Natic - Services

12/20/2006

Tax Relief and Health Care Act of 2006

In the early morning hours of December 9, 2006, Congress passed legislation to extend expired tax provisions, expand incentives for renewable energy resources, make it easier for Americans to afford health insurance, extend trade benefits for developing countries, and protect doctors from cuts in Medicare payments. The President signed the legislation into law on December 20, 2006.

Extension of Expired Tax Provisions

Tuition and fees deduction, The legislation extends the deduction for two years through 2007.

Sales tax deduction, The legislation extends the deduction for two years through 2007.

Educator expense deduction, The legislation extends the deduction for two years through 2007.

Combat pay treated as earned income, The election to treat combat pay as earned income for purposes of the earned income credit is extended one year through 2007.

Leasehold improvements and restaurant property, The 15-year recovery period provision is extended for two years through 2007.

Residential energy efficient property credit, The credit is extended for property placed in service prior to 2009.

Energy efficient home credit, Home construction contractors may qualify for the new credit if they sell an energy efficient home prior to 2009.

Work opportunity credit and welfare-to-work credit, The legislation extends the credit for one year without modification for qualified individuals who begin work before 2007. The two credits are combined and modified for qualified individuals who begin work during 2007.

Credit for increasing research activities, Extension of the credit two years for amounts paid or incurred before 2008. For 2007, the research credit is modified by increasing the rates of the alternative incremental credit, and allows the taxpayer to elect a new alternative simplified research credit.

New markets tax credit, Credit extended through 2008.

Indian employment credit, Credit extended through 2007.

Energy credit, Credit extended through 2008.

Energy efficient commercial building property, The legislation extends the deduction to property placed in service prior to 2009.

Environmental clean-up costs, . The legislation extends the election to deduct environmental clean-up costs as current business expenses through 2007.

Archer MSAs, . Provision extended through 2007.

Special depreciation allowance for gulf opportunity zone property, . The legislation extends the placed-in-service deadline for nonresidential real property and residential rental property to December 31, 2010. Only the adjusted basis of such property attributable to the manufacture, construction, or production before January 1, 2010 is eligible for the additional first-year depreciation. This placed-in-service deadline extension also applies to MACRS personal property with a recovery period of 20 years or less, computer software, and water utility property, if substantially all the use of such property is in such building and such property is placed in service within 90 days of the date the building is placed in service.

Controlled corporation distribution of stock or securities, The legislation makes this provision permanent.

Self-created musical works, The legislation makes the capital gain treatment of this provision permanent.

Imputed interest on below-market loans, The legislation makes the qualified continuing care facilities exception to the imputed interest rules permanent.

Elections

Various tax provisions are available to a taxpayer by making a timely election by a certain due date and in a certain manner. Any expired provision for 2006 extended by this legislation that is available by election is allowed provided the election is made by April 15, 2007.

Form 1040 Instructions Update

The IRS is expected to release the following instructions on how to report the extended deductions on the 2006 Form 1040.

Educator expenses. Taxpayers must file Form 1040 to take this deduction. It cannot be claimed on Form 1040A. Include the deduction on line 23 of Form 1040. To the left of the entry space for that line, enter �E� for educator expenses or �B� for both the Archer MSA deduction and educator expenses. For an entry of �B,� taxpayers also must attach a statement with a breakdown of the amounts.

Tuition and fees deduction. Taxpayers must file Form 1040 to take this deduction. It cannot be claimed on Form 1040A. Include the deduction on line 35 of Form 1040. To the left of the entry space for that line, enter �T� for tuition and fees or �B� for both the domestic production activities deduction and tuition and fees. For an entry of �B,� taxpayers also must attach a statement with a breakdown of the amounts.

State and local general sales tax deduction. The IRS will reissue Publication 600 for 2006 with the state and local sales tax tables, worksheets, and instructions for figuring the deduction. On Schedule A (Form 1040), taxpayers will enter the deduction on line 5 and enter �ST� to the left of the entry space for that line.

Form 1040. The IRS does not plan to make any changes to the existing Form 1040 or Schedule A instructions for 2006 that have already been posted on the IRS website. The IRS will publicize the above changes in IRS Publication 553, on their website at www.irs.gov, and through the news media.

Optional State and Local Sales Tax Tables

Click here for the advance proof copies of the 2006 Optional State and Local Sales Tax Tables that will be included in IRS Publication 600. These tables and accompanying text were received from IRS Research. Because the tables and text have not been fully reviewed by IRS Tax Forms and Publications, they are subject to change. If any changes are made by IRS, we will post the corrections on this updates page.

