Jeff Schnepper

The Basics

Last-minute reprieve for taxpayers

If you paid college tuition in 2006, live in a state with no personal income tax or plan to buy a house in 2007, Congress just saved you a bundle.

By Jeff Schnepper

After months of political wrangling that could have cost taxpayers billions, Congress has finally passed a series of "extenders" for breaks on college tuition and sales taxes.

These are tax provisions that technically expired in 2005, though Democrats and Republicans had always agreed they should be extended. Only political game playing by both parties had kept the extensions from being passed long ago.

The $38 billion in tax breaks and credits have been extended for two years, retroactive to January 2006. But tax forms were printed Nov. 7. Internal Revenue Service publications, forms and Web sites now will need to be amended.

All tax-preparation software must now be corrected and updated as well. If you've always done your taxes by pencil and calculator, this might be a year to let a pro, or at least some tax software, help you out.

Here's what is included in the provisions:

Sales-tax deduction

If you live in one of the nine states without an income tax, you're going have a tough time wiping that smile off your face!

You can continue to claim a deduction for the sales taxes you pay. Taxpayers in states with an income tax will deduct state and local taxes paid if more than their sales-tax deductions.

We're talking real money here. Say you and your spouse each earn $45,000 and have investment income of $10,000. If you live in Washington (one of the nine states without an income tax) and have three kids, that's a standard sales-tax deduction of about $1,333. That could mean as much as $467 more in your pocket, not counting any sales taxes paid on a car, boat or airplane, which would be added to the standard amount. You could get even more if you had kept records of your actual sales taxes paid, which you might actually have done if Congress had passed the extension earlier.

'Raise' for teachers

Normally, employee expenses are allowed only as a miscellaneous itemized deduction, subject to reduction by 2% of your adjusted gross income. That means that if you don't itemize (or if your income is too high), you don't get to deduct any of those expenses.

Congress gave a special break to teachers, teacher aides, counselors and principals at elementary and secondary schools. A "qualified educator" can continue to take an above-the-line deduction up to $250 annually for expenses paid for books, supplies, computer equipment and supplementary materials. You don't have to itemize. But if you spend more than $250, any excess may be included as part of your miscellaneous itemized expenses.

Higher-education deduction

Here again, you don't have to itemize to get this deduction.

Last year, if your adjusted gross income didn't exceed $65,000 ($130,000 if you were married and filed jointly), you could deduct as much as $4,000 for payments of qualified tuition and fees. Even if your adjusted gross income was as much as $80,000 ($160,000 on a joint return), you could still wipe off as much as $2,000 from your income. The numbers for 2006 are the same.

Health savings accounts

The bill also increases the tax-free-contribution limits for health savings accounts for 2007. The limits, now $2,700 for singles and $5,450 for couples filing jointly, would rise to $2,850 and $5,650 in 2007.

Health savings accounts, an alternative to employer-provided health insurance, allow taxpayers to save money tax-free toward future health-care expenses. They require enrollment in a catastrophic-health-care plan, which cut premiums drastically but typically don't cover the first several thousand dollars in costs. Those costs are paid from the savings account.

Break for homebuyers

There's a break for people who buy homes in 2007. The legislation allows taxpayers who itemize their deductions to deduct premiums paid for mortgage insurance -- which typically is required when homebuyers purchase their homes with less than 20% down. Currently, only the interest paid on a mortgage is deductible.

The new insurance-premiums deduction will apply only to mortgage insurance contracts issued in 2007 and will be available only to taxpayers whose adjusted gross incomes do not exceed $110,000 ($55,000 for married taxpayers filing separately). The move is expected to save a typical tax filer $200 to $400 a year.

Tax credits

The research-and-development, work-opportunity and welfare-to-work credits were also extended.

A credit is a dollar-for-dollar reduction in your tax. While a deduction reduces your income on which the tax is applied, a $100 credit puts the full $100 in your pocket.

These credits were created to encourage R&D expenditures and stimulate the hiring of targeted disadvantaged groups. But you don't stimulate economic activity for 2006 by extending a law with only about three weeks left in the year.

Don't get me wrong. I'm in favor of all these extensions. In fact, I'd make them permanent so we don't have to go through the motions every two years.

My anger is directed at the political game playing. It's hard to play the economic game successfully if Congress waits until the year is just about over to change the rules. Not knowing what the rules are going to be for the first 11 months of the year creates anxiety, confusion and chaos. You can't plan if you don't know what the parameters are.

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