INTRODUCTION

On August 5, 1997, President Clinton signed into law the Taxpayer Relief Act of 1997 (TRA) that includes many provisions you may find attractive. TRA cuts taxes for American families, investors, business owners, and descendants. Something for everyone, if you can find it, and if you have jumped through the right hoops. 

Complex, confusing, convoluted, cryptic are just some of the terms that have been used to describe TRA. Since TRA contains many traps for the unwary, it is essential that you not rely on this brief summary to do your tax planning for 1997 and beyond. Instead, TRA, referred to as the accountants and lawyers Relief Act of 1997, makes it as necessary as ever for you to obtain competent advice from your accountant or attorney. 

INVESTING

Capital Gains 

For sales of capital assets after May 6, 1996, the rates on capital gains for assets held more than eighteen months have been cut from a maximum of 28 percent to 20 percent and to 10 percent for taxpayers in the 15 percent bracket. Beginning in the year 2001, the maximum rate on capital gains for assets held more than five years will be 8 percent for taxpayers in the 15 percent bracket and 18 percent for all other taxpayers. Thus, if you sold your Microsoft stock that you purchased many years ago on July 1, 1997, you will pay a maximum tax rate to the federal government of 20 percent. 

Other provisions of interest are the following: 

 If you receive capital gains from other entities, mutual funds, real estate        investment trust, S corporation, partnership, estate or trust, the entity should provide information to you on the proper treatment of the distributions.

 If you collect payments from an installment sale after May 7, 1997, the payments should generally qualify for the new capital gains rates.

 Collectible items such as art, antiques, jewelry, stamps, and coins are not eligible for the new capital gains rates.

 Capital losses of up to $3,000 are still deductible against other income. Any excess capital loss can be carried forward to future years. 

YOUR HOME 

Tax Free Gain on the Sale of Your Home 

            TRA eliminates most income taxes when you sell your home. Once every two years you can sell your home at a gain of $250,000 if single or $500,000 if married and pay no tax. The former provisions that deferred the gain on your home if you purchased a replacement home, and that excluded the first $125,000 of gain for taxpayers over 54 years of age, have been eliminated. 

Home Office Deduction Expanded

            Beginning in 1999, you may be able to claim a home office deduction on your individual tax return. This provision is most helpful to self‑employed individuals. If you are an employee, you will be allowed this deduction only if the office is for the convenience of your employer. 

RETIREMENT PLANNING
 

Regular IRAs 

            If you are an active participant in an employer's retirement plan, you can make deductible contributions to an IRA only if your income falls below a certain level. The current law phases out the deduction of $2,000 for incomes between $25,000 and $35,000 for single taxpayers and between $40,000 and $50,000 for married taxpayers filing a joint return. Starting in 1998, TRA increases the ranges in steps from $50,000 to $60,000 for single persons and $80,000 to $100,000 for married taxpayers filing a joint return. 

            The new law also expands the deduction for a spouse whose spouse is a participant in an employers retirement plan. In that situation, the maximum deduction of $2,000 is phased out for taxpayers with incomes between $150,000 and $160,000 

Roth IRAs 

            Starting in 1998, the Roth IRA offers you an additional investment option. This new IRA is similar to the regular IRA. However, you do not get a tax deduction when you put money into the IRA. Instead, you do not have to report the income from the Roth IRA when you withdraw it. The maximum annual contribution is $2,000 per participant. The maximum annual contribution is phased out for single taxpayers with an income between $95,000 and $110,00 and for married persons filing a joint return with incomes between $150,000 and $160,000. You can continue to make contributions to this IRA even after you reach age 70'/x. Unlike regular IRAs, the Roth IRA does not have to be distributed during your lifetime. 

Medicare and Choice Medical Savings Accounts 

            If you are eligible for Medicare and otherwise qualify, you will have the option of participating in Medicare or in a Medicare and Choice Medical Savings Accounts (MSA). Contributions, income on the account, and withdrawals for qualified medical expenses are not income to the participant. Withdrawals not used for qualified medical expenses are taxable income and may be subject to several additional taxes. 

