Highlights of 2007 Tax Changes

From TaxAlmanac

Have questions about these changes? Ask your colleagues on the Tax Questions Discussion Board.

Tax Changes for Individuals

Alternative Minimum Tax (AMT)

The following changes to the AMT went into effect for 2007.

• AMT exemption amount decreased. The AMT exemption amount has decreased to $33,750 ($45,000 if married filing jointly or qualifying widow(er); $22,500 if married filing separately).
• Exemption amount for a child. The minimum exemption amount for a child under age 18 has increased to $6,300.
• Hurricane Katrina additional exemption expired. The additional exemption for taxpayers who provide housing for a person displaced by Hurricane Katrina has expired. Therefore, the additional exemption amount (formerly line 6 of Form 8914) is no longer allowable for the AMT.
• Certain credits no longer allowed against the AMT. The credit for child and dependent care expenses, credit for the elderly or the disabled, education credits, residential energy credits, mortgage interest credit, and the District of Columbia first-time homebuyer credit are no longer allowed against the AMT, and a new tax liability limit applies. This limit is your regular tax minus any tentative minimum tax (figured without any AMT foreign tax credit).

Standard Mileage Rate

• Business-related mileage. For 2007, the standard mileage rate for the cost of operating your car for business use is 48½ cents per mile.
• Car expenses and use of the standard mileage rate are explained in chapter 4 of Publication 463, Travel, Entertainment, Gift, and Car Expenses.
• Medical- and move-related mileage. For 2007, the standard mileage rate for the cost of operating your car for medical reasons or as part of a deductible move is 20 cents per mile. See Transportation under What Medical Expenses Are Includable in Publication 502 or Travel by car under Deductible Moving Expenses in Publication 521.
• Charitable-related mileage. For 2007, the standard mileage rate for the cost of operating your car for charitable purposes remains 14 cents per mile.

Earned Income Credit (EIC)

The following paragraphs explain the changes to the credit for 2007.

• Amount of credit increased. The maximum amount of the credit has increased. The most you can get is:
  • $2,853 if you have one qualifying child,
  • $4,716 if you have more than one qualifying child, or
  • $428 if you do not have a qualifying child.

• Earned income amount increased. The maximum amount of income you can earn and still get the credit has increased for 2007. You may be able to take the credit if:
  • You have more than one qualifying child and you earn less than $37,783 ($39,783 if married filing jointly),
  • You have one qualifying child and you earn less than $33,241 ($35,241 if married filing jointly), or
  • You do not have a qualifying child and you earn less than $12,590 ($14,590 if married filing jointly).

The maximum amount of adjusted gross income (AGI) you can have and still get the credit also has increased. You may be able to take the credit if your AGI is less than the amount in the above list that applies to you.

• Investment income amount increased. The maximum amount of investment income you can have and still get the credit has increased to $2,900 for 2007.

• Advance payment of the credit. If you get advance payments of the credit from your employer with your pay, the total advance payments you get during 2007 can be as much as $1,712.

• Nontaxable combat pay election extended. You can elect to have your nontaxable combat pay included in earned income when you figure your earned income credit for 2007. This election was previously due to expire at the end of 2006 but has been extended through 2007. For more information about the election, see Publication 596.

Standard Deduction Amount Increased

The standard deduction for people who do not itemize deductions on Schedule A (Form 1040) is, in most cases, higher for 2007 than it was for 2006. The amount depends on your filing status, whether you are 65 or older or blind, and whether an exemption can be claimed for you by another person. The 2007 Standard Deduction Tables are shown in Publication 505, Tax Withholding and Estimated Tax.

Exemption Amount Increased

The amount you can deduct for each exemption has increased to $3,400 in 2007.

You lose part of the benefit of your exemptions if your adjusted gross income is above a certain amount. The amount at which the phaseout begins depends on your filing status. For 2007, the phaseout begins at:

• $117,300 for married persons filing separately,
• $156,400 for single individuals,
• $195,500 for heads of household, and
• $234,600 for married persons filing jointly or qualifying widow(er)s.

