduction, however. It gives taxpayers a choice to deduct their state income taxes or their sales taxes on their federal returns.
It’s fairly rare that sales taxes amount to more, but for those with a lot of tax-free income -- or those making major one-time purchases out of savings, rather than income -- it might be worth a look. Make sure to retain receipts.
To claim sales taxes instead of income taxes, write “ST” or “sales tax” on line 5 of Schedule A, the itemized deduction form.
* Alternative motor vehicle credit. Those who bought certain hybrid cars in 2006 qualify for tax credits that range from $250 to $3,400, depending on the car. These credits replaced a $2,000 tax deduction that was available for hybrid car purchasers. The deduction was simpler, but the credits are far more valuable.
That’s because a deduction reduces the amount of income that’s subject to tax, while a credit reduces the tax itself. For example, a $2,000 deduction saves a person in the 30% federal tax bracket $600, but a $2,000 credit saves $2,000.
The tax credits for hybrids vary based on a complex formula. The good news is you don’t have to calculate the credit yourself. Just ask your car dealer or visit the IRS website at www.irs.gov.
* Solar and fuel cell credit. These were also launched in 2006 for those who outfitted their homes with solar panels or took pains to insulate or buy energy-saving heating and air conditioning equipment.
The credits range from $50 to $2,000. Claim them on line 52 of the 1040.
* Telephone excise tax refunds. Anyone with long-distance phone bills had been paying a federal excise on those charges until the middle of last year. After losing several court battles over the legality of this tax, the IRS opted to nix it and refund 41 months of tax payments.
There are two ways to claim the refund. The easy way is to use the IRS default formula that would give a single filer a $30 credit and a family of four a credit of $60.
But if you spent a lot of time on long-distance calls, it might be more lucrative to collect past phone bills and claim the full amount of the tax you paid. Those who go this route need to detail the charges on form 8913. The refund is claimed on line 71 of the 1040.
* Kiddie taxes. Children with investment income are more likely than ever to fall under the “kiddie tax” rules, which now subject a minor with investment income of at least $1,700 to his or her parents’ higher tax rates.
* Charity traps. Rules on deductions for clothing and other used household items were changed in 2006, denying deductions for anything that wasn’t in “good” condition, unless it was worth more than $500 and had been appraised.
The IRS is not requiring new documentation to be filed with the return, but to protect themselves in the event of an audit, taxpayers should be able to document that their gifts were in good condition. A statement from the charity is ideal, but a photo or video of the item could also be used.
Kathy M. Kristof welcomes your comments, but regrets that she cannot respond to every question. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For previous columns, visit latimes .com/kristof.
