Recent law changes prompt IRS to issue special guidance

Background The Tax Relief and Health Care Act of 2006 extended several tax provisions that were scheduled to expire, resurrected several tax provisions that had already expired, and created several new tax provisions. But its passage in December 2006 came after IRS tax forms for the year went to print, requiring IRS guidance to help tax filers correctly complete their 2006 tax returns.

The IRS recently issued guidance to help tax filers claim the extended deductions and other tax benefits contained in the Tax Relief and Health Care Act of 2006 ("the Act") on their 2006 federal income tax returns. The Act was signed in December 2006, after IRS tax forms were finalized.

According to the IRS, the most significant effect on individual taxpayers involves the deductions for state and local sales taxes, higher education tuition and fees, and teacher-related expenses. The IRS won't be able to process tax returns claiming these deductions until early February. In addition, the IRS expects a slight delay in the processing of returns for a small number of business taxpayers who may be impacted by the Act. All other returns can be filed and processed as normal.

The IRS encourages taxpayers to file their taxes electronically because tax software will contain updated information on the three tax provisions, reducing the chance of errors. Taxpayers filing a paper 1040 will need to follow special instructions if they are claiming any of the three deductions.

State and local general sales tax deduction:

• The deduction must be claimed on Schedule A (Form 1040), line 5 ("State and local income taxes"). Enter "ST" on the dotted line to the left of line 5 to indicate that you are claiming the general sales tax deduction instead of the deduction for state and local income tax.
• The IRS plans to mail Publication 600 (State and Local General Sales Taxes) to approximately 6 million taxpayers in mid-January. Publication 600 includes state and local sales tax tables, a worksheet, and instructions for claiming the deduction.

Higher education tuition and fees deduction:

• Taxpayers must file Form 1040 to take this deduction for up to $4,000 of tuition and fees paid to a post-secondary institution. It can't be claimed on Form 1040A.
• The deduction must be claimed on Form 1040, line 35 ("Domestic production activities deduction"). Taxpayers should enter "T" on the dotted line to the left of line 35 if claiming the tuition and fees deduction, or "B" if claiming both a deduction for domestic production activities and the deduction for tuition and fees. For those entering "B," taxpayers must attach a breakdown showing the amounts claimed for each deduction.

Educator expense deduction:

• Educators must file Form 1040 in order to take the deduction for up to $250 of out-of-pocket classroom expenses. It can't be claimed on Form 1040A.
• The deduction must be claimed on Form 1040, line 23 ("Archer MSA deduction"). Enter "E" on the dotted line to the left of line 23 if claiming educator expenses, or "B" if claiming both an Archer MSA deduction and the deduction for educator expenses. If entering "B," taxpayers must attach a breakdown showing the amounts claimed for each deduction.

For more details, see IRS Notice IR-2006-195, or visit the IRS website generally at www.irs.gov

And for more information on the new tax act, see Tax Relief and Health Care Act of 2006