See Publication 505 for more information on figuring the amount you can deduct.

Charitable Contributions

• New recordkeeping requirements for cash contributions. You cannot deduct a cash contribution, regardless of the amount, unless you keep as a record of the contribution a bank record (such as a canceled check, a bank copy of a canceled check, or a bank statement containing the name of the charity, the date, and the amount) or a written communication from the charity. The written communication must include the name of the charity, date of the contribution, and amount of the contribution. For more information, see Publication 526.

• Contributions to donor advised funds. You cannot deduct a contribution to a donor advised fund after February 13, 2007, if the sponsoring organization is a war veterans' organization, a fraternal society, or a nonprofit cemetery company. There are also other circumstances in which you cannot deduct your contribution to a donor advised fund. Generally, a donor advised fund is a fund or account in which a donor can, because of being a donor, advise the fund how to distribute or invest amounts held in the fund. For details, see Internal Revenue Code section 170(f)(18).

• Filing fee for easements on buildings in historic districts. A new $500 filing fee must be paid for each qualified conservation contribution after February 12, 2007, that is an easement on a building in a registered historic district, if the claimed deduction is more than $10,000. See Form 8283-V, Payment Voucher for Filing Fee Under Section 170(f)(13).

Social Security and Medicare Taxes

The maximum amount of wages subject to the social security tax for 2007 is $97,500. There is no limit on the amount of wages subject to the Medicare tax.

Income Limits Increased for Student Loan Interest Deduction

For 2007, the amount of the student loan interest deduction is phased out if your modified adjusted gross income (MAGI) is between $55,000 and $70,000 (between $110,000 and $140,000 if married filing jointly). You cannot take the deduction if your MAGI is $70,000 or more ($140,000 or more if married filing jointly). For more information, see chapter 4 in Publication 970.

Income Limits Increased for Hope and Lifetime Learning Credits

For 2007, the amount of your Hope or lifetime learning credit is phased out (gradually reduced) if your modified adjusted gross income (MAGI) is between $47,000 and $57,000 ($94,000 and $114,000 if you file a joint return). You cannot claim an education credit if your MAGI is $57,000 or more ($114,000 or more if you file a joint return). For more information, see chapters 2 and 3 in Publication 970, Tax Benefits for Education.

Earned Income Amount for Additional Child Tax Credit

For 2007, the minimum earned income amount used to figure the additional child tax credit has increased to $11,750.

Mortgage Insurance Premium Deduction

Premiums that you pay or accrue for “qualified mortgage insurance” during 2007 in connection with home acquisition debt on your qualified home are deductible as an itemized deduction. The amount you can deduct is reduced by 10% (.10) for every $1,000 ($500 if your filing status is married filing separately) by which your adjusted gross income exceeds $100,000 ($50,000 if your filing status is married filing separately). For the definitions of home acquisition debt and qualified home, see Publication 936, Home Mortgage Interest Deduction.

Mortgage insurance premiums you paid or accrued on any mortgage insurance contract issued before January 1, 2007, are not deductible as an itemized deduction. Mortgage insurance premiums you paid or accrued after December 31, 2007, or that are properly allocable to any period after December 31, 2007, are not deductible as an itemized deduction.

• Qualified mortgage insurance. Qualified mortgage insurance is mortgage insurance provided by the Veterans Administration, the Federal Housing Administration, or the Rural Housing Administration, and private mortgage insurance (as defined in section 2 of the Homeowners Protection Act of 1998 as in effect on December 20, 2006).

• Special rules for prepaid mortgage insurance. If you paid premiums for qualified mortgage insurance that are properly allocable to periods after the close of the taxable year, such premiums are treated as paid in the period to which they are allocated. No deduction is allowed for the unamortized balance if the mortgage is satisfied before its term (except in the case of qualified mortgage insurance provided by the Department of Veterans Affairs or Rural Housing Administration).

• Schedule A (Form 1040). You can deduct mortgage insurance premiums you paid or accrued during 2007 on line 13 of the 2007 Schedule A (Form 1040).

