The Retirement Savings Contribution Credit—Not the Bonanza that It Seems

As tax time approaches, various articles, on the web and in print publications, detail tips on how to save on taxes. One of these tips often mentioned is the retirement savings contribution credit. If you make a contribution to a traditional IRA, a Roth IRA, certain salary reduction contributions, or contributions to a section 501(c)(18) plan, you, supposedly, may be able to claim a credit for up to $1,000 for a $2,000 contribution, if your adjusted gross income is low enough. That sounds really nice! Put $2,000 into your IRA or Roth account and have the federal government pay for half of that.

However, the devil is in the details, specifically, in the way that the retirement savings contribution credit is calculated. On Form 8880, the form used to calculate the credit, you must take the amount on line 46 on Form 1040, which is the adjusted gross income minus the standard deduction and personal exemptions, then subtract the sum of any foreign tax credit, the credit for the elderly or disabled, the credit for child and dependent care expenses, and education credits. This will yield the maximum amount of the credit. However, because of the income limitations for the retirement credit, subtracting the standard deduction and personal exemptions will yield a tax that is lower than the maximum credit, even if the sum of the above credits (lines 47-50) is zero. And because the amount of the tax is calculated before social security taxes are added, the credit can’t be used to offset any social security taxes.

To illustrate, consider the following examples for the tax year of 2006:

For a single person, the maximum amount of the adjusted gross income for which a 50% credit can be claimed is $15,000. Subtracting the standard deduction of $5,150 and the personal exemption of $3,300 yields $6,550, which yields a tax of $653. Thus, this is the most that a single person can claim. If the person makes even a little more than $15,000, then the credit rate drops to 20%.
A head of household can make as much as $22,500 and still claim the 50% credit. However, a head of household would have at least 2 personal exemptions, because to be a head of household, there must be at least 1 other dependent. So subtracting the $7,550 standard deduction for head of household and 2 personal exemptions worth $6,600 would yield a taxable income of $8,350, which yields a tax of $838—still less than the theoretical maximum of $1,000. The credit becomes much less if the head of household has more dependents—it becomes zero if the number of dependents is 4 or more.
A married couple filing jointly can earn up to $30,000 dollars total, and still qualify for a 50% rate that applies to each spouse. In other words, a married couple can theoretically claim a credit of $2,000, but, again, the standard deduction and personal exemptions lowers the taxable amount to less than the credit. Subtracting the standard deduction for married couples filing jointly of $10,300 and the $6,600 of personal exemptions that they could claim for themselves from the maximum adjusted gross income of $30,000 yields a taxable income of $13,100, which yields a tax of $1,313. So $1,313, not $2,000, is the maximum retirement savings contribution credit that can be claimed. If they have children, the credit becomes much less.

So the government isn’t so generous after all! Permalink

Research Tax Laws, Rulings, Procedures, and Related Information

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Legalbitstream offers free searchable databases of Federal tax law, including Tax Cases and IRS Materials. This comprehensive and timely updated tax research resource contains tax cases from the Supreme Court, Circuit and District Courts, US Tax Court, and more. IRS Materials include Revenue Rulings, Revenue Procedures, Private Letter Rulings, Treasury Decisions, and more.

Highlights of 2006 Tax Changes

Highlights of 2006 Tax Law Changes

FS-2007-2, January 2007

New energy-saving tax credits, expanded retirement savings incentives and new rules for giving to charity are among the changes taxpayers will find when they start filling out their 2006 federal income tax returns.

More information about the changes, summarized below, can be found on this Web site and in various IRS documents, including the instructions for Form 1040.

In addition, some important changes, not covered here, are addressed in separate fact sheets. They include:

FS 2007-1, One-Time Tax Refund Available to Long-Distance Telephone Customers
FS-2007-3, Recently Enacted Tax Law Extends State Sales Tax Deduction

FS-2007-4, Special Steps Needed for Paper 1040 Filers to Claim Late Tax Changes
FS-2007-5, Taxpayers Have More Direct Deposit Options for their 2006 Refunds
FS-2007-9, Credit Available for Taxpayers Who Purchase or Lease Hybrid Vehicles In 2006

New Energy-Saving Tax Credits

A ten-percent credit can be claimed for various energy-saving improvements made to a taxpayer’s main home. The credit is based on the cost of new energy-efficient improvements including insulation, exterior windows, exterior doors, water heaters, heat pumps, central air conditioners, furnaces and hot water boilers. The overall credit is limited to $500 and further dollar limits apply to specific components (for example, 200 for windows).
Separately, there is a thirty-percent credit for the cost of photovoltaic property, solar water heating property and fuel cell property.
These credits are claimed on Form 5695. See the instructions for this form for more information.

