Think you’re all set to do your 2007 federal income tax? Maybe not. Are you aware of the last-minute changes – some fairly significant – Congress made in December to filing Form 1040? If not, here’s an overview:
• The AMT “patch”
Most middle and upper income 1040 filers are aware of the threat of the Alternative Minimum Tax (AMT). In today’s tax environment, most substantive 1040s need to have two tax computations: the regular tax and AMT. An individual is required to pay the greater of the two calculations.
While the regular income-tax rates are indexed for inflation, this has never occurred with the AMT. As a result, Congress needs to constantly increase the amount of income exempt from the AMT, in order to prevent the AMT from becoming the prevailing tax in most returns. Had Congress not updated the exemption for 2007, most joint tax returns with income above approximately $70,000 would have been subject to the AMT.
But, as expected, we received a last-minute AMT “patch.” The AMT exemption for 2007 for single filers was increased by roughly $2,000 over the prior year amount, while the joint exemption was increased by $3,700.
The important point to understand is that these increased exemption amounts for 2007 simply preserve the status quo. The AMT exemption was bumped over the 2006 amount only to compensate for the small inflation-indexing that occurred in the regular income-tax rates.
• AMT refundable credit improved
When AMT is incurred as the greater tax, in some cases that AMT becomes a tax credit carried forward to future years that can offset regular income tax. Beginning in 2007, there is a new refund feature to that AMT credit carryover, making it much more likely that the taxpayer will recover some portion of prior AMT payments.
Unfortunately, this new refundable credit comes with a number of restrictions. First, the AMT must have been paid more than three years earlier to qualify. Further, the credit availability is only for AMT arising from timing differences, such as AMT triggered by the exercise of stock options or from differences between regular and AMT depreciation rules (AMT from high state and local taxes or personal exemptions does not fit these rules). Finally, upper income filers are not eligible for this new refundable credit. Single filers above $279,000 and joint filers above $357,000 of adjusted gross income are totally ineligible.
For those fortunate enough to qualify to use this new tax credit, Congress further improved it in a late December tax bill. Previously, the refundable credit was under a declining calculation, which would have taken many years to recover. Under the revised computation, we will typically be able to secure the refunds of the more-than-3-year-old prior AMT over a five year period.
••Home mortgage debt forgiveness
In recognition of the subprime lending crisis and the increase in real estate foreclosures that are occurring in many parts of the country, Congress has added a new provision allowing a taxpayer to exclude up to $2 million of mortgage debt forgiveness without taxation. The exclusion only applies to debt related to the acquisition or substantial improvement of an individual’s principal residence. It is not available for home equity debt, nor for debt forgiveness related to a seasonal or vacation residence debt. This new provision is available for debt discharged on or after January 1, 2007 and before 2010.
For taxpayers who do receive this tax-free debt forgiveness, the tax basis of the residence must be reduced by the amount of excluded debt. But in most cases, that will be of no consequence, due to the ability to apply a separate provision allowing the tax-free sale of a principal residence.
• Mortgage insurance premium deductibility
Beginning in 2007, a new homeowner who incurs a mortgage insurance premium, where that mortgage insurance contract originated in 2007, is allowed to deduct the insurance premium as if it was residential interest expense. This new deduction is limited to those who have adjusted gross income under $110,000.
As originally enacted, any prepayment of the mortgage insurance premiums in 2007 was not deductible. But a last-minute IRS Notice now allows any prepaid mortgage insurance to be amortized over the shorter of the mortgage term or 84 months. Prepayments might occur with respect to new home acquisitions using VA or FHA financing.
• Cash contribution rules for 2007
Beginning with the 2007 Form 1040, an individual must have either a cancelled check, credit card charge or a receipt from the charity to support a cash contribution. Stated differently, any “greenback” donations are no longer deductible unless the taxpayer has a receipt from the charity, regardless of how small the amount. Estimates and notations are no longer sufficient to support the deductibility of cash contributions.
• E-mail scams
No matter how you pay your taxes, beware of e-mails that appear to be from the IRS suggesting that a refund may be due to you. These are scams looking for personal information to attempt identity theft. Do not respond to them. The IRS does not contact taxpayers by e-mail in this manner. •
Grafton H. “Cap” Willey IV, CPA, is a director and shareholder in charge of Tofias’ Rhode Island offices. The firm, which has offices in Providence, Newport, Cambridge and New Bedford, provides accounting, tax and consulting services. Willey can be reached by e-mail at willeycap@tofias.com.