Limit on Itemized Deductions Increased

If your adjusted gross income is above a certain amount, you may lose part of your itemized deductions. In 2007, this amount is increased to $156,400 ($78,200 if married filing separately). See Publication 505 for more information on figuring the amount you can deduct.

Health Savings Accounts (HSAs)

• High deductible health plan (HDHP). For HSA purposes, the minimum annual deductible of an HDHP increases to $1,100 ($2,200 for family coverage) and the maximum annual deductible and other out-of-pocket expenses limit increases to $5,500 ($11,000 for family coverage).

• Deductible limitation on contributions. The annual deductible limitation for contributions to your HSA based on the amount of your health insurance deductible is repealed. For 2007, the maximum HSA deduction increases to $2,850 ($5,650 for family coverage) regardless of the amount of your health insurance deductible. The maximum additional deduction for individuals age 55 or older increases to $800.

• Deductible contributions for part-year coverage. For HSA purposes, you can be treated as an eligible individual for each month in your tax year if you are an eligible individual during the last month of your tax year. This applies to each month for which you would not otherwise qualify as an eligible individual. For these months, you are treated as enrolled in the same HDHP that you were enrolled in for the last month of your tax year. However, if you are not an eligible individual, for any reason other than death or becoming disabled, for the 12 months following the end of your tax year, any contribution attributable to these months is included in your income and is subject to an additional 10% tax. The income and additional 10% tax are reported for the tax year in which you cease to be an eligible individual.

• Transfers from a health reimbursement arrangement (HRA) or health flexible spending arrangement (FSA) to an HSA. Your employer can make a one-time direct transfer of the balance in your HRA or health FSA to your HSA without violating the requirements for those arrangements. The maximum allowable transfer is the smaller of the HRA or health FSA balance on September 21, 2006, or on the date of transfer. The amount transferred is not included in your gross income, is not taken into account in applying the HSA contribution limitation, and is not deductible. However, if you are not an eligible individual, for any reason other than death or becoming disabled, for the 12 months following the month of the transfer, the amount transferred is included in your income and is subject to an additional 10% tax. The income and additional 10% tax are reported for the tax year in which you cease to be an eligible individual.

If the employer makes a transfer available to any employee, all employees who are covered under an HDHP of the employer must be allowed to make a transfer. Otherwise, the employer is subject to an excise tax.

Generally, you are not an eligible individual for an HSA if you have health coverage other than an HDHP. For tax years beginning after 2006, coverage under a health FSA for the period immediately following the health FSA's plan year during which unused benefits or contributions remaining at the end of the year may be paid or reimbursed to you for qualified expenses incurred during that period does not disqualify you from being an eligible individual. The coverage does not disqualify you if the balance in the health FSA at the end of the plan year is zero or the entire remaining balance in the health FSA is transferred to your HSA as described above.

• Transfers from an individual retirement account (IRA) to an HSA. You can elect to make a one-time direct trustee-to-trustee transfer from your IRA (other than a Simple IRA or a SEP IRA) to your HSA. The maximum amount you can transfer is the maximum HSA contribution limitation for the year. The amount transferred is not included in your income, is not deductible, and reduces your HSA contribution limitation for the year. If the initial transfer is made during a month when you have self-only coverage at the beginning of the month, an additional transfer (up to the contribution limitation) can be made during a later month in that year in which you have family coverage. However, if you are not an eligible individual, for any reason other than death or becoming disabled, for the 12 months following the month of the transfer, the amount transferred is included in your income and is subject to an additional 10% tax. The income and additional 10% tax are reported for the tax year in which you cease to be an eligible individual.

• Comparable contributions by an employer. An employer that makes contributions to the HSAs of employees must make comparable contributions to all comparable participating employees' HSAs. For tax years beginning after 2006, for purposes of making contributions to the HSA of an employee who is not highly compensated, a comparable participating employee does not include a highly compensated employee.