ESTATE PLANNING

Cost of Living Adjustments to Unified Credit, Estate Tax Filing Requirement, and Annual Gift Tax Exclusion 

            Beginning in 1998, the unified credit will be gradually increased. The current credit allows you to transfer either by gift or at death $600,000 of assets without a transfer tax. In 1998, you may transfer $625,000 and eventually in 2006 you may transfer up to $1,000,000 of assets without a transfer tax. As the credit increases each year, the estate tax return filing requirements also will be relaxed. 

            You can currently give $10,000 per person each year without incurring a transfer tax. Starting in 1999 the $10,000 will be indexed for inflation and rounded to the next lowest multiple of $1,000. 

Estate Tax Exclusion for Qualified Businesses

            If you die after December 31, 1997, your personal representative (executor) may elect special estate tax treatment for qualified family‑owned business interests if those interests comprise more than 50 percent of your estate and the other requirements are met. The new rule excludes the first $1,300,000 of value in qualified family owned business interests from descendant's taxable estate. 

            A qualified family‑owned business includes any interest in a trade, business, or farm (regardless of the form in which it is held) with a principal place of business in the U.S. if ownership of the trade or business is held at least 50 percent by one family, 70 percent by two families, or 90 percent by three families, as long as the descendant's family owns at least 30 percent of the trade or business. Members of an individual's family include his or her spouse, ancestors, and lineal descendants, as well as the lineal descendants of the individual's spouse or parents and the spouses of any such descendants. 

            The benefit of this exclusion for qualified family‑owned business interest is subject to recapture if, within ten years of the descendant's death and before the qualified heir's death, the qualified family‑owned business interest is terminated. If recapture is triggered, the heirs must pay the estate tax that was not paid. 

Installment Payment of Estate Tax 

            In general, the federal estate tax is due within nine months of a descendant's death. However, your personal representative may elect to pay the estate tax attributable to an interest in a closely held business in installments over a 14‑year period. For persons dying after 1997, the interest rate is two percent on the first $1,000,000 of qualified family‑owned business interest and a reduced but higher rate on the balance. 

EDUCATION BENEFITS 

HOPE Credit 

            Beginning in 1998, you can claim a non‑refundable HOPE credit against federal income taxes up to $1,500 per student per year for amounts paid for the first two years of the student's post‑secondary school. Enrollment during at least one academic period beginning in the tax year with at least one half of a normal full‑time workload qualifies as half time. Only you or the dependent may claim the credit. 

Lifetime Learning Credit 

            Beginning after June 30, 1998, you can claim a nonrefundable Lifetime Leaming credit against your federal income tax equal to 20 percent of qualified tuition and fees incurred during the year on behalf of yourself, your spouse, or any dependents. For expenses paid after June 30, 1998, and before 2003, up to $5,000 of qualified tuition and fees are eligible for the 20 percent Lifetime Leaming credit, or up to a maximum credit of $1,000. For expenses paid after 2002, the maximum credit will be $2,000 or. $10,000 of expenses. 

            The income limits, the eligibility of students, and qualified tuition and fees are generally the same as for the HOPE credit. However, qualified tuition and fees for purposes of the Lifetime Learning credit include tuition and fees incurred for undergraduate and graduate‑level courses. The Lifetime Leaming credit also is available for any course of instruction at an eligible educational institution (whether enrolled in by the student on a full‑time or part‑time basis) to acquire or improve job skills of the student. 

            If the educational expense otherwise qualifies as a tax deduction, the Lifetime Learning credit may not be claimed for those expenses. Also, the same education expenses do not qualify for both credits. 

Student Loan Interest Deductible 

            Starting in 1998, if you qualify and have paid interest on qualified educational loans, you may take a maximum deduction of $1,000 against your income. By the year 2001, the maximum deduction will be $2,500. The deduction is allowed only for interest paid on a qualified educational loan during the first 60 months in which interest payments are required. 

A qualified educational loan generally is any indebtedness incurred to pay for qualified higher education expenses you, your spouse, or any dependent incur for attending post‑secondary educational institutions and certain vocational schools, or institutions conducting internship or residency programs leading to a degree or certificate from an institution of higher education, a hospital, or a health care facility conducting postgraduate training. 

