Untangling the tax code

Now that tinkering with the tax code has become a favorite legislative pastime in Washington, the annual filing season is an ordeal like rarely before, with laws kicking in and phasing out virtually every year.

This time around there are new breaks for songwriters, homeowners and onetime dot-com millionaires whose shares turned to dust. There are new hurdles for children with income, people who donate cash to charity and buyers of hybrid cars. A variety of income thresholds have been indexed to inflation, giving some a chance to claim breaks they might otherwise have missed. As always, there are a handful of nagging challenges when it comes to claiming breaks that aren't specifically noted on tax forms.

And for millions of Americans, tax filing season has only just started, because last-minute changes by Congress made it all but impossible for the IRS to process certain forms before Monday of last week.

Ready, set, go? Here's what you need to know about the work-in-progress tax code:

What's new

Laws passed in the last two years ushered in a host of new deductions and hazards. Specifically:

* Mortgage insurance write-offs. Although mortgage insurance premiums are deductible, there are caveats. The insurance has to be on a mortgage that you used to buy your main or second home in 2007 -- not before. Jackie Perlman, tax researcher for H&R Block in Kansas City, noted that the deduction is phased out for single or joint filers earning more than $100,000 and evaporates completely once income hits $110,000.?

* Debt cancellation exclusion. In the past, if you lost your house in foreclosure or were forced to sell it for less than the loan amount, you'd typically be subject to "debt cancellation income." The short version: The IRS assessed income tax on the money you didn't have to pay back -- but won't for 2007.

Let's say you had a home with a $500,000 mortgage and a market value of $450,000. Before Congress passed a two-year exception to help people cope with the sub-prime crisis, if the lender took the home in foreclosure and you walked away owing nothing, the $50,000 difference was taxable income to you.

For 2007 through 2009, debt cancellation on your primary residence, whether as the result of a so-called "short sale" or a foreclosure, is not taxable. (Taxpayers are likely to get a 1099C showing the phantom income, however, so you must fill out a Form 982 to exclude that income from tax, Perlman said.)