Health Savings Accounts

The legislation makes the following changes to HSAs:

Rollovers from FSAs and HRAs. Effective on December 20, 2006 and before January 1, 2012, amounts in a health flexible spending arrangement (FSA) or a health reimbursement arrangement (HRA) may be contributed through a direct transfer into an HSA without violating the otherwise applicable requirements for such arrangements. The amount eligible for rollover may not exceed the lesser of:

The balance in the FSA or HRA as of September 21, 2006, or

The balance in the FSA or HRA as of the date of the distribution.

Amounts rolled over into the HSA are excluded from taxable income, are not deductible, and are not taken into account in applying the maximum deduction limitation for other HSA contributions. This provision is limited to one distribution with respect to each FSA or HRA of the individual. All other eligibility requirements for HSAs continue to apply. For example, if an individual rolls over amounts from an FSA or HRA to an HSA, but continues to be eligible for the FSA or HRA after the rollover, the individual is not an eligible individual for the HSA. An exception applies for certain FSA coverage after the end of a plan year during which unused FSA benefits may be paid or reimbursed to the plan participant. The IRS is directed to provide guidance with respect to the timing of FSA distributions.

One time rollovers from IRAs to HSAs. Beginning in 2007, a one-time tax free rollover from an IRA into an HSA is allowed. The rollover must be a direct trustee-to-trustee transfer. Amounts rolled over are not included in income and not subject to the 10% early withdrawal penalty to the extent the amount would otherwise be includible in income. Amounts rolled over from a traditional IRA to an HSA are treated as coming first from pre-tax amounts rather than after tax basis. The amount rolled over from the IRA to an HSA is limited to the otherwise maximum deductible contribution amount to the HSA computed on the basis of the type of coverage under the high deductible health plan at the time of the rollover. The limitation on other contributions to the HSA during the year are reduced by the amount rolled over from the IRA. The provision allows for only one rollover during the lifetime of the individual, except in the case where an individual with self-only coverage switches to family coverage in a subsequent month within the taxable year. The individual must remain an eligible individual after the rollover for 12 months, except in the case of death or disability. This provision does not apply to SEP IRAs or SIMPLE IRAs.

Repeal of annual plan deductible limitation on HSA contributions. Beginning in 2007, the annual contribution deduction limit is no longer limited by the annual deductible under the high deductible health plan. For example, the maximum HAS contribution allowed for 2007 is $2,850 for self-only coverage and $5,650 for family coverage. It no longer matters if the annual deductible is less than these amounts, provided the health plan still qualifies as a high deductible health plan.

Full year contribution allowed regardless of month individual becomes eligible. Beginning in 2007, an individual who becomes covered under a high deductible plan during the year can make a contribution to an HSA as if the individual was an eligible individual for the entire year. For example, an individual who first becomes an eligible individual on the last month of the year can make an HAS contribution as if he or she were eligible for the entire year. Thus, such individual is allowed to make contributions for months before the individual was enrolled in a high deductible health plan. Special rules apply if the individual does not remain an eligible individual during a full 12 month period. Exceptions apply in case of death or disability.

Comparable contribution requirements. Beginning in 2007, an exception applies to the comparable contribution rules, which allows larger HAS contributions for non-highly compensated employees than for highly compensated employees. For example, an employer is permitted to make a contribution to the HSA of each non-highly compensated employee for a year without making any contributions to the HSA of each highly compensated employee.

Indexing for inflation. The calculation of the inflation adjusted amounts with regard to HSA dollar amounts is modified beginning in 2008.

AMT Credit Relief

For tax years beginning after December 20, 2006, an individual�s minimum tax credit allowable for any taxable year beginning before January 1, 2013, is not less than the AMT refundable credit amount. The AMT refundable credit amount is the greater of:

The lesser of $5,000 or the long-term unused minimum tax credit, or

20% of the long-term unused minimum tax credit.

The long-term unused minimum tax credit for any taxable year means the portion of the minimum tax credit attributable to the adjusted net minimum tax for taxable years before the 3rd taxable year immediately preceding the taxable year (assuming the credits are used on a first-in, first-out basis). In the case of an individual whose AGI exceeds the beginning personal exemption phase-out amount, the AMT refundable credit amount is reduced by the phase-out percentage. The additional credit allowable by reason of this provision is refundable.