Withdrawals from Regular IRA's for Education Expenses 

            Beginning in 1998, you can make withdrawals from individual retirement accounts (IRAs) to pay eligible higher‑educational expenses, including cost for graduate‑level courses. The withdrawal must normally be included in income in the year it is withdrawn. The withdrawal is not subject to the 10 percent early‑withdrawal penalty if it is used to pay eligible higher‑educational expenses. 

Qualified State Tuition Programs 

            To save for education expenses, you can make cash contributions to qualified state tuition programs. When the student begins post‑secondary education, you can withdraw the contributions from the account to cover educational expenses. The income tax on the income as it accumulates is deferred. At the time you begin withdrawals, you must report the earnings portion as income. However, to the extent the distributions are used for expenses which qualify, you can use the HOPE credit and the Lifetime Learning credit for those expenses. 

            A qualified state tuition program is one maintained by the state under which you can either purchase credits or make cash contributions for a designated beneficiary to cover the beneficiary's costs of higher education. 

Educational IRAs 

            Starting in 1998, you can set up an educational IRA, which is a qualified or custodial account similar to an IRA, to be used exclusively for paying the qualified educational expenses of the account holder. The contributions are treated like nondeductible contributions to regular IRAs. Annual contributions to educational IRAs are limited to $500 per beneficiary. The $500 limit is phased out for incomes between $95,000 and $110,000 for single persons and between $150,000 and $160,000 for married persons filing a joint return. 

            Distributions from an educational IRA are not included in gross income to the extent that the distribution does not exceed qualified higher education expenses incurred by the beneficiary during the year the distribution in made. Educational IRAs can only be created for paying qualified higher education expenses, which include post-secondary tuition, fees, books, supplies, equipment, and certain room and board expenses, but not including elementary or secondary school expenses. 

Employer‑Provided Assistance 

            You can continue to exclude up to $5,250 per year of educational assistance from your employer until June 1, 2000. 

Forgiven Educational Loans 

            A student who borrows from a tax‑exempt charitable organization to pay educational expenses is now eligible to exclude forgiven loan amounts from income if the forgiveness is in exchange for the student working in an area that fulfills an unmet public service need. 

PAYING YOUR TAXES

Child Care Credit 

            Beginning in 1998, a credit against federal income taxes is allowed for each child under the age of 17 whom you can claim as an exemption and who is your son or daughter, a descendant of your son or daughter, your stepchild, or your foster child. The credit is $400 for 1998 and $500 thereafter. The credit is phased out if your income exceeds $75,000 for a single person and $110,000 for married persons filing a joint return. 

Increase for the Standard Deduction for Dependents 

            The standard deduction for a dependent has been increased slightly for 1998 and thereafter. 

Payment by Credit Card 

            After the Internal Revenue Service has formulated the rules, you may pay your income taxes with a credit card, debit card, or charge card. This new payment method may lighten the taxpayer's burden.
 

BUSINESS CHANGES 

Deduction for Health Insurance Costs for Self‑Employed Persons 

            Currently, if you are self‑employed, you may deduct 40 percent of your health insurance costs on your tax return. Gradually, this percentage will increase to 100 percent by 2007. 

Income Averaging for Farmers 

            If you are engaged in the business of fanning, the new law allows you to elect for tax years after 1997 and before 2001 to average your farm income over a three-year period. Farm income includes gain from the sale of property other than land used in the farming business for a substantial period of time. 

CONCLUSION 

Most of you will benefit from the TRA. It contains many provisions that will help you reduce your federal income taxes in the future. However, unless you are your own tax expert, you will probably need professional assistance to properly comply with the new provisions. As in all financial planning, it is important that your do your tax planning early for 1997, 1998, and thereafter. Have a pleasant adventure. 

Sources:

1997 Tax Legislation Highlights, CCH Incorporated, 1997. 

Summary of TAXPAYER RELIEF ACT OF 1997, West Publishing, 1997.