The Tax Relief and Health Care Act of 2006 passed Congress on Dec. 9, 2006, and was signed by President Bush on December 20. Most of the provisions are good news for taxpayers - extending popular tax breaks, many of which had expired at the end of 2005.Still, the timing could have been better.
The Internal Revenue Service was forced to go to print with many of its major 2006 tax forms and instructions before the legislation passed. The IRS does not intend to revise those forms. This means that supplemental instructions will be used to explain how to insert these last-minutes changes on existing lines of the form, with explanatory coding.
This also means that the IRS will need to reprogram its systems to process these tax returns. Tax prep software from private vendors will also have to be updated to accommodate the changes. The result is likely to be a delayed tax filing season, and one with a higher than normal level of complications and errors.
While the new tax legislation did much more than extend expired provisions, here we will focus on more than a dozen provisions likely to have the greatest impact on 2006 return filing.
1. State and local sales tax deduction. The retroactively re-instated state and local sales tax deduction will work the same way that it has worked for the last couple of years. The main problem will be that Form 1040 Schedule A and the Form 1040 instructions will make no mention that it is available. The information of the sales tax deduction will be provided in Publication 553, Highlights of Tax Changes, and the state tables showing what each taxpayer is allowed will be published in Publication 600, as was done in 2004. The sales tax deduction is to be inserted on the Schedule A line for the state income tax deduction, Line 5, with the code "ST" to let the IRS know that it is a sales tax number.
2. Higher education tuition and fees deduction. On the 2005 Form 1040, the deduction for higher education tuition and fees appeared on Line 34 of Form 1040. Because of the late congressional action on the retroactive extension, it does not appear on the 2006 Form 1040. The IRS is instructing taxpayers to insert the tuition and fees deduction on 2006 Form 1040 Line 35 (domestic production activities deduction) with the code "T" added to indicate to the IRS that the amount is for tuitions and fees. The details on the deduction would be similar to those for 2005.
3. Out-of-pocket educator expenses. The deduction for out-of-pocket educator expenses appeared on Line 23 of the 2005 Form 1040. Once again, it does not appear on the 2006 Form 1040, even though the deduction was retroactively extended for 2006. The IRS is instructing taxpayers to insert the deduction on 2006 Form 1040 Line 23 (Archer MSA deduction) with the code "E" added to indicate to the IRS that the amount is for educator expenses.
4. Business credits. The research credit, work-opportunity credit and welfare-to-work credit were all retroactively extended by the Tax Relief and Health Care Act of 2006. Although the credits also received significant modifications, those modifications are not effective until 2007. For 2006, therefore, these credits will work in a manner similar to 2005. The research credit is to be reported on Form 6765, the work-opportunity credit on Forms 5884 and 8850, and the welfare-to-work credit on Forms 8861 and 8850.
For 2007, the research credit is modified to increase the rates of the alternative incremental credit and add a new alternative simplified credit. Also, in 2007, the welfare-to-work credit is merged into the work-opportunity credit and some additional modifications are made.
5. Donations of computer technology and equipment. Not all of the modifications to retroactively extended items were postponed to 2007. The enhanced charitable deduction for donations of computer technology and equipment for educational purposes was retroactively extended from Jan. 1, 2006, through Dec. 31, 2007.
However, both for the enhanced donation of computer technology equipment and the donation of scientific property for research, property qualifying for the enhanced deduction was expanded to include property assembled by the donor corporation, as well as property constructed by the donor corporation. These changes are effective for contributions made in tax years beginning after Dec. 31, 2005. This donation would be reported on Form 8283.
6. Brownfield remediation costs. Similarly, the election to deduct environmental remediation costs was retroactively extended to apply to expenditures paid or incurred after Dec. 31, 2005. This retroactive extension was also accompanied by a retroactive modification, expanding hazardous materials to include petroleum products.
7. Amortization of leasehold improvements and restaurant property. The 15-year amortization of leasehold improvements and restaurant property was retroactively extended to apply to property placed in service after Dec. 31, 2005. This deduction is to be reported on Form 4562.
Other retroactively extended provisions
In addition to these more common provisions, there were several additional retroactively extended provisions that might impact particular taxpayers. These include:
* Suspension of the taxable income limit on depletion for marginal well production;
* The Indian employment tax credit;
* Accelerated depreciation for certain business property on a Native American reservation;
* The District of Columbia Enterprise Zone and first-time homebuyer tax breaks;
* Suspension of the limitation on the coverover of tax on distilled spirits with respect to Puerto Rico and the Virgin Islands;
* The Qualified Zone Academy Bond credit (along with new arbitrage, spending and reporting requirements), and;
* The availability of Archer Medical Savings Accounts.
SUMMARY
The TRHCA of 2006 should make the 2006 tax return filing season an interesting one. The legislation also introduces a number of additional concepts that should make 2007 interesting as well. Tax practitioners will want to make sure that they are working with updated information and software for the upcoming filing season.
Tax practitioners may also want to alert their clients that tax refunds may be slower than usual this year. The IRS was already dealing with split refunds and refunds of the telephone excise tax for this filing season. Now, due to the agency's need to reprogram its systems to accommodate this year-end tax legislation, those refunds are likely to be delayed even further.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH, a Wolters Kluwer business.
