Abe Kutner, C.P.A.

468 N. Camden Drive, Suite 200

Beverly Hills, California 90210

Tel:  310-996-8800 / Fax: 310-838-6443

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The Taxpayer Relief Act of '97 carries a wide variety of important tax changes that affect, individuals, families, investors and businesses. It is also one of the most complex tax laws enacted in recent memory. Many of you may have to reorient your tax and financial plans in order to take advantage of the new tax breaks, and to avoid the few crackdowns. This letter is designed to give you a brief summary of the new law's major provisions so that you can begin to consider how your personal, family, investment and business plans and goals should be changed in the coming weeks and months.

The major new tax breaks for individuals and families are as follows:

Tax Credits for Families with Children:

… In '98, parents get a new tax credit equal to $400 ($500 after '98) for each qualifying dependent child under age 17. The credit phases out for those whose adjusted gross income exceeds $75,000 ($110,000 for married persons filing jointly; $55,000 for married persons filing separately).

 

Savings Incentives:

… Beginning in '98, more individuals will be able to make deductible IRA contributions. The new law boosts the adjusted gross income levels at which the IRA deduction begins to phase out for individuals who participate in an employer retirement plan. And a spouse who isn't a retirement plan participant will be able to make a deductible IRA contribution even if the other spouse is a retirement plan participant. The new break for spouses phases out for those with adjusted gross income between $150,000 and $160,000.

… Beginning in '98, retirement savers have a new tax-favored alternative called the Roth IRA. The new IRA won't yield deductions when you put money in, but will result in tax-free distributions for payouts made after five years on account of attaining age 59-1/2, death, disability, or to pay for certain first-time homebuyer expenses. Otherwise allowable contributions to Roth IRAs phase out for single taxpayers with adjusted gross income between $95,000 and $110,000, and for joint filers, between $150,000 and $160,000 of adjusted gross income.

 

Education Tax Incentives:

… A wide range of new tax incentives for higher education is on the way, including the following:

… There are two new elective tax credits for higher education. The first is a HOPE credit of up to $1,500 a year per student for qualified tuition paid during the first 2 years of a student's post-secondary education. This credit is effective for post-'97 payments for post-'97 education. The second is a Lifetime Learning Credit per taxpayer (as opposed to per student) equal to 20% of up to $5,000 ($10,000 after 2002) of qualifying higher education expenses, including graduate-level education. The credit for lifetime learning applies to post-June 30, '98 expenses for education beginning after that date. Neither credit is available to tax dependents. Both credits phase out for those with adjusted gross income between $40,000 and $50,000 (between $80,000 and $100,000 for joint return filers). Qualified tuition for purposes of the Lifetime Learning Credit doesn't include tuition of an individual for whom a HOPE credit is allowed for the year. Neither of these credits can be claimed for a year in which a person makes tax-free distributions from an education IRA (see below).

… After '97, individuals will be able to make annual nondeductible contributions of up to $500 per beneficiary to an education IRA. Distributions from the IRA to pay for college expenses will be tax and penalty-free if a number of conditions are met. The education IRA contribution limit phases out for those with adjusted gross income between $95,000 and $110,000 (between $150,000 and $160,000 for joint return filers).

… After '97, penalty-free distributions can be made from non-education-IRAs to pay for higher-education expenses.

… Part of qualified education-loan interest due and paid after '97 may be deductible. The maximum deductible amount is $1,000 for '98 (increasing $500 a year in '99 through 2001), but it phases out for those with adjusted gross income between $40,000 and $55,000 (between $60,000 and $75,000 for joint return filers). This deduction is available to nonitemizers as well as to itemizers.

… The annual exclusion for up-to-$5,250 of employer-provided educational assistance has been extended and will apply to expenses paid for courses beginning before June 1, 2000 (it had expired for courses beginning after June 30, '97).

 

… More of a person's assets can be passed on or gifted to family members (or anyone else) free of estate or gift taxes. The amount exempted from estate or gift tax (currently $600,000) rises to $625,000 for decedents dying and gifts made in '98, $650,000 in '99, and $675,000 in 2000 and 2001, with still more increases in later years until the exempt amount tops out at $1 million in 2006 and later years.

… If more than 50% of a person's estate consists of qualified family owned business interests, his or her executor can elect to exclude up to $675,000 of such interests from the gross estate. This exclusion, which is available for decedents dying after '97, can't exceed (1) $1.3 million less (2) the amount that can be left or given free of estate or gift taxes. For example, in '99, the exclusion for qualified family owned business interests can't exceed $650,000 ($1.3 million less $650,000).

… For individuals dying after '97, executors who choose the installment method of paying estate taxes arising from closely held businesses will qualify for a lower interest rate (2% instead of current law's 4%). And the lower rate will apply to a larger amount of deferred estate tax.

… Taxpayers will no longer be penalized for taking large payouts from IRAs, qualified plans and tax-sheltered annuities, or leaving large retirement plan accumulations to their heirs. The 15% excise tax on excess distributions, which had been suspended for '97 through '99, is repealed (effective after '96), and so is the additional 15% estate tax on excess retirement accumulations (effective for decedents dying after '96).

