Taxes 2006: Year of the tax credit
By Kay Bell • Bankrate.com

2006 was the year of tax credit. That's definitely a good thing for taxpayers, since credits are a more valuable tax-cutting tool than deductions.

A deduction will reduce your taxable income amount, which usually means a lower tax bill, but a credit is taken after you figure what you owe the IRS and it reduces that bill dollar for dollar.

The year began with a batch of tax credits for those homeowners who choose to make energy-efficient improvements to their residences.

Another energy-saving tax break was created in 2006 for motorists. Purchasers of IRS-approved hybrid vehicles found that this year the old deduction was converted to a tax credit.

The only problem here is that the credit varies by auto make and model and, depending upon your timing, a purchase of particularly popular hybrid could mean a reduced tax credit.

Retirement account enhancements
In August, Congress finally approved, and the president signed into law, the Pension Protection Act of 2005. This comprehensive pension reform measure focuses primarily on company pensions, but it also contains some welcome tax news for retirement savings that are controlled by individual taxpayers.

Allowable contributions to IRAs, both Roth and traditional, had been increasing for the last few years. But they, too, are set to expire in 2010. Now those higher limits will continue and be indexed for inflation.

The Pension Protection Act also allows older IRA holders to directly transfer money from such accounts to a charity. For individuals with traditional IRAs, this option will allow them to avoid paying taxes on the distribution. The change allows eligible taxpayers (those age 70½ and up) to meet existing requirement minimum distribution requirements, says Donna LeValley, tax attorney and editor of the annual "J.K. Lasser" guide to taxes, as well as let these taxpayers avoid counting the charitable transfer as taxable income.

Even better, says LeValley, this is a "positive midyear change" for taxpayers who might have found their wish to make a large donation curbed because it accounted for more than tax law allows. In most cases, a donor cannot give amounts that come to more than 50 percent of his or her adjusted gross income. That limit does not apply to the new direct IRA charitable transfer option.

Continuing the trend to reward taxpayers with credits, the pension law continues the Saver's Tax Credit, which provides more tax savings for lower-income workers who put some of their earnings into retirement accounts, including IRAs and 401(k)s. The credit was scheduled to expire this Dec. 31 but now is a permanent part of the tax code.

Investment tax give and take
Tax action in 2006 for investors, however, was a bit mixed.

In general, those who rely on investment income are happy that Washington extended until the end of 2010 the 15 percent rate (10 percent for lower-income taxpayers) on qualified dividends and capital gains.

But young investors lost a tax break. Previously, when an account holder turned 14, earnings from an investment in the child's name were taxed at the youth's tax rate. Now, however, the kiddie tax, which requires a child's investment income be taxed at the parents' usually higher tax rate, applies to accounts held in the names of investors until the youngster turns 18.

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