Adoption Benefits Increased

For 2007, the maximum adoption credit has increased to $11,390. Also, the maximum exclusion from income for benefits under your employer's adoption assistance program has increased to $11,390. These amounts are phased out if your modified adjusted gross income (MAGI) is between $170,820 and $210,820. You cannot claim the credit or exclusion if your MAGI is $210,820 or more.

Income Limits Increased for Reduction of Education Savings Bond Exclusion

For 2007, the amount of your interest exclusion is phased out (gradually reduced) if your filing status is married filing jointly or qualifying widow(er) and your modified adjusted gross income (MAGI) is between $98,400 and $128,400. You cannot take the deduction if your MAGI is $128,400 or more.

For all other filing statuses, your interest exclusion is phased out if your MAGI is between $65,600 and $80,600. You cannot take a deduction if your MAGI is $80,600 or more. For more information, see chapter 9 in Publication 970, Tax Benefits for Education.

Credit for Prior Year Minimum Tax

If you have any unused minimum tax credit carryforward from 2003 or earlier years, your minimum tax credit allowable for 2007 is not less than the “AMT refundable credit amount.” In addition, a portion of the credit may be refundable in 2007. That means, if the refundable part of the credit is more than your tax, you can get a refund of the difference.

• Credit refundable. The refundable amount of your credit is the amount by which your minimum tax credit for the year exceeds the amount your minimum tax credit would be without regard to the above rules.

• Form 8801. To claim the refundable and nonrefundable parts of this credit, use the 2007 Form 8801, Credit for Prior Year Minimum Tax—Individuals, Estates, and Trusts.

Increase in Deductible Limit for Long-Term Care Premiums

For 2007, the maximum amount of qualified long-term care premiums you can include as medical expenses has increased. You can include qualified long-term care premiums, up to the amounts shown below, as medical expenses on Schedule A (Form 1040).

• Age 40 or under - $290.
• Age 41 to 50 - $550.
• Age 51 to 60 - $1,110.
• Age 61 to 70 - $2,950.
• Age 71 or over - $3,680.

Note. The limit is for each person.

Increase in Limit on Long-Term Care and Accelerated Death Benefits Exclusion

The limit on the exclusion for payments made on a per diem or other periodic basis under a long-term care insurance contract increases for 2007 to $260 per day. The limit applies to the total of these payments and any accelerated death benefits made on a per diem or other periodic basis under a life insurance contract because the insured is chronically ill.

Under this limit, the excludable amount for any period is figured by subtracting any reimbursement received (through insurance or otherwise) for the cost of qualified long-term care services during the period from the larger of the following amounts.

• The cost of qualified long-term care services during the period.
• The dollar amount for the period ($260 per day for any period in 2007).

Archer MSA Limits Increased

For Archer MSA purposes for 2007, the minimum annual deductible of a high deductible health plan increases to $1,900 ($3,750 for family coverage). The maximum annual deductible of a high deductible health plan increases to $2,850 ($5,650 for family coverage). The maximum out-of-pocket expenses limit increases to $3,750 ($6,900 for family coverage).

Capital Asset Treatment for Self-Created Musical Works

Musical compositions and copyrights in musical works are generally not capital assets. However, you can elect to treat these types of property as capital assets if you sell or exchange them in tax years beginning after May 17, 2006, and:

• Your personal efforts created the property, or
• You acquired the property under circumstances (for example, by gift) entitling you to the basis of the person who created the property or for whom it was prepared or produced.

Whistleblower Fees

If you receive an award from the IRS for information provided after December 19, 2006, that substantially contributes to the detection of violations of tax laws by the IRS, you may be able to deduct attorney fees and court costs paid by you in connection with the award, up to the amount of the award includible in your gross income on account of the award, as an adjustment to income.

Frivolous Tax Submissions

For returns filed after March 15, 2007, the penalty for filing a frivolous tax return is increased to $5,000. The $5,000 penalty also applies to other specified frivolous submissions made and issues raised after March 15, 2007. Notice 2007-30, which will be published in Internal Revenue Bulletin 2007-14, contains a list of frivolous positions that will trigger the increased penalty amount. The penalty is in addition to any other penalty provided by law.