Contribution Limits Raised for IRAs and Other Retirement Plans: Special Rules for Military

For 2006, the contribution limit for Roth and traditional IRAs rises to $5,000, up from $4,500 in 2005, for those age 50 or over. For those under 50, the limit remains unchanged at $4,000.
The $10,000 phase-out range for IRA deductions for those covered by a retirement plan begins at income of $75,000 if married filing jointly or a qualifying widow(er), up from $70,000 in 2005. It still begins at $50,000 for a single person or head of household and at $0 for a married person filing a separate return. Use the worksheet in the Form 1040 instruction booklet for Line 32, Form 1040.
The elective deferral (contribution) limit for employees who participate in 401(k), 403(b) and most 457 plans rises to $15,000. For SIMPLE plans, the limit remains at $10,000. The catch-up contribution limit for persons age 50 or older rises to $5,000 for 401(k), 403(b) and 457 plans and to $2,500 for SIMPLE plans.
Beginning in 2006, 401(k) and 403(b) plans can create a qualified Roth contribution program so that participants may choose to have part or all of their elective deferrals to the plan designated as after-tax contributions. Despite the name, a so-called “Roth 401(k)” is not the same as a Roth IRA.
Military members serving in Iraq, Afghanistan and other combat zone localities can count tax-free combat pay when figuring how much to contribute to a Roth or traditional IRA. Because taxpayers usually must have taxable earned income, members of the military whose earnings came from tax-free combat pay were often barred from putting money into an IRA. This change is retroactive to 2004, and eligible taxpayers have until May 28, 2009 to make contributions for 2004 and 2005. Taxpayers who have already filed returns for 2004 and 2005 and choose to make these special back-year contributions to a traditional IRA must report them on an amended return ( Form 1040X), along with, in some cases, Form 8606.
Military reservists, including members of the National Guard, called to active duty can receive payments from their individual retirement accounts, 401(k) plans and 403(b) tax-sheltered annuities, without being subject to the additional ten-percent early-distribution tax. The ten-percent tax that normally applies to most retirement distributions received before age 59 ½ is waived for reservist called to active duty for at least 180 days or for an indefinite period. Eligible reservists activated after Sept. 11, 2001 and before Dec. 31, 2007 qualify for this relief. Although the ten-percent early-distribution tax does not apply, regular income taxes continue to apply to these payments in most cases.

New Rules for Giving to Charity

To be deductible, clothing and household items donated to charity after Aug. 17, 2006, must be in good used condition or better. However, a taxpayer may claim a deduction of more than $500 for any single item, regardless of its condition, if the taxpayer includes a qualified appraisal of the item with the return. Household items include furniture, furnishings, electronics, appliances, and linens.
To deduct any charitable donation of money, taxpayers must have a bank record or a written communication from the recipient showing the name of the organization and the date and amount of the contribution. Though taxpayers are already required to keep records to support their contribution deductions, this new provision is designed to provide greater certainty, both to taxpayers and the government, in determining what may be deducted as a charitable contribution. This provision applies to contributions made in taxable years beginning after Aug. 17, 2006. For taxpayers that file returns on a calendar-year basis, including most individuals, the new provision applies to contributions made beginning in 2007.
An IRA holder, age 70 ½ or over, can directly transfer tax-free, up to $100,000 per year to an eligible charity. This option is available in tax years 2006 and 2007. Eligible IRA holders can take advantage of this provision, regardless of whether they itemize their deductions. Funds must be contributed directly by the IRA trustee to the eligible charity. Transferred amounts are counted in determining whether the holder has met the IRA’s required minimum distribution rules. .

Kiddie Tax — Age and Income Changes

Children under 18 who receive taxable investment income may need to figure tax using their parents' higher marginal rates. The tax does not apply to a married child who files a joint return. In the past, the so-called “kiddie” tax only applied to children under the age of 14. Also, the amount of taxable investment income a child can have without being taxed at their parent's rate rises to $1,700, up from $1,600. The rest of the child’s taxable income — earned income plus unearned income minus the standard deduction — is taxed at the child’s regular rates.