Example: Assume in 2010 an individual has an adjusted gross income that results in an exemption phase-out of 50%, a regular tax of $45,000, a tentative minimum tax of $40,000, no other credits allowable, and a minimum tax credit for the taxable year before limitation of $1.1 million of which $1 million is a long-term unused minimum tax credit. The AMT refundable credit amount for the taxable year is $100,000 (20% of the $1 million long-term unused minimum tax credit reduced by 50%). The minimum tax credit allowable for the taxable year is $100,000 (the greater of the AMT refundable credit amount or the amount of the credit otherwise allowable). The $5,000 credit allowable without regard to this provision is nonrefundable and the additional $95,000 of credit allowable by reason of this provision is treated as a refundable credit. Thus, the taxpayer has an overpayment of $55,000 ($45,000 regular tax less $5,000 nonrefundable AMT credit less $95,000 refundable AMT credit). The $55,000 overpayment is allowed as a refund or credit to the taxpayer. The remaining $1 million minimum tax credit is carried forward.

If, in the above example, the adjusted gross income did not exceed the personal exemption threshold phase-out amount, the AMT refundable credit amount for the taxable year would be $200,000, and the overpayment would be $155,000.

Author�s Comment: This provision was added to help taxpayers who get hit with AMT because of their exercise of incentive stock options. For example, the taxpayer in the court case cited on page 14-4 under Incentive Stock Options would have benefited by this new refundable AMT credit provision.

Stock options. For calendar tax years beginning after the date of enactment of this legislation, employers must file an information return with the IRS, in addition to providing information to the employee, regarding the transfer of stock pursuant to the exercise of an incentive stock option, and to certain stock transfers regarding employee stock purchase plans.

Mortgage Insurance Premiums

Beginning in 2007, premiums paid for qualified mortgage insurance in connection with acquisition indebtedness on a qualified residence is treated as deductible mortgage interest. The deduction is phased out ratably by 10% for each $1,000 by which the taxpayer�s AGI exceeds $100,000 ($500 and $50,000 respectively for MFS). Thus the deduction is not allowed when AGI exceeds $110,000 ($55,000 MFS).

For this purpose, qualified mortgage insurance means mortgage insurance provided by the Veterans Administration, the Federal Housing Administration, or the Rural Housing Administration, and private mortgage insurance.

Amounts paid for qualified mortgage insurance that are properly allocable to periods after the close of the taxable year are treated as paid in the period to which they are allocated. No deduction is allowed for the unamortized balance if the mortgage is paid before its term (except in the case of qualified mortgage insurance provided by the Department of Veterans Affairs or Rural Housing Administration).

Effective dates. This deduction does not apply with respect to any mortgage insurance contract issued before January 1, 2007. The provision terminates for any amount paid or accrued after December 31, 2007, or properly allocable to any period after that date.

Research Tax Credit

The legislation extends the research credit two years (for amounts paid or incurred after December 31, 2005, and before January 1, 2008). The legislation also modifies the research credit for taxable years ending after December 31, 2006.

The legislation increases the rates of the alternative incremental credit:

a credit rate of 3% (rather than 2.65%) applies to the extent that a taxpayer�s current-year research expenses exceed a base amount computed by using a fixed-base percentage of 1% (i.e., the base amount equals 1% of the taxpayer�s average gross receipts for the four preceding years) but do not exceed a base amount computed by using a fixed-base percentage of 1.5%;

a credit rate of 4% (rather than 3.2%) applies to the extent that a taxpayer�s current-year research expenses exceed a base amount computed by using a fixed-base percentage of 1.5% but do not exceed a base amount computed by using a fixed-base percentage of 2%; and

a credit rate of 5% (rather than 3.75%) applies to the extent that a taxpayer�s current-year research expenses exceed a base amount computed by using a fixed-base percentage of 2%.

A taxpayer can elect an alternative simplified credit for qualified research expenses. The alternative simplified research is equal to 12% of qualified research expenses that exceed 50% of the average qualified research expenses for the three preceding taxable years. The rate is reduced to 6% if a taxpayer has no qualified research expenses in any one of the three preceding taxable years.

An election to use the alternative simplified credit applies to all succeeding taxable years unless revoked with the consent of the IRS. An election to use the alternative simplified credit may not be made for any taxable year for which an election to use the alternative incremental credit is in effect. A transition rule applies which permits a taxpayer to elect to use the alternative simplified credit in lieu of the alternative incremental credit if such election is made during the taxable year which includes January 1, 2007. The transition rule only applies to the taxable year which includes that date.

Effective Date. The extension of the research credit applies to amounts paid or incurred after December 31, 2005. The modification of the alternative incremental credit and the addition of the alternative simplified credit are effective for taxable years ending after December 31, 2006. See the text of the legislation for special transitional rules that apply to fiscal year 2006-2007 taxpayers.

Work Opportunity Credit and Welfare-to-Work Credit

First year of extension. The legislation extends the work opportunity tax credit and welfare-to-work tax credits for one year without modification, respectively (for qualified individuals who begin work for an employer after December 31, 2005 and before January 1, 2007).