Expired Tax Benefits

• Relief granted for Hurricanes Katrina, Rita, and Wilma. The following tax benefits have expired and will not apply for 2007.
  • Tax-favored treatment of qualified hurricane distributions from eligible retirement plans.
  • Increased limits and delayed repayment on loans from qualified employer plans.
  • Special rules so a temporary relocation did not affect whether you provided more than half of an individual's support, whether you furnished more than half the cost of keeping up a household, and whether you could treat an individual as a student.
  • Increased limits and an expanded definition of qualified education expenses for the Hope and lifetime learning credits.
  • Additional exemption for housing individuals displaced by Hurricane Katrina.
  • Exclusion from income for discharge of nonbusiness debt by reason of Hurricane Katrina.

• Qualified electric vehicle credit. You cannot claim this credit for any vehicle you placed in service after 2006.

Tax Changes for Businesses

Depreciation and Section 179 Deduction

• Increased section 179 limits. The maximum section 179 deduction you can elect for qualified section 179 property placed in service in 2007 has increased to $125,000 ($147,000, for qualified enterprise zone and qualified renewal community property). This limit is reduced by the amount by which the cost of qualified property placed in service during the tax year exceeds $450,000. For qualified section 179 Gulf Opportunity (GO) Zone property, the maximum section 179 deduction is higher than the deduction for most other section 179 property.

• Depreciation limits on electric vehicles. The higher maximum depreciation deduction for a passenger automobile that is an electric vehicle does not apply to electric vehicles placed in service after December 31, 2006.

• Limited reduction in Liberty Zone tax benefits. The special depreciation allowance for qualified New York Liberty Zone property does not apply to property placed in service after December 31, 2006 (except for qualified nonresidential real property and qualified residential rental property).

Self-Employment Tax

The maximum amount of net earnings subject to the social security part of the self-employment tax for tax years beginning in 2007 has increased to $97,500. All net earnings of at least $400 are subject to the Medicare part of the tax.

Social Security and Medicare Taxes

The maximum amount of wages subject to the social security tax for 2007 is $97,500. There is no limit on the amount of wages subject to the Medicare tax.

Domestic Production Activities Deduction

For tax years beginning after December 31, 2006, the domestic production activities deduction percentage increases to 6%. For more information on this deduction, see Form 8903, Domestic Production Activities Deduction, and its instructions.

Work Opportunity Credit

After December 31, 2006, the welfare-to-work credit was combined with the work opportunity credit. Use Form 5884, Work Opportunity Credit, to claim a credit for an employee who begins work for the employer after December 31, 2006.

• Members of targeted groups. For employees who begin work after December 31, 2006, the following changes pertaining to targeted group members apply.
  • Ex-felons are no longer required to be a member of a low-income family.
  • Food stamp recipients must be at least age 18 when hired, but not age 40 or older.

• Form 8850. The Form 8850, Pre-Screening Notice and Certification Request for the Work Opportunity Credit, that you are required to file with the work opportunity tax credit (WOTC) coordinator for your state workforce agency (SWA) is now due no later than the 28th day after the job applicant begins work for you. See Instructions for Form 8850 for more information.

Fringe Benefit Parking Exclusion and Commuter Transportation Benefit

You can generally exclude a limited amount of the value of qualified parking and commuter highway vehicle transportation and transit passes you provide to an employee from the employee's wages subject to employment taxes. For 2007, the monthly exclusion for qualified parking increases to $215 and the monthly exclusion for commuter highway vehicle transportation and transit passes increases to $110. See Qualified Transportation Benefits in section 2 of Publication 15-B, Employer's Tax Guide to Fringe Benefits.

Health Savings Accounts

• Eligibility. For 2007, a qualifying high deductible health plan (HDHP) must have a deductible of at least $1,100 for self-only coverage or $2,200 for family coverage and must limit annual out-of-pocket expenses of the beneficiary to $5,500 for self-only coverage and $11,000 for family coverage.

