Since 2006 was an election year, it’s not surprising that lawmakers spent much of it creating and adjusting tax laws. Now, as taxpayers put these new measures into practical effect by filing their annual returns, many will find changes that produce some nice tax savings.

Tax-law winners range from environmentally conscious homeowners and motorists to teachers and college students. Even folks who simply rang up long-distance friends and family get a tax break this year.

Other taxpayers, however, will find some of the changes costly. Americans who work abroad are likely to end up with a larger tax bill this year. So are parents who opened investment accounts in their children’s names.

To help you determine whether you’ll be a winner or loser in this year’s annual filing game, check out these 10 tax changes. Even if they don’t apply to your 2006 return, they could give you a head start in planning your 2007 tax-saving strategy.

New laws to know
These major changes in the tax code can make a difference for people filing their 2006 returns — or doing their 2007 tax planning.
Some will help you save money, while a few could cost you, in paperwork as well as cash.
10 big tax law changes
1.
Telephone tax credit
2.
Multiple direct deposit option
3.
Energy-saving home improvements
4.
Alternative fuel auto credit
5.
Tougher donation rules
6.
Older philanthropist options
7.
Kiddie tax tightened
8.
Foreign income adjustments
9.
Rolling over retirement money
10.
Old deductions are new again

1. Telephone tax credit

One of the most welcome tax changes comes not from Congress but from the Internal Revenue Service, which decided last year to stop collecting the 3 percent federal telephone excise tax. That charge on long-distance calls originated in 1898 to help pay for U.S involvement in the Spanish-American War. While that war ended after just three years, the tax continued to show up on phone bills.

Unfortunately, despite the phone tax’s long history, the rebate is only for taxes paid on long-distance service after Feb. 28, 2003, and before Aug. 1, 2006. Still, every taxpayer is eligible to get cash back, without having to prove that they actually had phone service during the applicable rebate months.

Even better, you don’t have to dig out your old phone bills, presuming you still have them, to come up with the amount you paid years ago. The IRS has calculated average phone tax costs based on the total number of taxpayer exemptions. If you claim one exemption you’ll get $30 back; the refund is $40 for two exemptions, $50 for three exemptions and $60 for four or more exemptions.

To get the refund, simply enter your applicable amount on the new line found on all three individual 1040 forms. If you don’t have to file a return this year, the IRS has a special form for you, the 1040EZ-T, that you can use to get back your phone tax money. And if you do happen to have all your old phone bills and they show taxes greater than the IRS-figured amount, you can get that larger refund by filing Form 8913.

 

“For small businesses that have been keeping records, it makes sense to go back, open up the storage box and find the exact amount,” says Donna LeValley, New York City-based attorney and contributing editor to “J.K. Lasser’s Your Income Tax 2007: For Preparing Your 2006 Tax Return.” Most filers, though, will probably take the easy $30 to $60 prefigured credit.

2. Multiple direct deposit option

If the phone rebate bumps up your refund amount, the IRS is making it easier for you to save instead of spend that money. You can now have your tax refund divided and directly deposited into up to three accounts.

Simply decide how much you want to go into each account, be it one for checking, an IRA or even a health savings account, and include the account and bank routing numbers on Form 8888. There’s no minimum deposit requirement. If you are getting back $100 and want to put $80 in your retirement plan, $15 in your medical account and $5 in checking, the IRS will follow your instructions.

Just make sure you correctly enter the account numbers on the form. William Perez, of Perez Tax Associates in San Francisco, says the multiple account and bank numbers could get confusing and a misplaced numeral could pose big refund trouble.

3. Energy-saving home improvements

If you replaced your home’s drafty windows last year with new, energy-efficient panes, make sure you file the long Form 1040, along with Form 5695, to get the corresponding tax credit. That’s just one way to take advantage of the

energy-efficient home improvement provisions included in the energy bill that took effect Jan. 1, 2006.

Simple upgrades, such as the new windows or added insulation, offer relatively small tax breaks. You can claim more generous credits if you added solar water, heat or power systems to your house. If you didn’t get the improvements in by the Dec. 31 deadline to claim the credit this year, you get another chance by completing the work this year; a couple credits also carry over into 2008.

“What’s great about the energy credits is that everybody can take them,” says LeValley. “There are no income phaseouts. It’s not about how much — too little, too much — you earn. It’s about just making the right purchase.”

