State sales-tax deduction: Is it a thing of the past?

Q: Individuals could use state sales taxes paid in 2005 as an itemized deduction on their 2005 tax returns. But this deduction no longer applies for the 2006 tax year. Is it possible that Congress might still approve this deduction for 2006? Or might it be approved in early 2007 and made retroactive to 2006?
J.F., Seal Beach, Calif.

A: You'll have to keep a close eye on the news during the next few months, says Donna LeValley, a tax attorney who coauthored "J.K. Lasser's Your Income Tax 2007."

Either scenario is possible; it can be approved in the remaining days of this congressional session or be addressed next year retroactively.

In addition to the deduction for state and local sales taxes, also awaiting renewal are the deductions for college tuition and fees and the educator expense deduction. Taxpayers who file in early January may want to file an amended return if they are eligible to claim any of these deductions.

The important thing to know for folks interested in claiming the deduction for state and local sales taxes is that there's still hope. If you gave up and stopped saving receipts, you can use the "safe harbor" amount provided by the IRS to value your deduction.

Q: I am considering an interest-only mortgage for a new house. It offers a lower interest rate than a 30-year fixed mortgage does and allows me to make additional payments to principal whenever I want. Is this a good move?
B.F., Tewksbury, Mass.

A: The cornerstone to building financial security is to have a debt-free home to live out your retirement, and an interest-only loan does not get you closer to that goal, says Richard Manchester, founder of Wave Wealth Management in Laguna Beach, Calif. So from the perspective of long-term financial planning, at least, the general rule is that interest-only loans are a bad idea.

But Mr. Manchester says that there can be exceptions to this rule.

First, if you're a savvy investor and have consistently earned a return above the interest-only cost of the mortgage and expect to maintain that spread through an increasing-interest environment then, by all means, go interest-only. Invest the difference between the interest-only payment and the amortized 30-year payment, and segregate the funds into a "mortgage payoff" account.

Another exception is if you live in an area that has historically appreciated in value more rapidly than the general real estate market has. If you have funds set aside to pay off your mortgage already (and it is a tax concern) and you want to spread out your discretionary money to accomplish more financial strategies, then interest-only is OK.

In the end, Manchester says, the answer is predicated on your ability to save, invest, and monitor. You have to be very disciplined and on top of your finances to make an interest-only loan truly work to your long-term benefit. And keep in mind that the mortgage industry loves interest-only loans. They get paid forever!

Q: My husband is on medical disability. He didn't want any monthly payments besides utilities, so he questioned our tax preparer about paying off our home mortgage. He was advised to do so and told that since he was on medical disability, it would not be considered taxable income. Now we find out we will owe in excess of $7,000 on taxes. Is there anything we can do?
B.C., via e-mail

A: Sorry, but you're on the hook for the taxes, according to John L. Sullivan, a certified financial planner in Glen Burnie, Md.

Before your tax adviser dispensed this advice, he or she should have looked at who paid the disability premiums. If it was the employer, then it's taxed as wages. If it was the employee, then it's not a taxable issue.

But a $7,000 tax bill sounds pretty high to Mr. Sullivan if it's based solely on disability income. He wonders if there is other income being calculated into this equation.

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