… The estimated tax rules are overhauled for individuals with adjusted gross income over $150,000 in the tax year preceding the current year. Under the rules that apply this year, they avoid underpayment penalties for '97 if estimated tax payments at least equal the lesser of (1) 110% of the tax shown on their '96 return, or (2) 90% of the tax shown on the '97 return. For tax years beginning in '98, these taxpayers are subject to the same rules that apply to others: underpayment penalties are avoided if their estimated tax payments at least equal the lesser of (1) 100% of the tax shown on their '97 return, or (2) 90% of the tax shown on the '98 return. The estimated tax penalty safe harbor rules for higher-income taxpayers will change again for tax years beginning in '99 through 2003.

… For tax years beginning after '97, the estimated tax penalty is not imposed if the shortfall for the year is less than $1,000 (up from $500).

… The standard mileage rate deduction for charitable use of a car is increased from 12¢ a mile to 14¢ a mile, for tax years beginning after '97.

… Charitable givers can continue to deduct the fair market value of qualified appreciated stock (publicly traded stock which is capital gain property) donated to private foundations. This break, which had expired on May 31, '97, is extended for the period June 1, '97 through June 30, '98.

The major new tax changes for investors and home-sellers are as follows:

Capital Gains Provisions:

… The top tax on long-term capital gain is reduced from 28% to 20% (to 10% for taxpayers in the 15% bracket). Thus, for example, if you currently sell appreciated stock you bought several years ago, your profit won't be taxed at a rate higher than 20%. However, there are some tricky holding period rules to contend with. For example, if you sold a capital asset, such as stock:

 Still lower capital gains rates are on the way. After the year 2000, the top tax rate for long-term capital gains will be 18% (8% for taxpayers in the 15% bracket) if a 5-year holding period is met. The 18% rate (but not the 8% rate) will apply only if the holding period for the assets begins after the year 2000.

The reduced capital gain rates apply for purposes of the regular tax and the Alternative Minimum Tax.

Long-term capital gain from the sale of collectibles continues to be taxed at a maximum rate of 28%, and part of the profit from the sale of depreciable residential or nonresidential income or business real property will be taxed at 25%.

… Up to $250,000 of home-sale profit is tax-free, if the sale takes place after May 6, '97. The exclusion is doubled to $500,000 for married persons filing jointly. The new break replaces the home-sale rollover rules and the up-to-$125,000 exclusion rules for home-sellers age 55 and over.

The major new tax breaks for businesses are as follows:

… For tax years beginning after '97, the Alternative Minimum Tax (AMT) is repealed for small corporations. In brief, the exemption from the AMT applies to a corporation that has under $5 million of 3-year-average annual gross receipts, and continues to apply as long as it has under $7.5 million of average gross receipts.

… The AMT adjustment requiring use of a generally longer depreciation write-off period than applies for regular tax purposes is repealed, effective for property placed in service after '98.

… Retroactively effective to tax years beginning in '87, qualified farmers are eligible to use the installment method of accounting for AMT and regular tax purposes.

… A self-employed individual's "above the line" deduction for health insurance costs (40% of eligible expenses for '97), will increase at a quicker pace than it would have under prior law. The deduction will be equal to 45% of eligible costs in '98 and '99, and 50% in 2000 and 2001. The deductible percentage will grow in later years until it reaches 100% in 2007 and later years as follows:

… Starting in '99, more individuals will be able to claim home-office deductions. Qualifying home-offices will include those used to conduct administrative or management activities relating to a business if there's no location outside the home where the taxpayer conducts those activities.

There are some crackdowns in the new law. Changes you should watch out for include the following:

… Certain constructive sales of assets entered into after June 8, '97 are treated as actual sales. One target of this rule is the short-sale technique.

… A number of relatively specialized corporate provisions are subject to tougher rules (e.g., gain recognition on certain distributions of controlled corporate stock, tougher holding period rules for the corporate dividends-received deduction, registration of certain confidential corporate tax shelters).

… There are several changes in the partnership area. For example, contributing partners recognize gain on the property distributed to another partner or on distribution of other property to the contributing partner within seven years of the original contribution (had been five years). This is effective generally for appreciated property contributed to a partnership after June 8, '97. In addition, effective generally for sales, exchanges and distributions after August 5, '97, gain on the sale or exchange of a partnership interest generally is taxed as ordinary income to the extent it is attributable to inventory (had applied only to the extent attributable to substantially appreciated inventory).

… Gross proceeds reporting will be required on all post-'97 payments to attorneys made in the course of a trade or business (except those now reported on Form 1099-MISC or Form W-2).

… The net operating loss (NOL) carryback period is decreased from three to two years, but the carryforward period is increased from 15 to 20 years, effective for NOLs arising in tax years beginning after August 5, '97. But the three-year carryback is retained for losses in disaster areas by farmers or a small business, and for an individual's casualty losses.

Keep in mind that you won't be exposed to estimated tax penalties to the extent the underpayment was created or increased by the Taxpayer Relief Act of '97. This penalty protection applies for any period before '98 for any payment due before Jan. 16, '98.

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                    Last modified: 11/28/06