New opportunities in 2006: tax changes for the coming year

By Robert E. Burke, CPA, Jacksonville, Florida

As we wrap up our income-tax calculations for 2005, we can look forward to a number of changes in 2006. Several deductions will disappear, but new opportunities are emerging to take advantage of tax credits, which generally are much more valuable than a deduction because they come straight off the amount of tax you owe, independent of your tax bracket. In addition, inflation adjustments for retirement contributions, tax brackets and other annually evaluated areas will continue in the coming year. Here are several of the principal changes you should be considering as you carry out your tax planning in 2006:

1. Energy-saving improvements: You may qualify for new tax credits if you make home improvements that save energy. Credits of up to $500 are available when you purchase items like insulation, new windows, water heaters or furnaces. To qualify, a component must meet or exceed the criteria established by the 2000 International Energy Conservation Code 9including supplements) and must be installed in the taxpayer’s primary residence in the United States.
2. End of deduction for sales taxes: To boost consumer confidence and encourage spending, Congress temporarily brought back the itemized deduction for state and local sales taxes for tax years 2004 and 2005, but that deduction expired at the end of 2005. During the two years in which the deduction applied, additional deductions—beyond those allowed in the tables for sales taxes—could be taken for purchase of large-screen TVs, boats, new cars and other big-ticket items. That opportunity also has expired. If you pay state or city income taxes, however, you can still claim a federal deduction for those.
3. Larger credits for hybrid vehicles: In support of the government’s energy policy that promotes the use of alternative fuels, Congress has created tax credits, instead of the previous deductions, for the purchase of hybrid vehicles. Last year you could deduct a flat $2,000 if you bought a hybrid car. For 2006 the new credit depends on the type of hybrid vehicle you purchase. The following are estimates of the hybrid tax credit amount. The IRS should officially announce the hybrid tax credits soon. If you purchase a Toyota Prius the estimated hybrid tax credit could be upwards of $3,150. If you purchase a Honda Civic Hybrid (auto) it could be around $650. The basic rules for obtaining the hybrid tax credit are: You must take delivery of the qualifying vehicle on or after January 1, 2006, Vehicle purchased must be new and not used, Must be purchased with the intention of using it not selling it. Whether the tax credit and fuel savings are sufficient to offset the additional cost of a hybrid vehicle depends in part on how you drive the vehicle and your geographic location.
4. Greater contributions to employer-sponsored retirement savings: You can contribute more to your 401(k) plan and your IRA in 2006. The contribution limit for a 401(k) has been increased to $15,000, up by $1,000 from 2005. If you are age 50 or older, you’re allowed to contribute an additional $5,000 in deferred savings to help your nest egg catch up with your retirement needs. For a SIMPLE IRA, available through employers, the cap on contributions remains at $10,000, but the catch-up amount for those 50 or older has been increased to $2,500 for 2006, $500 more than last year.
5. Higher catch-up amount for IRAs: While the basic IRA contribution maximum remains unchanged at $4,000, the catch-up amount for people 50 and older increases to $1,000 in 2006, double the catch-up cap available in 2005. These contributions are considered adjustments to income.
6. Increased standard deduction: Each year, you have the choice of itemizing your deductions or taking the standard deduction on your federal tax form. For 2006, the standard deduction goes up to $10,300 for those filing jointly, $5,150 for singles and $7,550 for head of household. In 2005, the standard deduction was $10,000 for joint filers, $5,000 for singles and $7,300 for head of household. You should evaluate your itemized deductions in 2006 to determine if you would be better off taking the standard deduction or if itemizing will produce greater tax savings.
7. Higher personal exemptions: The personal exemption in 2006 increases by $100, rising to $3,300; so you’ll be able to reduce your taxes a little more this year for each family member you support.
8. Widened income tax brackets: All income tax brackets have increased and widened for 2006, while the basic tax rates remain unchanged. For example, in 2005 if you were single and made up to $7,300, you were in the 10-percent bracket. In 2006, that bracket widens to $7,550. For 2005, the 15-percent bracket for singles extended up to $29,700. This year it reaches to $30,650. The effect is lower taxes for those with taxable income between $29,700 and $30,650 in 2006. The highest tax rate remains unchanged at 35 percent.
9. More earnings allowed for Social Security recipients: Individuals who are under 65 and collecting Social Security were allowed to make up to $12,000 in 2005 without their Social Security benefits being taxed. In 2006, that amount increases by $480. If you’re over 65, no limit applies to money you can earn while collecting untaxed Social Security.
10. Improved exemption for estate taxes: As real-estate values have soared, some families who purchased a home 25 or 30 years ago for tens of thousands of dollars are discovering that its value has soared to $500,000 or even a million dollars. Many more people are approaching the point at which estate taxes will apply upon their death. So the federal government has increased the exemption for estate taxes to $2 million this year, up from $1.5 million in 2005. The top estate-tax rate also was reduced slightly to 46 percent from the previous 47 percent. If a homeowner sells his house before he dies, he can exclude up to $500,000 of the gain; or he can put it into other vehicles, such as gifting, to keep it below the $2 million where estate taxes apply. An increasing number of younger couples now are seeking financial-planning advice as a way to preserve their wealth in later years, taking advantage of this and other exemptions.
11. Variations in standard mileage: With the recent tremendous fluctuations in fuel prices, the standard mileage allowed for business travel has varied over the past year and will continue to be adjusted. For the first eight months of 2005, the IRS allowed 40.5 cents a mile. After September, that amount rose to 48.5 cents. At the beginning of 2006, the rate has dropped to 44.5 cents. This standard amount is what companies most often use to reimburse individuals who drive their own vehicles for business purposes.

As you continue your tax planning in 2006, keep in touch with your CPA for information on pending or new tax legislation that could affect the taxes you owe this year.

Circular 230 Disclosure: Pursuant to recently-enacted U. S. Treasury Department Regulations, I am required to advise you that, unless otherwise expressly indicated, any federal tax advice contained in this communication, including attachments and enclosures, is not intended or written to be used, and may not be used, for any purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to any other party any tax-related matters addressed herein.

About the author

Robert E. Burke, a Certified Public Accountant, graduated from Rider University with a B.S. in Commerce and a major in Accounting. His experience includes working at the large international CPA firm Deloitte and Touche in addition to a regional accounting firm, specializing in audit and tax. Bob is a licensed CPA in both New Jersey and Florida, where he now practices. Bob preferred the difference he could make with smaller companies and developed his practice accordingly.

Company Info: Robert E. Burke, CPA, began private practice in 1998, providing accounting; tax preparation and tax and financial planning to small businesses and individuals. His 25 years in the profession enables him to effectively respond to and resolve the various issues small business owners face, often times assuming a management team role to help these organizations develop and organize their financial infrastructure. He works with business owners on both the specific and systemic needs of their organizations, implementing accounting systems; assessing internal control; and reducing corporate and individual tax liabilities. Bob continues as a sole practitioner with a full time staff to help meet the needs of his clients.

Note: This information is provided to you by third parties for informational purposes only and shall not constitute tax or legal advice. Microsoft has not checked or verified any of the information provided and makes no representations or warranties as to its accuracy. Each individual’s tax situation is unique and you should check with your accountant or other tax professional for particular advice on your situation.