AMT Exemption Increased for One Year

For tax year 2006, the alternative minimum tax exemption rises to $62,500 for a married couple filing a joint return, up from $58,000 in 2005, and to $42,500 for singles and heads of household, up from $40,250. Under current law, these exemption amounts will drop to $45,000 and $33,750, respectively, in 2007.

Standard Mileage Rates Adjusted for 2006

The standard mileage rate for business use of a car, van, pick-up or panel truck is 44.5 cents a mile.
The standard mileage rate for the cost of operating a vehicle for medical reasons or as part of a deductible move is 18 cents a mile.
The standard mileage rate for using a car to provide charitable services solely related to Hurricane Katrina is 32 cents per mile. Otherwise, the rate for providing services to charitable organizations is set by law and remains at 14 cents a mile.

Inflation Adjustments for 2006

Personal exemptions and standard deductions rise, tax brackets are widened and more than three dozen individual and business tax provisions are adjusted to keep pace with inflation. A complete rundown of these changes can be found in "2006 Inflation Adjustments Widen Tax Brackets, Change Tax Benefits."

Popular items adjusted include the following:

The value of each personal and dependency exemption is $3,300, up $100 from 2005. Most taxpayers can take personal exemptions for themselves and an additional exemption for each eligible dependent. An individual who qualifies as someone else’s dependent cannot claim a personal exemption, and personal and dependency exemptions are phased out for higher-income taxpayers.
The standard deduction is $10,300 for married couples filing a joint return and qualifying widow(er)s, a $300 increase over 2005; $5,150 for singles and married individuals filing separate returns, up $150; and $7,550 for heads of household, up $250. Higher amounts apply to blind people and senior citizens. The standard deduction is often reduced for a taxpayer who qualifies as someone else’s dependent. Nearly two out of three taxpayers take the standard deduction, rather than itemizing deductions, such as mortgage interest, charitable contributions, and state and local taxes.
The maximum earned income tax credit is $4,536 for taxpayers with two or more qualifying children, $2,747 for those with one child and $412 for people with no children. Available to low and moderate income workers and working families, the EITC helps taxpayers whose incomes are below certain income thresholds, which in 2006, rise to $38,348 for those with two or more children, $34,001 for people with one child and $14,120 for those with no children. One in six taxpayers claim the EITC, which unlike most tax breaks, is refundable, meaning that people can get it, even if they owe no tax and even if no tax is taken out of their paychecks.
The maximum Hope credit rises to $1,650 (100% of the first $1,100 of eligible expenses and 50% of the next $1,100 of expenses). These dollar amounts are doubled for students attending an eligible educational institution in the Gulf Opportunity Zone. The Hope and lifetime learning credits are phased out if a taxpayer’s modified adjusted gross income (MAGI) is between $45,000 and $55,000 ($90,000 and $110,000 if filing a joint return).

New Tax Laws for 2006 and Beyond

WSJ.com - Tax Report

Retirement Savings: Increases of maximums that can be contributed to 401(k): $15,000 for people younger than 50; $20,000 for older people, who can also contribute up to $5,000 to their IRA.

In 2010, there will be no income limit to convert a traditional IRA to a Roth IRA.

Charity: Anyone older than 701/2 can give up to $100,000 of nontaxed distributions from their IRA to qualified charities in 2006 and 2007, which will count as part of that year's required minimum distributions.

Kiddie Tax: The age limit for the kiddie tax has been increased from 14 to 18, which taxes any unearned income, such as dividends and interest, above $1,700 per year at the parents' higher rate.

Energy Tax Breaks: A tax credit, with a lifetime limit of $500, for qualified home improvements that increase energy efficiency, and new credits for hybrid and flexible-fuel vehicles.

Working Abroad: New higher taxes for Americans working abroad.

Taxes on Out-of-State Municipal Bonds Ruled Unconstitutional

WSJ.com - Tax Report

Kentucky's Court of Appeals has ruled—and the Kentucky Supreme Court has declined to review it—that a state cannot tax the interest on out-of-state municipal bonds any differently than in-state issued bonds because it violates the U.S. Constitution's Commerce Clause. The state's taxing authorities say that it will reduce the ability of the state and its municipalities to raise money for public interests, but I don't see how that would necessarily follow. In fact, it might lower their costs because there would be a larger market for their bonds.

