Tax laws save on the dotted line

NORTH PALM BEACH, Fla. -- Jan. 24, 2006 -- The major new laws of 2005 were prompted by Mother Nature.

The violent hurricane season wreaked havoc on millions of coastal residents, motivating lawmakers to enact measures to help out the storm victims. In the process, they also added some storm-related breaks for the rest of the country's taxpayers.

The Internal Revenue Service also issued a couple of rulings that many taxpayers will welcome, such as increased mileage deduction rates and an easier way to put off the inevitable task of filing.

But other changes, most notably the new tax definition of a child, will cause some filers extra effort and potentially costly headaches.

There's also one welcome change that's due simply to the calendar. This year, April 15 falls on a Saturday, pushing the filing deadline to the next business day, Monday, April 17.

Now that you have all that spare time, let's put it to use by looking at 10 tax changes that could make a difference on your 2005 return and to your 2006 tax planning.

Tax help for hurricane victims

There are myriad hurricane-related new tax provisions to help the millions of 2005 storm victims. The changes include ways for people to cover their immediate living expenses, pay longer-term recovery costs and take advantage of other benefits on their tax returns.

The measures apply to specially designated areas: the Gulf Opportunity, or GO, Zone, the Rita GO Zone, the Wilma GO Zone and separate disaster areas for these three hurricanes, affecting residents in Alabama, Florida, Louisiana, Mississippi and Texas.

The various new laws and geographic eligibility standards mean that storm victims will have to do extra work to make sure they find and utilize tax benefits specific to their situations. The Internal Revenue Service has a Web page with details, but here are some of the major provisions and how they could help.

1. Easier access to retirement money

People who need to tap their retirement accounts to cover post-hurricane expenses can take out the money without paying the normal early distribution penalty. This option is available to victims of hurricanes Rita, Wilma and Katrina, says Mark Luscombe, a principal analyst with the tax-research, publishing and software firm CCH Inc., of Riverwoods, Ill.

Eligible taxpayers can withdraw up to $100,000 total from all of their retirement plans, annuities or IRAs. Accountholders still will have to pay taxes due on any distributions of tax-deferred money and earnings, but the 10-percent charge usually assessed when someone younger than 591⁄2 takes out retirement money is waived.

As for those taxes, Luscombe says the law offers taxpayers the option to recover them by repaying the early distributions into a qualified plan within three years. In this case, you would file an amended return when you repay the retirement money and get back the taxes you paid.

If you can't repay the money, you can spread any tax due over a three-year period instead of having to come up with all of it this year.

The effective date for such penalty-free distributions differs, depending on which hurricane necessitated the withdrawal of the funds, so check with the IRS or your personal tax adviser to make sure you qualify. But in all cases, hurricane victims have until the end of 2006 to take advantage of this distribution provision.

2. Larger casualty loss deduction

Many hurricane victims will rely on existing tax provisions that will allow them to deduct their losses. This tax break helps, but it also generally limits the deduction to the loss amount that is more than 10 percent of the taxpayer's adjusted gross income plus $100. Tax-law changes now eliminate those limits for taxpayers whose losses are attributable to hurricanes Katrina, Rita or Wilma. For them, the entire amount of unreimbursed personal property losses is fully deductible.

3. Education breaks for storm-affected students

Persons who attend college in the federally designated Gulf Opportunity Zone, which encompasses parts of Alabama, Louisiana and Mississippi, can now get double the standard Hope or Lifetime Learning credit amounts. This could provide up to $3,000 for the Hope Credit. The Lifetime benefit is expanded from 20 percent to 40 percent of eligible costs up to $10,000, meaning this credit could reach a maximum $4,000.

Even better, says Luscombe, this added credit amount is not restricted to specific storm dates. The increase applies to all qualified costs in 2005 and 2006.

"So someone at Tulane who hasn't been able to go back to school can use the larger credit to pay the tuition applied to the first part of the [2005 school] year," says Luscombe. "This is aimed at encouraging persons to go back to those [storm-affected] schools, so it applies through 2006 to give them incentive to go back."

In addition to providing tax considerations for individuals directly affected by the storms, several new laws also offer tax breaks for persons who came to the aid of hurricane victims.

4. Additional personal exemption

Most Hurricane Katrina evacuees initially went to public shelters, but many soon found themselves welcomed into private homes nationwide. If you made a place in your residence for someone who lost their home in the storm or subsequent flooding, you might be eligible for additional personal exemptions.

"Individuals who put up a displaced person at their residence for at least 60 consecutive days can get an added exemption of $500 per person," says Luscombe. You can claim exemptions for up to four persons, giving you a potential maximum benefit of $2,000.

Luscombe says the hurricane guest doesn't have to be a stranger.

"This can also apply to putting up a relative, as long as it's someone who's not a dependent of the taxpayer," he says. That means you couldn't claim it for your child who was living in New Orleans, while attending school there, and who returned home in the wake of Katrina. But a sister or brother, or aunt or other relative could count toward the exemption, says Luscombe.

This exemption is also available in 2006. However, you cannot claim more than $2,000 total for both years. So if you claim four displaced individuals on your 2005 return and they continue to live with you for several months this year, you cannot take the exemptions again on your 2006 return.

If you are confident you will meet the added exemption requirements in 2006 and they would be more worthwhile on that tax return instead of your 2005 one, you might consider waiting until next year to claim this benefit.

5. Enhanced donation and driving breaks

In response to the outpouring of hurricane-related charitable gifts, several tax-law changes in this area were enacted last year.

In most cases, you can't contribute more than 50 percent of your adjusted gross income in a tax year, meaning if your AGI is $30,000 you can only deduct gifts up to $15,000 on a return. You can carry forward any excess into future tax years.

