Flurry of federal tax legislation predicted just before filing season

With the start of 2008 filing season just weeks away, everyone is waiting to see when Congress will pass alternative minimum tax (AMT) relief, help for homeowners caught in the subprime mortgage crisis and a package of popular but temporary tax breaks. At the same time, the IRS is warning that unless Congress enacts an AMT “patch” soon, return processing and refunds could be delayed.

AMT patch

Congress designed the AMT nearly 40 years to ensure that very wealthy individuals could not avoid paying federal income taxes. However, Congress forgot to index the AMT for inflation. Overtime, as incomes have risen, more middle-income individuals are finding themselves liable for the AMT. According to the Treasury Department, more than 20 million taxpayers will be liable for the AMT this year.

That’s why Congress needs to enact a patch. The patch is a temporary fix. It allows taxpayers to take most personal tax credits to reduce AMT liability. It also gives taxpayers higher exemption amounts. The patch will keep those 20 million taxpayers out of the AMT.

The House has already passed a patch. However, the House wants the patch offset with revenue raisers. The Temporary Tax Relief Bill of 2007 (H.R. 3396) would change the tax treatment of carried interest to raise the money to pay for the patch.

Offsets are not as popular in the Senate and some powerful lawmakers have signaled their opposition to paying for the patch. Senators left Capitol Hill for their Thanksgiving recess without enacting a patch. They are expected to take up the patch when they return to work in early December.

IRS warning

Meanwhile, the IRS is warning that it needs 10 weeks to reprogram its computer systems for the patch. The 2008 filing season starts on January 14, which is less than 10 weeks away. The IRS will not process returns and issue refunds until its computer systems are reprogrammed. “We’d rather hold the returns than process them incorrectly,” a senior IRS official recently said.

The first spike in the filing season occurs in late February and early March, after individuals receive their Forms W-2. That gives the IRS some extra time, but not much, to reprogram its computer systems. 

Foreclosure tax relief

The AMT patch is not the only piece of pending legislation. The House has passed legislation to give homeowners in foreclosure some tax relief. The bill would permanently exclude discharged home mortgage indebtedness, up to $2 million, from gross income. Relief would be retroactive to January 1, 2007 to assist as many homeowners stung by the subprime mortgage crisis as possible. The Senate is also expected to take up this bill in early December.

Extenders

If you deducted your state and local sales taxes, higher education tuition or took some other popular tax breaks in 2006, and plan to as a matter of course on your 2007 return, you’ll be surprised to learn that they officially expire at the end of this year; you won’t be able to take them again in 2008 unless Congress acts.

These popular but temporary tax incentives are routinely extended every year. The House has voted to extend them but the bill is still pending in the Senate. Just like the AMT patch, lawmakers disagree whether the extenders should be offset with revenue raisers.

Planning

All this uncertainty about the AMT patch, foreclosure help and the extenders complicates year-end tax planning. While it is very likely that Congress will enact all three, it’s a good idea to “run the numbers” and compare the different outcomes. The AMT is extremely complex and is a trap for the unwary. Our office is ready to help you. Give us a call today.