4. Alternative fuel auto credit

Did your environmental concerns extend to the road? Then you might be able to drive away with substantial tax savings.

In 2006, the previous tax deduction for autos that run on alternative fuel was changed into a tax credit. In general, credits are better than deductions, since credits offer a dollar-for-dollar reduction of your tax bill. And a credit for buying an IRS-approved vehicle could cut as much as $4,000 from your tax bill.

However, if you waited until the latter part of 2006 to purchase a car, depending on which brand you bought, your tax credit might be cut in half. The exact credit amount is based on a

complicated formula involving the vehicle’s fuel economy and its total expected lifetime fuel savings.

The good news is that the IRS is working with each auto manufacturer to certify vehicles and then let you know how much tax savings each offers. The bad news is that the credit is phased out based on total sales, meaning that the most popular hybrids will become less tax valuable over the coming months.

That already has happened to Toyota’s cars, whose credit amounts were cut in half on Oct. 1, 2006. For 2007 tax purposes, the Japanese automaker’s credits will be reduced further on April 1.

 

5. Tougher donation rules

Tax breaks for charitable gifts provide rewards for both donors and their favorite nonprofit groups. In 2006, however, lawmakers decided some taxpayers had been pushing the goodwill envelope a bit too far.

So beginning on Aug. 18, any donated clothing or household goods must be in good or better condition. If the IRS determines it’s not, or in official terms finds the items were of “minimal monetary value,” the IRS can disallow the deduction.

The change was prompted by IRS suspicion that many taxpayers claimed excessive value for items that should have gone to the garbage dump instead of the charity box. The groundwork for this change was laid a couple of years ago when the IRS clamped down on valuations of donated autos.

And in 2007, the IRS is getting tougher on donation documentation. Previously, you had to get a receipt or other acknowledgement from a charity if you gave $250 or more. Now, for a monetary gift of any amount, you’ve got to have “a bank record or a written communication” from the charity detailing the group’s name and the date and amount of the gift.

A canceled check is fine. If you charge a contribution, your credit card statement should be sufficient. Many charities also already provide a receipt for all monetary gifts, regardless of the amount.

“The most often asked question now,” says LeValley, “is: How do I account for the cash I drop in the church collection plate each week?

“Think about making periodic pledges to your house of worship, usually larger donations on a quarterly basis. It might be easier to keep records that way.”

6. Older philanthropist options

Some charitable giving, however, got easier thanks to tax-law changes. Now if you’re 70½ or older, you can transfer money directly

from an IRA to a charitable organization. The option is available to either Roth or traditional IRA owners, but it is most beneficial when the money comes from a traditional account, since much of that cash is eventually taxed.

Taxpayers who must take

required minimum distributions from a traditional IRA but don’t need the money to live on might find this donation option worthwhile. By going directly to the charity, the donated amount isn’t included in the giver’s taxable income, thereby lowering the filer’s tax bill a bit.

However, taxpayers can’t double dip by claiming a deduction for the contribution. For this reason, it might be valuable for taxpayers who otherwise wouldn’t get a tax deduction, such as those who take the standard deduction instead of itemizing.

This new tax law, however, is temporary; it’s only in effect for the 2006 and 2007 tax years.

7. Kiddie tax tightened

In order to save for their child’s college costs, some parents open accounts in the child’s name. Not only does this designate the fund for the youngster’s use, but it also had the tax advantage of having the earnings taxed at the youth’s usually lower rate. That changed in 2006.

 

In an effort to raise money to pay for other federal programs, Congress changed the child investment earnings rules, popularly known as the kiddie tax, last May. The change, however, was made retroactive to all transactions since Jan. 1, 2006.

Previously, when an account was held in a child’s name, any earnings exceeding an annual threshold amount ($1,700 in 2006) were taxed at the parents’ highest marginal tax rate. But when the child turned 14, his or her usually lower tax rates applied. Now, however, the cutoff age is 18, meaning the higher adult tax rates apply for four additional years.

“Your highest marginal rate will be applied to the investment income of your children,” says LeValley. “So if you’re in the 25 (percent) or 30 percent marginal rate, that’s what will apply to the investment income instead of the 15 percent capital gains rate.”

In essence, families who had utilized this tax strategy now lose not only the lower capital gains rates that would normally have applied to most long-term investment transactions, but also the benefit of the child’s lower rates for any short-term profits. The excess child’s investment income is essentially taxed at his or her parents’ much higher tax rates.

