The Tax Relief and Health Care Act of 2006

On December 20, 2006, President Bush signed into law the Tax Relief and Health Care Act of 2006. The Act extends several tax provisions scheduled to expire, resurrects several tax provisions that had already expired, and contains several new provisions that include changes to the alternative minimum tax and health savings accounts.

Provisions extended through December 31, 2007:

• Above-the-line deduction for higher education expenses
• Deduction of state and local general sales tax
• Above-the-line deduction for certain expenses of elementary and secondary school teachers
• Election to treat combat pay as earned income for purposes of the earned income tax credit
• Archer medical savings accounts (Archer MSAs)
• Research credit (with modifications)

Key dates extended for energy tax provisions:

• The energy efficient commercial buildings deduction is extended to property placed in service prior to January 1, 2009
• The energy efficient new homes credit for builders is extended to homes purchased prior to January 1, 2009
• The credit for residential energy efficient property is extended to property placed in service before January 1, 2009

Premiums for mortgage insurance deductible for 2007

The Act allows taxpayers who itemize their deductions on Schedule A of Form 1040 to deduct premiums paid or accrued for qualified mortgage insurance.

However, the provision applies only to amounts paid or accrued in 2007, and does not apply with respect to any mortgage insurance contract issued before January 1, 2007. That's not-so-great news for individuals who started paying mortgage insurance before 2007--they won't be able to deduct their premiums unless they refinance in 2007.

In addition, the deduction is phased out for taxpayers with adjusted gross incomes exceeding $100,000 ($50,000 for married individuals filing a separate return).

Alternative minimum tax (AMT) credit relief for individuals

The Tax Relief and Health Care Act of 2006 establishes a new AMT refundable credit that effectively allows individuals to utilize long-term unused minimum tax credit amounts. For taxable years beginning before January 1, 2013, an individual will be able to claim the AMT refundable credit amount if it is greater than his or her allowable ordinary minimum tax credit.

The new AMT refundable credit amount is the greater of:

• $5,000 or the long-term unused minimum tax credit (whichever is less), or
• 20% of the long-term unused minimum tax credit

The long-term unused minimum tax credit for any taxable year is essentially the portion of the minimum tax credit that's more than three years old.

The AMT refundable credit amount is reduced for individuals with higher adjusted gross incomes. In 2007, the AMT refundable credit amount will be phased out for individuals with adjusted gross incomes exceeding $234,600 for married individuals filing jointly, $195,500 for individuals filing as head of household, $156,400 for single individuals, and $117,300 for married individuals filing separate returns.

Changes to health savings accounts (HSAs):

Funds can be transferred from an existing flexible spending account (FSA) or a health reimbursement arrangement (HRA)

The Act allows a one-time direct rollover of a health FSA or HRA balance to an HSA. However, transfers will be limited to the balance of the FSA or HRA as of the transfer date or the balance as of September 21, 2006, whichever is less. This provision is effective for transfers made on or after the date of enactment, but before January 1, 2012.

Annual plan deductible limitation on HSA contributions is repealed

Existing rules limited annual HSA contributions to a certain dollar amount ($2,850 for individuals or $5,650 for families in 2007) or 100% of the high deductible health plan (HDHP) deductible, whichever is less. Effective for tax years beginning after December 31, 2006, the Act eliminates the HDHP deductible limitation, leaving only the dollar amount limitation on annual HSA contributions.

Contribution limits for part-year coverage expanded

Under existing rules, individuals who enroll in a qualifying HSA/HDHP can contribute no more than one-twelfth of the annual limit for each month they are eligible. For tax years beginning after December 31, 2006, the Act provides that individuals will be able to make full deductible contributions to an HSA (up to the annual limit), even if they enroll in a qualifying HSA/HDHP partway through the year.

Employer contribution requirements modified

Effective for tax years beginning after December 31, 2006, the Act provides that employers may make larger HSA contributions for employees that are not highly compensated than for employees that are highly compensated.

One-time rollovers from IRAs to HSAs allowed

Effective for tax years beginning after December 31, 2006, the Act allows eligible individuals to roll over funds directly from an IRA to an HSA once during their lifetimes (the contribution can't exceed the HSA contribution limit for that year).

Publication of cost-of-living adjustment accelerated

Effective for tax years beginning after 2007, the Act requires the government to publish annual cost-of-living adjustments to HSA and HDHP dollar amounts earlier in the year. Adjusted amounts for a year must now be published no later than June 1 of the preceding calendar year.

Additional changes and modifications:

• The new markets tax credit is extended through December 31, 2008.
• The work opportunity tax credit and welfare-to-work tax credit are extended for one year, through December 31, 2006. For 2007, the two credits are combined, with modification.
• The placed-in-service deadline for Gulf Opportunity Zone property, for purposes of additional first-year depreciation, is extended for specified property to December 31, 2010.
• U.S. businesses operating as branches in Puerto Rico are allowed to claim the domestic manufacturing deduction (the provision is effective for two years).
• The penalty for frivolous tax submissions is increased from $500 to $5,000, and the application of the penalty is expanded.
• Provisions relating to the capital gain exclusion on the sale of a home that apply to active military personnel are extended to nonmilitary intelligence officers stationed abroad (sales of homes before January 1, 2011).
• Charitable remainder trusts that earn unrelated business income are allowed to maintain their tax-exempt status through the imposition of a 100% excise tax on such unrelated business income.
• The provision in the Tax Increase Prevention and Reconciliation Act of 2005 that reforms the tax treatment of loans to qualified continuing care facilities is made permanent.