The federal income tax is a pay-as-you-go tax. You must pay the tax as you earn or receive income during the year. There are two ways to pay as you go.

This publication explains both of these methods. It also explains how to take credit on your return for the tax that was withheld and for your estimated tax payments.

If you did not pay enough tax during the year either through withholding or by making estimated tax payments, you may have to pay a penalty. The IRS usually can figure this penalty for you. This underpayment penalty, and the exceptions to it, are discussed in chapter 4.

You should consider the items in this section when figuring any underpayment penalty for 2005. Figuring the penalty is discussed in chapter 4.

Penalty rate. The penalty for underpayment of 2005 estimated tax is figured at an annual rate of 6% for the number of days the underpayment remained unpaid from April 15, 2005, through September 30, 2005, and 7% from October 1, 2005, through April 15, 2006.

If you were affected by Hurricane Katrina, the due dates for the September 15, 2005, and January 17, 2006, required installments are both extended to February 28, 2006. If you were affected by Hurricane Rita or Wilma, the due date for the January 17, 2006, required installment is extended to February 28, 2006. See the 2005 Instructions for Form 2210 for more information.

This section summarizes important changes that could affect your estimated tax payments for 2006. More information on these and other changes can be found in Publication 553.

Additional exemption for housing individuals displaced by Hurricane Katrina. You may be able to claim an additional exemption amount of $500 per person (up to $2,000) if you provided housing to a person who was displaced from his or her main home as a result of Hurricane Katrina. See Taxpayers housing individuals displaced by Hurricane Katrina in chapter 2 for more information.

Personal exemption and itemized deduction phaseouts reduced. The phaseouts of the limitations on personal exemptions and itemized deductions are reduced by 33⅓%. See chapter 2 for more information.

Earned income credit (EIC). You may be able to take the EIC if:

For more information, see Publication 596, Earned Income Credit (EIC).

Retirement savings plans.  The following paragraphs highlight changes that affect individual retirement arrangements (IRAs) and pension plans. For more information, see Publication 590, Individual Retirement Arrangements (IRAs). Traditional or Roth IRA contribution limits increased. The contribution limit to a traditional or Roth IRA for 2006 is increased to $5,000 if you are 50 or older. Traditional IRA deduction limits increased. For 2006, if you are covered by a retirement plan at work and your filing status is married filing jointly or a qualifying widow(er), your deduction for contributions to a traditional IRA will be reduced (phased out) if your modified adjusted gross income (AGI) is more than $75,000 but less than $85,000. Additional salary reduction contributions to SIMPLE IRAs. For 2006, additional salary reduction contributions can be made to your SIMPLE IRA if you meet certain requirements. For more information, see How Much Can Be Contributed on Your Behalf? in Publication 590, chapter 3.

Standard mileage rates.  For tax years beginning in 2006, the standard mileage rate for the cost of operating your car is:

Alternative motor vehicles and refueling property. You may be able to take a credit if you place an energy efficient motor vehicle or alternative fuel vehicle refueling property in service in 2006. You can no longer take a deduction for clean-fuel vehicles or refueling property. For details, see Form 8910 (Form 8911 for alternative fuel vehicle refueling property).

Clean renewable energy bond credit. You may be able to take a credit based on the face amount of any clean renewable energy bond you hold during 2006. The amount of any credit claimed must be included as interest income. For details, see Form 8912.

Nonconventional source fuel credit. You may be able to claim the nonconventional source fuel credit for facilities producing coke or coke gas. Also, the nonconventional source fuel credit is now a general business credit subject to the general business credit tax liability limits. In general, any 2006 unused credit can be carried forward 20 years. See Form 8907 for details.

Qualified contributions expired. You can no longer elect to treat gifts by cash or check as qualified contributions on Schedule A. Qualified contributions for which you made this election were not subject to the 50% of adjusted gross income limit or the overall limit on itemized deductions.