Telephone Tax Refund

IRS Announces Standard Amounts for Telephone Tax Refunds

WASHINGTON — The Internal Revenue Service today announced the standard amounts that most long-distance customers can use to figure their telephone tax refund. These amounts, which range from $30 to $60, will enable millions of individual taxpayers to request the telephone tax refund without having to dig through old phone bills.

In general, anyone who paid the long-distance telephone tax will get the refund on their 2006 federal income tax return. This includes individuals, businesses and nonprofit organizations. The 2006 return is usually filed during 2007.

The standard amounts are based on the total number of exemptions claimed on the 2006 federal income tax return. The standard amounts are $30 for a person filing a return with 1 exemption, $40 for 2 exemptions, $50 for 3 exemptions and $60 for 4 or more exemptions. For example, a married couple filing a joint return with two dependent children (for a total of 4 exemptions) will be eligible for the maximum standard amount of $60.

To get the standard amount, eligible taxpayers only need to fill out one additional line on their regular 2006 return. The IRS is creating a special short form (Form 1040EZ-T) for those who don’t need to file a regular return.

The standard amounts are based on actual telephone usage data, and the standard amount applicable to a family or other household reflects the long-distance phone tax paid by similarly sized families or households. Those who paid the long-distance tax on service billed after Feb. 28, 2003 and before Aug. 1, 2006 are eligible for a refund.

Only individuals can use the standard amounts. Alternatively, individual taxpayers can choose to figure their refund using the actual amount of tax paid.

Details on requesting the telephone tax refund will be included in all 2006 tax return materials and on irs.gov.

Though businesses and nonprofits must base their telephone tax refund on the actual amount of tax paid, the IRS is looking for ways to make the refund process easier for these taxpayers. The IRS is considering an estimation method businesses and nonprofits may use for figuring the tax paid.

Who Pays taxes

Federal Income Tax Burden by Income Group, 2003
Income Group	Number of Returns	AGI ($ millions)	Income taxes paid ($ millions)	Group's share of total AGI (%)	Group's share of income taxes (%)	Average tax rate (%)
All taxpayers	128,609,786	6,287,586	747,939	100	100	11.9
Top 1%	1,286,098	1,054,567	256,340	16.77	34.27	24.31
Top 5%	6,430,489	1,960,676	406,597	31.18	54.36	20.74
Top 10%	12,860,979	2,663,470	492,452	42.36	65.84	18.49
Top 25%	32,152,447	4,078,277	627,380	64.86	83.88	15.38
Top 50%	64,304,893	5,407,851	722,027	86.01	96.54	13.35
Bottom 50%	64,304,893	879,735	25,912	13.99	3.46	2.95
SOURCE: Internal Revenue Service, Individual Income Tax Returns with Positive Adjusted Gross Income (AGI), Tables 5 and 6; www.irs.gov/taxstats/indtaxstats/article/0,,id=133521,00.html.

Tax Tips

When Your Spouse Is Your Business Partner (Tax Guide: Personal Finance)| SmartMoney.com

Save self-employment taxes for a spouse if you live in a community-property state, you and your spouse are exclusive owners of an unincorporated business, and your combined income is greater than $90,000 per year. Revenue Procedure 2002-69 allows you to file your joint return as a sole proprietorship, filing out a single Schedule C for the business and paying the 12.4% social security tax on the first $90,000 of net profit instead of the first $180,000—a potential savings of up to $11,160.

Filing Electronically

Filing Taxes Electronically

A good, concise article about the benefits of efiling your tax returns this year for free with IRS selected income tax preparation providers, if you have an adjusted gross income of less the $50,000. This article also outlines the steps to take to file electronically. Benefits include fewer mistakes, faster refunds, provides proof of filing, and eliminates the need to re-enter information that didn't change from the previous year. 37 states now accept efiling, and data can be transferred from the federal return to the state return.

deducting a Home Office from your Taxes

Depreciation Appreciation 101: The Ins and Outs of Deducting for a Home Office - New York Times

Discusses the benefits and pitfalls of claiming a home office deduction, especially if you sell your residence after claiming a home office deduction.