• Employer contributions. Up to specified dollar limits, you can generally exclude your contributions (must be in cash) to the health savings account (HSA) of a qualified individual (determined monthly) from federal income tax withholding, social security tax, Medicare tax, and FUTA tax. For 2007, you can contribute up to the following amounts to a qualified individual's HSA.
  • $2,850 for self-only coverage or $5,650 for family coverage.
  • $3,650 for self-only coverage or $6,460 for family coverage for qualified individuals who are age 55 or older at any time during the year.

The Tax Relief and Health Care Act of 2006 allows employers to make larger HSA contributions for a nonhighly compensated employee than for a highly compensated employee.

For more information, see Health Savings Accounts in section 2 of Publication 15-B, Employer's Tax Guide to Fringe Benefits (For Benefits Provided in 2007).

Certain Transfers of Qualifying Geothermal or Mineral Interests

A 25% exclusion from gross income is allowed for long-term capital gain from certain conservation sales of qualifying mineral and geothermal interests located on eligible federal land. The sale must be to an eligible entity and occur after December 19, 2006. An excise tax may be imposed if an eligible entity fails to take steps consistent with the protection of conservation purposes.

For details, including the geographical location of eligible federal land, see section 403 of Title IV, Division C, of the Tax Relief and Health Care Act of 2006. Also see Form 8924, Excise Tax on Certain Transfers of Qualifying Geothermal or Mineral Interests, when it is released in 2007.

IRAs and Other Retirement Plans

Catch-Up Contributions if Employer Bankrupt

For 2007, if you participated in a 401(k) plan and the employer who maintained the plan filed for bankruptcy, you may be able to contribute an additional $3,000 to your IRA. For this to apply the following conditions must be met.

• You must have been a participant in a 401(k) plan under which the employer matched at least 50% of your contributions to the plan with stock of the company.

• You must have been a participant in the 401(k) plan 6 months before the employer filed for bankruptcy.

• The employer (or a controlling corporation) must have been a debtor in a bankruptcy case in an earlier year.

• The employer (or any other person) must have been subject to indictment or conviction based on business transactions related to the bankruptcy.

If you choose to make these additional contributions, you cannot use the higher contribution and deduction limits for individuals who are age 50 or older.

Income Exclusion for Retired Public Safety Officer

For distributions in tax years beginning after 2006, you can elect to exclude from income an eligible retirement plan distribution if you are a retired public safety officer. The distribution must be from a governmental plan and must be transferred directly to pay premiums for accident or health insurance or qualified long-term care insurance for you, your spouse, or your dependents.

The maximum annual exclusion is $3,000. You cannot deduct these premiums as medical expenses or, if you are self-employed, health insurance costs.

Modified AGI Limit for Traditional IRA Contributions Increased

For 2007, if you are covered by a retirement plan at work, your deduction for contributions to a traditional IRA is reduced (phased out) if your modified adjusted gross income (AGI) is:

• More than $83,000 but less than $103,000 for a married couple filing a joint return or a qualifying widow(er),

• More than $52,000 but less than $62,000 for a single individual or head of household, or

• Less than $10,000 for a married individual filing a separate return.

For 2007, if you are not covered by a retirement plan at work, your deduction for contributions to a traditional IRA may be reduced (phased out) if you either live with your spouse at any time during 2007 or file a joint return for 2007.

If you either live with your spouse or file a joint return, and your spouse is covered by a retirement plan at work, but you are not, your deduction is phased out if your AGI is more than $156,000 but less than $166,000. If your AGI is $166,000 or more, you cannot take a deduction for contributions to a traditional IRA. See How Much Can You Deduct in chapter 1 of Publication 590.

Rollovers by Nonspouse Beneficiary

After 2006, you may be able to roll over tax free all or a portion of a distribution you receive from an eligible retirement plan of a deceased employee. You must be the designated beneficiary of the employee, but you cannot be the surviving spouse. The distribution must be a direct trustee-to-trustee transfer to your IRA that was set up to receive the distribution. The transfer will be treated as an eligible rollover distribution and the receiving plan will be treated as an inherited IRA. For information on inherited IRAs, see Publication 590.

