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The Tax Relief and Health Care Act of 2006

Late in December Congress passed this bill composed of a number of popular tax breaks, and the bill was signed into law on December 20, 2006. The problem with such late changes is that it becomes difficult to correct tax forms to accommodate these changes. In this particular case, the IRS has indicated that tax forms will not be updated, but instead they will provide instructions for how the taxpayer can modify the form to include these items when appropriate. As of this writing, those instructions have not been issued.

The other issue that results is the inability of the IRS to process forms with these tax benefits. The last word is that all such returns will have processing delayed into February.

We are making no attempt to detail all the many provisions of this bill. However, we have addressed the most common ones below which are divided into the following categories:

So why is this so late? Politics!

For the most part, these provisions are tax incentives that everyone knew would be extended. Thus they became political tools to attempt to gain votes for other provisions throughout the year. These provisions would be attached to an unrelated bill, in the hope of putting pressure on its opponents to pass the bill anyway. End the end, either those bills failed, or these provisions were removed.

That leaves Congress with the task of cleaning up the issues before the end of the year. So now we have these late changes to deal with.

Popular Items

College Tuition Deduction
This allows parents and students to deduct certain college expenses "above the line" to reduce their taxable income. It is an alternative to the Hope and Lifetime Learing tax credits. Restrictions still apply, but it is extended through 2007.
Sales Tax
This allows taxpayers to deduct state and local sales taxes as an itemized deduction in lieu of state and local income taxes. It is extended through 2007.
Combat Pay as Earned Income
This allows taxpayers to treat combat pay as earned income for the purposes of calculating the Earned Income Credit. It is extended through 2007.
Educator Expenses
This allows taxpayers who are elementary and secondary school teachers to deduct up to $250 for personal funds used for classroom supplies. (Receipts and documentation are required.) It is extended through 2007.
Archer Medical Savings Accounts
This Archer MSA provisions are extended through 2007.

Health Savings Accoutns (HSA)

Rollovers from FSAs and HRAs
This allows certain amounts in health Flexible Spending Arrangements (FSAs) and Health Reimbursement Arrangements (HRAs) to be transferred to an HSA without violating the otherwise applicable requirements for those arrangements. Plenty of restrictions apply, but the provisions applies through 2011.
Certain FSA Coverage Disregarded
A couple of years ago the laws on FSAs were changed to allow employers to modify their plan to permit funds remaining at the end of the year to be used for medical expenses in the first months of the following year. This provision means such "next-year" distributions are not to be considered in the normal manner that would disallow participation in a HSA.
One-time IRA Rollovers
Allows certain one-time direct roll-overs from a Traditional IRA into an HSA without being included in income. This is effective beginning in 2007 and the exemption or exclusion does not apply to SEP-IRAs or SIMPLE IRAs. (An example of an exception to the exception....)
Additional Provisions
  • Repeal annual plan limitations on HSA contribution limits beginning 2007.
  • Modified employer contribution rules for non-highly paid employees.
  • Provides for earlier indexing related to cost-of-living adjustments after 2007.
  • Allow contributions for months preceding the month the taxpayer becomes an eligible individual beginning in 2007.

Energy Tax Provisions

Residential Energy Efficient Property
The bill extends the credit for residential energy efficient property placed in service after 2005 through 2008.
Energy Efficient New Homes
Extends the credit for homes substantially completed after 2005 and purchased after 2005 through 2008.
Additional Provisions
  • Extension of credit for alternative methods of producing electricity.
  • Extension of deduction for energy efficient commercial building.

Other Items

Work Opportunity and Welfare-to-Work Credit
Extends these programs through 2006 and then combines and modifies them for 2007.
Alternate Minimum Tax (AMT) Credit
Provides for extension of carry-over credits through 2012. The credit is not less than the "AMT refundable credit amount" which is the greater of: 1) the lesser of $5,000 or the long-term unused tax credit, or 2) 20% of the long-term unused minimum credit. (The explanation gets more complicated after that....)
Capital-Gains for Certain Self-Created Musical Work
Makes permanent a provision that permits composers to elect to capitalize their investment and take capital gains rather than ordinary income for their work, but then restricts any contribution deduction to their basis.
Premiums for Mortgage Insurance
Allows a deduction from income for the premiums paid for mortgage insurance for contracts initiated during 2007 and payments before December 21, 2007, providing the contract is associated with securing acquisition debt on a taxpayer's qualified residence. (This one is plain weird! If this is extended or made permanent then it is reasonable. If allowed to expire, it looks like a personal favor for someone.)
Additional Provisions
  • Research credits....
  • "New markets credit" to spur development in certain rural areas.
  • Special accelerated depreciation for qualified leasehold improvements and qualified restaurant property.
  • Enhanced deduction for contributions of technology items by the manufacturer.
  • Extension of tax benefits for restoration in the Gulf Zone (hurricane recovery).
  • Tax incentives for investment in advanced mine safety and rescue preparation.
  • And many more....
"Tax software is no substitute for tax knowledge."

Any views expressed herein are based on our best information. The content of this web site was written as general information without specific individual information and thus may not apply in all situations. This material was not written, and cannot be used by the taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer.

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Janelle Ogg, EA
Richard Ogg, EA