When a home is sold, up to $250,000 of capital gains can be sheltered from taxes, but if the homeowner claimed a home office deduction, that depreciation may have to be recaptured at sale, even if the capital gains is less than $250,000. However, because of a 2002 tax rule change, everything inside the home is not considered commercial property, and thus, the $250,000 capital gain exclusion applies, even if the owner took a home office deduction. However, this exclusion does not apply if the home office is a separate structure, such as a detached garage. When the residence is sold, the gains for the separate structure must be computed separately, and a capital gains tax must be paid on any appreciation. However, this can be avoided if another commercial property is bought within 190 days, a so-called 1031 exchange.

Finally, is it worth it to take a home office deduction on Schedule C or simply claim non-reimbursable business expenses on Schedule A? It is worth it if you are self-employed because the Schedule C deduction lowers the 15.3% Social Security and Medicare tax. However, for employees working at home, it may not make as much sense, since the homeowner is probably already deducting interest and property taxes on Schedule A, and can't deduct against Social Security and Medicare taxes.

Do You Have a Deductible Home Office?

Here's an article from the IRS to answer the question of whether you can deduct a home office. Includes links for publications and forms concerning the home office deduction.

Tax Topics - Topic 509 Business Use of Home

Another IRS article about the business use of your home.

TaxAlmanac.org — New Tax Wiki

TaxAlmanac - TaxAlmanac: About

This is a new tax wiki for tax professionals, supported by Intuit, the same company that makes the popular tax software, but it can be read or edited by anyone. It's in beta right now, but it looks promising. Below are excerpts from its About page.

TaxAlmanac is a free tax research resource brought to you by Intuit. It is a revolutionary leap forward in how tax professionals research tax laws, create and share knowledge. Our goal is to transform tax research and to improve the effectiveness of tax professionals everywhere. TaxAlmanac draws on the power of community. Simply put, none of us is as smart as all of us. Content on TaxAlmanac is written by tax professionals from across the country and takes advantage of the knowledge of academia as well as practioners - in short, the real tax experts. The site includes key information that tax professionals find useful when conducting research - including the Internal Revenue Code, Treasury Regulations, Tax Court Cases, and a variety of Articles. TaxAlmanac currently contains 8,264 articles.

TaxAlmanac includes global search functionality so you can easily search for a particular topic.
You can create watch lists of articles that are of special interest to you.
Each article includes a historical look-back so that you can see how it has evolved over time.
Got a question? You can request a topic on our Ask a Question page. The community will answer it for you, making TaxAlmanac a unique interactive experience.
Current events are updated regularly to keep you up to date with issues in the profession.
Check the recent changes page for a list of the most recently edited articles.

TaxAlmanac is a very young website and was built internally by Intuit. Our employees contributed articles on tax and non-tax topics. A group of 30 tax professionals from Intuit wrote approximately 150 articles about tax law and compliance. In addition, we had a team of 5 people from our User Education group write help and other non-tax information.

We also engaged several engineers who imported the Internal Revenue Code and Treasury Regulations from the government website. Now, we are in the process of populating the site with other primary source information.

Now that we are a live beta site, the number of authors and reviewers will grow significantly, thereby adding tremendous value. We hope that many of you reading this right now will be active participants, editors, and reviewers.

A Simplified Tax System—the Automatic Tax

Automatic Tax

This seems like a really good idea, but, because of special interests, it will be hard as hell to implement. Nonetheless, once money becomes totally electronic, something like this will be a good possibility. According to this site, this system, called the automatic tax, has the following advantages:

1. It eliminates the IRS and all forms of taxation at the Federal level.
2. At the same time it eliminates State taxes, County taxes, City taxes and Local taxes.
3. It combines all these separate taxes into one single broad based tax of only 5%
4. It eliminates all requirements for accounting.
5. It eliminates tax form preparation and filing
6. It eliminates audits for all individuals and 99% of all businesses.
7. Tax collection is completely automatic. No human interface (hence its name)
8. It will save the United States economy $900 billion a year (2005 dollars).
9. It eliminates all political lobbying for special tax status by special interests and it eliminates social engineering possibilities. (If you ever injected truth into politics you would have no politics.-Will Rogers-)

"The income tax has made more liars out of the American people than golf has."
Will Rogers

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