Modified AGI Limit for Retirement Savings Contribution Credit Increased

For 2007, you may be able to claim the retirement savings contribution credit if your modified adjusted gross income is not more than:

• $52,000 if your filing status is married filing jointly,

• $39,000 if your filing status is head of household, or

• $26,000 if your filing status is single, married filing separately, or qualifying widow(er).

Rollover of Nontaxable Amounts

For tax years beginning after 2006, the nontaxable part of an eligible rollover distribution (such as after-tax contributions) from a qualified retirement plan can be rolled over to another qualified retirement plan or to an annuity contract described in section 403(b). Previously, this part of the distribution could be rolled over only to another qualified retirement plan that was a defined contribution plan.

The rollover must be a direct trustee-to-trustee transfer. The plan to which the rollover is made must separately account for these contributions and the earnings on them.

Modified AGI Limit for Roth IRA Contribution Increased

For 2007, your Roth IRA contribution limit is reduced (phased out) in the following situations.

• Your filing status is married filing jointly or qualifying widow(er) and your modified AGI is at least $156,000. You cannot make a Roth IRA contribution if your modified AGI is $166,000 or more.

• Your filing status is married filing separately, you lived with your spouse at any time during the year, and your modified AGI is more than -0-. You cannot make a Roth IRA contribution is your modified AGI is $10,000 or more.

• Your filing situation is different than either of those described above and your modified AGI is at least $99,000. You cannot make a Roth IRA contribution is your modified AGI is $114,000 or more.

Qualified Plans

The following changes apply to qualified plans. For more information, see Publication 560.

• Limits on contributions and benefits. For 2007, the maximum annual benefit for a participant under a defined benefit plan has increased to the smaller of:

• $180,000, or
• 100% of the participant's average compensation for his or her highest 3 consecutive calendar years.

For 2007, a defined contribution plan's maximum annual contributions and other additions (excluding earnings) to the account of a participant has increased to the smaller of:

• $45,000, or
• 100% of the compensation actually paid to the participant.

• Compensation limit. For 2007, the maximum compensation used for figuring contributions and benefits has increased to $225,000.

• Elective deferrals (401(k) plans). For 2007, the limit on elective deferrals (excluding catch-up contributions) for participants in 401(k) plans and SARSEPs (excluding SIMPLE plans) is $15,500.

Simplified Employee Pensions (SEPs)

The following changes apply to SEPs. For more information, see Publication 560.

• Elective deferrals (SARSEPs) limit. The limits on elective deferrals for participants in SARSEPs are discussed earlier under Elective deferrals (401(k) plans).

• Deduction limit increased. The maximum deduction for contributions to a SEP remains unchanged at 25% of the compensation paid or accrued during the year to your eligible employees participating in the plan. However, for 2007, the maximum combined deduction for a participant's elective deferrals and other SEP contributions has increased to $45,000.

• Contribution limit increased. For 2007, the annual limit on the amount of employer contributions to a SEP has increased to the smaller of:
  • $45,000, or
  • 25% of an eligible employee's compensation.

• Compensation limit. For 2007, the maximum amount of an employee's compensation you can consider when figuring SEP contributions (including elective deferrals) and the deduction for contributions has increased to $225,000.

SIMPLE Plans

The following change applies to SIMPLE plans. For more information, see Publication 560.

• Salary reduction contributions. For 2007, the limit on salary reduction contributions (excluding catch-up contributions) to a SIMPLE plan is $10,500.

403(b) Plans

The following changes apply to 403(b) plans. For more information, see Publication 571.

• Increase in the limit on elective deferrals. For 2007, the limit on elective deferrals (excluding catch-up contributions) has increased to $15,500.

• Limit on annual additions. For 2007, the limit on annual additions has increased to $45,000.

Estate and Gift Taxes

Annual Exclusion for Gifts to Spouses Increased

The annual exclusion for gifts made to spouses who are not U.S. citizens has increased to $125,000.

Maximum Estate and Gift Tax Rate Reduced=

For estates of decedents dying, and gifts made, after 2006 and before 2010, the maximum rate for the estate tax and the gift tax is 45%.