Compounding the problem is the date shifting of the law’s effective date. “People who made a move this year — rebalanced the portfolio because the youngster is closer to college or they sold assets held by the child to pay for tuition — they are going to owe more,” says LeValley.

8. Foreign income adjustments

U.S. workers with jobs abroad will likely find they’re now paying a higher tax price for their globe-trotting careers because of changes to the foreign earned income exclusion rules.

Under IRS rules, workers must pay U.S. taxes on their earnings regardless of where they live to make the money. However, if they pay taxes to the country where they are working, American taxpayers are allowed to exclude part of their foreign-earned income from U.S. taxes.

A new tax law bumps the 2006 exclusion amount up a bit — to $82,400 — but it adds some other tax burdens. In the past, after an overseas worker subtracted the exclusion amount, the worker was able to figure U.S. taxes on the remaining income. Now, however, regardless of the final taxable dollar amount, it is taxed as if it were still in the bracket it would have been before the exclusion was allowed.

Basically, that means expatriate workers will lose the tax-reducing value of the lower brackets in our progressive tax system. For example, if you make $100,000 overseas, your tax bracket is based on that amount, not just on the $17,600 you have after subtracting the $82,400 exclusion from your overall $100,000 income. That means that instead of figuring taxes on the $17,600 by beginning at the 10 percent bracket, the foreign-based worker would calculate starting at the 28 percent bracket into which the pre-exclusion income amount fell.

 

In addition, the new law places a tighter cap on the amount of housing costs that a foreign worker can consider in figuring the exclusion amount. Workers living in countries with very expensive housing, such as Hong Kong, will now face larger tax bills because of the housing tax limitations.

While the actual number of Americans working abroad might not be that large, Perez, who also writes About.com’s Guide to Tax Planning, suspects the change could catch quite a few folks by surprise.

“More people are claiming the foreign earned income exclusion because of nonmilitary support in the Iraq and Afghanistan rebuilding efforts,” says Perez.

9. Rolling over retirement money

However, if you’re planning to someday retire abroad instead of work there now, some law changes can help you build up your post-career nest egg.

To encourage workers to take their company retirement plans when they leave a job, the new Pension Protection Act of 2006 will soon allow departing employees to transfer that money directly into a Roth IRA. Such transfers are already OK, but require a two-step process: from company plan to traditional IRA, then to a Roth account. Unfortunately, you’ll have to wait a bit to take advantage of this new one-and-done transfer; it’s not available until Jan. 1, 2008. But it’s definitely something to keep in mind if you’re considering changing jobs in the next year or so.

If you eventually opt for this type of transfer, remember that you’ll have to meet the other Roth conversion requirements, such as making less than $100,000. And you’ll owe taxes on any tax-deferred amounts that you convert. But at least those tax calculations will now be done as part of the simpler, one-step transfer.

10. Old deductions are new again

Three popular tax breaks technically died at the end of 2005: deductions for state sales taxes, educators’ classroom expenses and college tuition and fees. They were resurrected at the very end of the 2006 congressional session and are back in force through 2007, just as they were previously.

You must itemize to claim the sales tax deduction, and if you also paid state income tax, you must decide which of those state levies to claim. Both education-related deductions, however, are available to anyone, regardless of whether you itemize or take the standard deduction amount.

The only issue with these three tax breaks is

where on the tax form to claim them. Because they were reinstated after the IRS printed the 2006 forms, you’ll have to make some special notations, especially if you file paper forms instead of using tax software.

Finally, there’s one other welcome change that’s due simply to the calendar. This year, April 15 falls on Sunday. That normally would give you one more day, until Monday, April 16, to finish your return. But because that day is the Emancipation Day holiday in Washington, D.C., it affects IRS activity nationwide, meaning that for everyone across the country, the filing deadline is Tuesday, April 17. So you’ve got two extra days to figure out just how the new laws can help you cut your 2006 tax bill.

In addition to the changes wrought by these 10 laws, many pre-existing laws have new dollar amounts this filing year, thanks to inflation adjustments. See Bankrate’s companion story,



Old tax laws, new amounts.”

Freelance writer Kay Bell writes Bankrate’s tax stories from her home in Austin, Texas, and blogs each day on tax topics at

Don’t Mess with Taxes.

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