Second year of extension. In general, the legislation combines and extends the two credits for a second year (for qualified individuals who begin work for an employer after December 31, 2006 and before January 1, 2008).

Targeted groups eligible for the combined credit. The combined credit is available on an elective basis for employers hiring individuals from one or more of all nine targeted groups. The nine targeted groups are the present-law eight groups with the addition of the welfare-to-work credit/long-term family assistance recipient as the ninth targeted group.

The legislation repeals the requirement that a qualified ex-felon be an individual certified as a member of an economically disadvantaged family. The provision raises the age limit for the food stamp recipient category to include individuals age 18 but less than age 40 on the hiring date.

Qualified wages. Qualified first-year wages for the eight work opportunity tax credit categories remain capped at $6,000 ($3,000 for qualified summer youth employees). No credit is allowed for second-year wages. In the case of long-term family assistance recipients, the cap is $10,000 for both qualified first-year wages and qualified second-year wages. The combined credit follows the work opportunity tax credit definition of wages which does not include amounts paid by the employer for:

Educational assistance excludable under a section 127 program (or that would be excludable but for the expiration of sec. 127);

Health plan coverage for the employee, but not more than the applicable premium defined under section 4980B(f)(4); and

Dependent care assistance excludable under section 129.

For all targeted groups, the employer�s deduction for wages is reduced by the amount of the credit.

Calculation of the credit:

First-year wages. For the eight work opportunity tax credit categories, the credit equals 40% (25% for employment of 400 hours or less) of qualified first-year wages. Generally, qualified first-year wages are qualified wages (not in excess of $6,000) attributable to service rendered by a member of a targeted group during the one-year period beginning with the day the individual began work for the employer. Therefore, the maximum credit per employee for members of any of the eight work opportunity tax credit targeted groups generally is $2,400 (40% of the first $6,000 of qualified first-year wages). With respect to qualified summer youth employees, the maximum credit remains $1,200 (40% of the first $3,000 of qualified first-year wages). For the welfare-to-work/long-term family assistance recipients, the maximum credit equals $4,000 per employee (40% of $10,000 of wages).

Second year wages. In the case of long-term family assistance recipients the maximum credit is $5,000 (50% of the first $10,000 of qualified second-year wages).

Certification rules. The provision changes the present-law 21-day requirement to 28 days.

Minimum employment period. No credit is allowed for qualified wages paid to employees who work less than 120 hours in the first year of employment.

Coordination of the work opportunity tax credit and the welfare-to-work tax credit. Coordination is no longer necessary once the two credits are combined.

Effective Date. Generally, the extension of the credits is effective for wages paid or incurred to a qualified individual who begins work for an employer after December 31, 2005, and before January 1, 2008. The consolidation of the credits and other modifications are effective for wages paid or incurred to a qualified individual who begins work for an employer after December 31, 2006, and before January 1, 2008.

Other Provisions

The legislation also includes the following provisions:

Domestic production gross receipts for purposes of the domestic production activities deduction can now include gross receipts from sources within Puerto Rico.

Extends the first-time homebuyer credit for the District of Columbia two years through 2007.

Extends the zero capital gains rates provisions of the D.C. Enterprise Zone.

Extends and expands the charitable contribution by a C corporation of scientific property used for research and computer technology.

Modification of excise tax on unrelated business taxable income of charitable remainder trusts.

Extends the facility placed in service date through 2008 for purposes of the renewable electricity production credit.

Extends the suspension of the taxable income limitation for percentage depletion for oil and natural gas produced from marginal properties.

Extends and expands the provision for clean renewable energy bonds.

Extension and modification of qualified zone academy bonds.

A provision allowing a taxpayer to expense 50% of the cost of qualified advanced mine safety equipment property in the year placed in service.

A new credit for mine rescue team training.

An increase in the frivolous tax submissions penalty.

Extends IRS authority for undercover operations.

Expands whistleblower reward program for individuals providing information to IRS on violations of the tax laws.

New special depreciation allowance for cellulosic biomass ethanol plant property.

Expansion of the qualified mortgage bond program.

Exclusion of gain on sale of a principal residence by a member of the intelligence community.

A new exclusion of 25% of capital gain for certain sales of mineral and oil leases for conservation purposes.

Extends the accelerated depreciation provision for businesses located on Indian reservations.

The Tax Court may review claims for equitable innocent spouse relief.

A provision that allows Medicare beneficiaries who are enrolled in traditional fee-for-service but not enrolled in a prescription drug plan to enroll in a Medicare Advantage plan that does not offer drug coverage after their enrollment period ended. These beneficiaries would be allowed to make this change once during the year, after their enrollment period had ended