Excise Taxes

Changes Effective for the First Quarter of 2007

• Air Transportation Taxes. For amounts paid during 2007, the tax on use of international air travel facilities will be $15.10 per person for flights that begin or end in the United States, or $7.50 per person for domestic segments that begin or end in Alaska or Hawaii (applies only to departures). For amounts paid for each domestic segment of taxable transportation of persons by air, the domestic segment tax is $3.40 per segment for transportation that begins in 2007.

• Arrow Shafts. The tax on arrow shafts (IRS No. 106) is $.42 per arrow shaft.

• Diesel Fuel Used in Trains. The tax rate on dyed diesel fuel used in trains is $.001. The claim rate for undyed diesel fuel used in trains is $.243.

• Inland Waterways Fuel Use Tax. The inland waterways fuel use tax is $.201.

• Taxable Vaccines. Meningococcal and human papillomavirus vaccines are taxable for sales or uses after January 31, 2007.

• Qualified Blood Collector Organizations. Qualified blood collector organizations are exempt from many federal excise taxes (or a credit or payment relating to the tax is available). These taxes include the tax on fuels, tires, communication services, and for heavy vehicles. Each blood collector organization must be registered by the IRS as a condition for applying for exemption (or credit or payments). To apply for registration, see Form 637, Application for Registration (For Certain Excise Tax Activities).

Changes Effective for the Tax Period Beginning July 1, 2007

• Heavy Highway Vehicle Use Tax (Form 2290)

• Qualified blood collector organizations. After June 30, 2007, qualified blood collector organizations are exempt from the heavy highway vehicle use tax on qualified blood collector vehicles. A qualified blood collector vehicle is a vehicle that was used by a qualified blood collector organization at least 80% of the time during the prior tax period for the purpose of collection, storage, or transportation of blood.

For the tax period in which the vehicle is first placed into service, the qualified blood collector organization must certify that the organization reasonably expects the vehicle to be used at least 80% of the time during the tax period for the purpose of collection, storage, or transportation of blood. Qualified blood collector organizations are not required to file Form 2290 for qualified blood collector vehicles.

Foreign Issues

Foreign Earned Income and Housing Exclusions

• Exclusion amount. The maximum foreign earned income exclusion has increased to $85,700.

• Housing expenses—base amount. The base housing amount has increased to $37.57 per day, or $13,712 for an entire calendar year.

Foreign Tax Credit

• Income categories eliminated. For tax years beginning after 2006, the following categories of income will be eliminated for purposes of computing the foreign tax credit limit. Income that previously fell in these categories will fall in either the passive income category or the general limitation income category.

• High withholding tax interest.
• Financial services income.
• Shipping income.
• Dividends from a domestic international sales corporation (DISC) or former DISC.
• Certain distributions from a foreign sales corporation (FSC) or former FSC.

High withholding tax interest and shipping income will fall in the passive income category or general limitation income category, depending on the circumstances. Financial services income will fall in the general limitation income category if you are predominantly engaged in the active conduct of a banking, insurance, financing or similar business. Dividends from a DISC or former DISC and certain distributions from a FSC or former FSC will fall in the passive income category. See Publication 514 for more information on the foreign tax credit for individuals.

• Recharacterization of overall domestic loss. If you have an overall domestic loss for any tax year beginning after 2006, you must recharacterize a portion of your U.S. source taxable income in succeeding years as foreign source taxable income for purposes of the foreign tax credit.

In a tax year you choose to claim the foreign tax credit, the overall domestic loss is the domestic loss for that tax year to the extent it offsets foreign source taxable income for that tax year or for any preceding tax year (in which you chose to claim the foreign tax credit) because of a carryback. If you do not choose to claim the foreign tax credit for a tax year, the overall domestic loss is the domestic loss for that tax year to the extent it offsets foreign source taxable income for any preceding tax year (in which you chose to claim the foreign tax credit) because of a carryback.

For additional Highlights of 2007 Tax Changes, refer to Publication 553.