This doesn't affect most of us, but wealthier donors sometimes run into this donation-deduction limit. These filers also find that their total deductions, charitable and all other categories, are reduced because of their higher incomes.

Katrina tax legislation removes both of these charitable-giving restrictions on gifts made between Aug. 28 and Dec. 31. The best part for donors able to give substantial amounts is that the limits aren't restricted to Katrina-connected donations. They are removed for any gift, regardless of the receiving organization's designated cause. So if you made substantial donations in the latter part of 2005, make sure you take the full deduction.

Another new law substantially increases the charitable mileage deduction, normally 14 cents a mile. If you used your vehicle in connection with Katrina relief services last year, you can deduct qualified miles driven between Aug. 25 and Aug. 31 at 29 cents a mile, and at 34 cents per mile for Katrina-related miles on Sept. 1 through Dec. 31. The higher-than-normal rate continues into 2006 at 32 cents per mile.

In both years, the increased deduction rates apply only to miles driven in connection with Hurricane Katrina relief services. Any other transportation for other charities must be calculated at only 14 cents per mile.

In addition to the charitable mileage changes, there are a couple of other auto-related tax laws that might be of note on your 2005 and 2006 returns.

6. Accounting for car contributions

Suspecting that automobile donors inflated the price of their gifts to charity, and thus overstated the associated tax deductions, Congress last year mandated tougher vehicle-donation rules.

Now when you give an auto (or boat or other motorized vehicle) to a charity, you can no longer automatically claim its fair market value as your deduction if that amount is more than $500. Instead, your deduction is limited to the actual amount the charity received when it sold the auto.

There are some exceptions that would allow you to claim the fair market amount. If, for instance, the charity uses the car, say, to deliver meals to homebound individuals, or sells it at a bargain price to a needy person, you then can claim the fair market value.

The key is to find out from the charity exactly what is planned for your donation. You'll also have to get written acknowledgement of your gift, with the price noted, and attach it to your tax return. In the past, you simply had to hold onto such receipts in case the IRS later questioned the gift.

7. Environmentally friendly auto tax breaks

The tax deduction for buying a clean-fuel car was supposed to drop to $500 last year. The law was changed, however, maintaining the deduction at the $2,000 level for 2005 returns. If you bought one of these vehicles, be sure to claim your deduction for it on the long Form 1040.

The news for environmentally conscious drivers gets even better for 2006.

Purchase a clean-fuel vehicle this year and you'll get a more-valuable tax credit, ranging from $250 to $3,400. The exact amount will be based on a complicated formula involving the vehicle's fuel economy and its total expected lifetime fuel savings. The IRS is working with auto manufacturers to certify specific autos, such as the popular hybrids, and calculate precise credit amounts.

One drawback of the credit is that its full value applies only to the first 60,000 eligible vehicles each automaker produces. That means credits for especially popular hybrid cars or trucks could be quickly gone. If you don't get one of the initial models, you'll receive a reduced credit.

8. Uniform definition of a child

There are several tax breaks that pertain to children. Taxpayers often found the different requirements to claim each break was confusing. So the IRS developed a uniform definition of a child for tax purposes.

In essence, says Luscombe, where the IRS found a broader definition of a child in any tax break, it applied it to all of the child-related benefits.

"While the standardization was generally supposed to be helpful, and it is more generous than it had been, they also changed some of the tests, and that could pose problems for some filers," says Luscombe.

The biggest hurdle is that what had been primarily a support test now is primarily a relationship test. This has led to some people who previously were able to claim child-related tax breaks losing those benefits.

"Take an unmarried couple that has a household that includes a child that is the biological child of only one of the adults," says Luscombe. "In addition, one of the adults is the sole wage earner for the household.

"Under the previous support test, the wage earner could claim head of household status. But now, using the relationship test, the exemption would apply to the biological parent in the house, who in this case has no earnings.

"And the other adult, who does have income, now loses the $3,200 exemption."

If you have a similar living arrangement and share custody with another parent or live with several adults who contribute to a child's upbringing, read the new definition carefully to make sure you and other taxpayers involved in the child's care take full and appropriate advantage of the new definition.

9. Increased IRA contribution amounts

Thanks to a tax-law change enacted years ago, contribution limits on retirement accounts have been steadily increasing. For 2005, you can put up to $4,000 into an IRA. Persons age 50 and older can contribute an added $500.

The $4,000 limit remains in 2006, but older filers this year can contribute an added $1,000.

10. Changes in the filing process

Finally, changes in ways to file your 1040 will make some computer-competent taxpayers happy, upset those who preferred a phone to a PC and delight the millions of procrastinators who don't want to think about taxes until they absolutely have to.

The IRS again is offering some taxpayers the opportunity to prepare and e-file their returns at no charge through the Free File Alliance. Nineteen software companies have made their services available at the IRS Web site, and taxpayers who make $50,000 or less should be able to find at least one company that will let them file for free.

The IRS has, however, done away with its TeleFile program that allowed taxpayers with less-complicated returns to file over the phone. These filers will now have to go back to pen and paper or try the Free File program, for which they are automatically eligible.

If you just can't get your taxes done, whether online or on paper, for free or by paying a professional, it's easier this year to delay the task. Now, instead of filing a request in April for a four-month extension and then another in August seeking two more months, the IRS says you just have to ask once.

Form 4868, used previously to make the first extension request, now will give you an automatic six-month delay. File it and you don't have to worry about your 1040 until Oct. 16.

One thing hasn't changed, though. Form 4868 will only get you more time to file your tax form. If you owe Uncle Sam money, you still have to come up with that amount or a close approximation of it by April 17 or face possible penalties and interest.

In addition to the changes wrought by these 10 laws, many pre-existing laws have had new dollar amounts added. See "Old tax laws remain, but effective amounts change."

© 2006 Bankrate.com

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