Residential Energy Credits. 
If you make energy saving improvements to your home in 2006, you may be able to take two new credits, the nonbusiness energy property credit and the residential energy efficient property credit. For credit purposes, costs are treated as being paid when the original installation of the item is completed, or in the case of costs connected with the construction or reconstruction of a building, when your original use of the constructed or reconstructed building begins. If less than 80% of the use of an item is for nonbusiness purposes, only that portion of the expenses that are allocable to the nonbusiness use can be used to determine the credit. A home includes a house, houseboat, mobile home, cooperative apartment, condominium, and certain manufactured homes. For factors used in determining if a home is your main home, see Publication 523. You must reduce the basis of your home by the amount of credit allowed.

If you are a member of a qualified condominium management association for a condominium that you own or a tenant-stockholder in a cooperative housing corporation, you are treated as having paid your proportionate share of any expenses of such association or corporation. Credits must be allocated based on the ratio of individual qualified costs to total qualified costs in the case of joint occupancy.

Nonbusiness energy property credit. You may be able to take a credit equal to (a) 10% of the amount paid in 2006 for qualified energy efficiency improvements installed during 2006, plus (b) any residential energy property costs paid in 2006. However, this credit is limited as follows.

Qualified energy efficiency improvements. Qualified energy efficiency improvements are the following items installed on or in your main home located in the United States if such items are new and can be expected to remain in use for at least 5 years.

To qualify for the credit, qualified energy efficiency improvements must meet certain energy efficiency requirements. Residential energy property costs. Residential energy property costs are costs of new qualified energy property that is installed on or in connection with your main home located in the United States. This includes labor costs properly allocable to the onsite preparation, assembly, or original installation of the property. Qualified energy property is any of the following.

To qualify for the credit, qualified energy property must meet certain performance and quality standards.

Residential energy efficient property credit. You may be able to take a credit of 30% of your costs of qualified photovoltaic property, solar water heating property, and fuel cell property. This includes labor costs properly allocable to the onsite preparation, assembly, or original installation of the property and for piping or wiring to interconnect such property to the home. This credit is limited to:

Costs allocable to a swimming pool, hot tub, or any other energy storage medium that has a function other than the function of such storage do not qualify for the residential energy efficiency credit. Qualified photovoltaic property costs. Qualified photovoltaic property costs are costs for property that uses solar energy to generate electricity for use in a home located in the United States and used by you as a home. This includes costs relating to a solar panel or other property installed as a roof or a portion of a roof. Qualified solar water heating property costs. Qualified solar water heating property costs are costs for property to heat water for use in a home located in the United States and used by you as a home if at least half of the energy used by such property for such purpose is derived from the sun. This includes costs relating to a solar panel or other property installed as a roof or a portion of a roof. To qualify for the credit, the property must be certified for performance by the nonprofit Solar Rating Certification Corporation or a comparable entity endorsed by the government of the state in which such property is installed. Qualified fuel cell property costs. Qualified fuel cell property costs are costs for qualified fuel cell property installed on or in connection with your main home located in the United States. Qualified fuel cell property is an integrated system comprised of a fuel cell stack assembly and associated balance of plant components that converts a fuel into electricity using electrochemical means. To qualify for the credit, the fuel cell property must have a nameplate capacity of at least one-half kilowatt of electricity using an electrochemical process and an electricity-only generation efficiency greater than 30%.

Pending legislation may eliminate one or more of the following changes.

Certain credits no longer allowed against alternative minimum tax (AMT). The credit for child and dependent care expenses, credit for the elderly or the disabled, education credits, mortgage interest credit, and carryforwards of the District of Columbia first-time homebuyer credit are no longer allowed against AMT and a new tax liability limit applies. For most people, this limit is your regular tax minus any tentative minimum tax.

AMT exemption amount decreased. The AMT exemption amount will decrease to $33,750 ($45,000 if married filing jointly or a qualifying widow(er); $22,500 if married filing separately).

Expired tax benefits.  The following tax benefits have expired and will not apply for 2006.

Social security (FICA) tax.  Generally, each employer for whom you work during the tax year must withhold social security tax up to the annual limit.

Photographs of missing children. The Internal Revenue Service is a proud partner with the National Center for Missing and Exploited Children. Photographs of missing children selected by the Center may appear in this publication on pages that would otherwise be blank. You can help bring these children home by looking at the photographs and calling 1-800-THE-LOST (1-800-843-5678) if you recognize a child.