Clear Answers to Questions   About Some Perplexing Issues

Q.

I thought the deduction for state and local sales taxes

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was still allowed but I can't find anything about it in an IRS publication I picked up. Can I still deduct them?

A.

Yes. The write-off, which expired at the end of 2005, has been reinstated for 2006 and 2007 tax years under the Tax Relief and Health Care Act. It allows you to deduct state and local sales taxes from your federal return, rather than state and local income taxes.

The tax break is especially important for taxpayers in states that have state or local sales tax but don't have state income tax - Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington and Wyoming. But it might also give a larger deduction to taxpayers who paid more in sales taxes than income taxes because they bought a new car or other expensive items.

Taxpayers are understandably confused about the availability of the sales tax deduction since the law restoring it was passed in December after the IRS printed most 2006 tax forms and instructions. That's why you won't find a mention of it there. Your tax adviser will know how to claim the write-off on your return.

The IRS just made a calculator available to help you decide whether you might benefit by deducting state and local sales taxes. Click here to try it.

Q.

How hard is it to qualify for nursing home benefits under Medicaid?

A.

It's a lot harder than it used to be.

As part of the Deficit Reduction Act, passed in February of 2006, severe new restrictions have been placed on the ability of elderly people to transfer assets and then qualify for nursing home care under Medicaid.

The law extends Medicaid's "look-back" period for all asset transfers from 36 months to 60 months, beginning on February 8, 2006. In other words, an applicant cannot give assets away to anyone, other than a spouse, in order to meet the Medicaid asset limits for five years before entering a nursing home.

The Deficit Reduction Act also strengthens the penalties on applicants who transferred assets during the look-back period and makes people with high amounts of home equity ineligible for Medicaid long-term care. (A principal residence is generally not counted for purposes of Medicaid eligibility.) Specifically, the law excludes anyone with home equity of more than $500,000, although it allows states to increase this threshold to $750,000.

Q.

Who is entitled to the tax benefits for a child?

A.

Like many tax questions, it depends.

For years, taxpayers were confused over this issue, especially when the child: had parents who were divorced, was being raised by a relative, or was living with one parent and an unmarried partner. A tax law change unified various tax code provisions affecting the children of taxpayers and established certain "tie-breaking rules."

However, last tax season was the first the changes were in effect and many people found the new rules weren't crystal clear. The IRS has now issued guidance concerning application of the complex rules for qualifying children. (IRS Notice 2006-86)

Details: The Working Families Tax Relief Act set a uniform definition of a qualifying child. It applies to all available tax breaks (although some special rules may continue to apply to specific benefits). To qualify, the child must satisfy tests concerning his or her relationship to the taxpayer, place of abode, age and amount of support.

Typically, a parent may still claim a dependency exemption for a qualifying child if he or she provides more than half of the child's annual support. There is no income limitation for a child under age 19 or a full-time student under age 24.

How the tie-breaking rules work: If a child is claimed as a qualifying child by two or more taxpayers in a particular year, the child will be treated as the qualifying child of the parent. If more than one taxpayer is the child's parent, the benefits go to the person with whom the child lived for the longest time during the year. If the time spent with each parent is equal, the parent with the highest adjusted gross income (AGI) is entitled to the benefit.

Similarly, if neither taxpayer is the child's parent, the benefits may be claimed by the taxpayer with the highest AGI.

Under the new IRS guidelines, a qualifying child generally must be claimed by the same person for all purposes under the tax code. Key exception: A noncustodial parent can take only the child credit and dependency deduction and leave the other tax benefits to the custodial parent.

Q.

Can taxpayers with any amount of income now convert a traditional IRA to a Roth IRA?

A.

Not yet. Under current law, an individual with modified adjusted gross income (MAGI) of more than $100,000 cannot convert a traditional IRA into a Roth IRA.

The Tax Increase Prevention and Reconciliation Act, passed in May of 2006, eliminates the income limitation, but you'll have to wait a long time to take advantage of it.

The favorable change will be available in 2010. For Roth conversions that occur in 2010 only, you will be able to report the taxable income triggered by the conversion over a two-year period. For conversions in 2011 and beyond, all the income must be reported in the conversion year - the same as current law.

If you want to plan ahead for the upcoming Roth opportunity, you can load up your traditional IRA with as much money as possible between now and then. That way, you'll have a substantial balance that can be converted to Roth status in 2010.

If you are in the high-income category, you probably can't make any deductible contributions. But you can always make nondeductible traditional IRA contributions if you have earned income for the year and haven't reached age 70 1/2.

Of course, given the inclination of Congress to tinker with the tax code, lawmakers could change their minds in the future and eliminate this favorable provision before it ever becomes effective.

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