Professor Carroll Says It’s Tax Season Again: Plan Now For Changes

March 30, 2007

Every year our elected officials in Washington, D.C. promise to overhaul the Internal Revenue Code so that it will be “simpler and fairer” for most Americans. Of course, it is hard to get a consensus on what is simpler and more equitable so that in most cases talk of tax reform is just that, talk. The crisis in Iraq has also diverted political attention away from tax legislation. The end result is that 2006 was a fairly quiet year in terms of regulations that will affect your tax return.

This is not to say that there weren’t any changes for taxpayers in 2006. The biggest was the extension of the infamous “kiddie tax.” Prior to 1986, a popular way of reducing tax liability was for parents to place bank interest and stock accounts in the names and Social Security numbers of their dependent children since their marginal tax rates tend to be a lot lower than that of their parents. The Tax Reform Act of 1986 stated that any unearned income above $1,000 in the name of a child 14 years old or under would be taxed at the parents’ tax rate. In 2006, Congress extended the reach of the kiddie tax to dependents 18 years of age. The amount of unearned income at which the parents’ tax rate kicks in is now $1,700.

While the extension of the kiddie tax to all dependent minors will raise more for the IRS coffers, that was not the key reason for its promulgation. Congress is hoping that more parents will have an incentive to contribute to college savings plans known as Section 529 plans where interest can accumulate tax free.

It used to be that you could not turn on a radio without hearing an advertisement extolling you to donate your old car to a charitable organization. The organization did not even seem to care if your automobile was a clunker that would require a towing service. Those ads did not escape the attention of the IRS, which now will allow a deduction only for the actual amount the charitable organization was able to receive when it sold your old car. The days of writing off the Kelley Blue Book amount are a thing of the past. The IRS, however, will allow you to take a deduction of $500 for your old clunker on Schedule A — no questions asked.

On the topic of cars, the standard mileage deduction is 44.5 cents per mile for 2006. 2005 was a mess as far as the standard mileage rate went. It was 40.5 cents per mile for the first eight months of the year and then jumped to 48.5 cents per mile for the final four months. Thus the 44.5 cents for this past tax year represents a midpoint of sorts.

One of the more controversial aspects of the Internal Revenue Code has been the alternative minimum tax, which has been on the books since 1969. The IRS wanted to ensure that those with high incomes but who also had large itemized deductions would still pay some taxes. The IRS forced such taxpayers to recalculate their taxable income if such Schedule “A” deductions as state and local taxes, real estate taxes, medical expenses and miscellaneous/unreimbursed employment expenditures were not allowed to be deducted.

The alternative minimum tax did not create much of a stir because it was only intended for wealthy taxpayers. If your income was $50,000 in 1969, you were considered to be in the upper earning echelon. The problem is that the alternative minimum tax has never been properly indexed for inflation. As a result, every year more and more taxpayers found themselves liable for more taxes than they expected after they fill out Form 6251.

Republicans and Democrats alike have promised to bring the alternative minimum tax into the 21st century, but so far not much has happened. This year Congress provided a scintilla of relief as the exemption amount (the amount of recalculated income by the alternative minimum tax rules) has been raised from $58,000 to $62,550 for joint returns before the tax kicks in.

Despite the clamor for Americans to provide more for their retirements, the basic rules for both the traditional (a.k.a. deductible) IRA and Roth IRAs, including income level phase outs, are unchanged from the previous year. The big change here affects taxpayers over 50 years of age. The maximum deductible IRA contribution has been raised from $4,000 to $5,000. In addition, employees over 50 can now contribute a maximum of $20,000 into their tax deferred retirement accounts most commonly known as 401(k) or 403(b) accounts.

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