Maximizing New Personal Tax Opportunities
The Taxpayer Relief Act of 1997 (the "Act") provides new tax opportunities which may affect both your personal and business taxes. The Act contains several tax benefits which affect individuals by providing investment and savings initiatives, as well as provisions impacting education and training. The following is meant only to be a summary of some of the new provisions. Because of the complexity of the new tax law, we recommend you seek professional guidance in order to maximize the opportunities available to you.
Capital Gains.
Taxpayers in all tax brackets were given relief from the capital gains tax. For all investors except for those in the 15% tax bracket, the maximum tax rate on net capital gain is generally lowered to 20%, if the asset has been held for more than 18 months. For those in the 15% tax bracket, the rate is lowered to 10%. For taxable years beginning after December 31, 2000, the maximum capital gains rates for assets purchased on or after January 1, 2001, and held more than 5 years, are 18% and 8% instead of 20% and 10%.
One exception to the new rates is for investments in collectibles. Under the Act, net capital gains attributable to collectibles are still taxed at a maximum rate of 28%. Special rules also apply for depreciable real property.
Child Tax Credit.
A $500 credit ($400 for taxable year 1998) is available for each qualifying child of a taxpayer under the age of 17. The credit is phased out for married taxpayers filing joint returns with modified adjusted gross income of $110,000, and $75,000 for single taxpayers filing under head of household status.
Sale of Home.
Capital gains earned on the sale of your principal residence may now be excluded if certain conditions are met. For sales made after May 6, 1997, a taxpayer who owns the property and used it as the principal residence for at least 2 of the 5 years prior to the sale may exclude a gain up to $250,000. A married couple filing a joint return may exclude up to $500,000 of the gain as long as one spouse owns the residence and both of them meet the use requirement.
College Expenses Tax Credit.
During the first two years of a student's post-secondary education, a tax credit is available against federal income taxes for qualified tuition and fees paid for the taxpayer, the taxpayer's spouse, or a dependent. The credit equals 100% of the first $1000 of qualified tuition and fees, and 50% of the next $1000 of qualified amounts. The credit is computed on a per-student basis and it is phased out based upon the taxpayer's adjusted gross income. The credit is reduced for individuals with modified adjusted gross income between $40,000 and $50,000 and between $80,000 and $100,000 for taxpayers filing joint returns. These amounts are to be adjusted for inflation after 2001. Convicted drug offenders cannot claim the credit.
In addition to the tax credit, taxpayers may make penalty-free withdrawals from the taxpayer's IRAs if the withdrawal is made for the purpose of paying educational expenses of the taxpayer or the taxpayer's dependents.
Student Loan Interest Deduction.
Taxpayers who pay interest on qualified higher education loans taken for themselves, their spouses, or any dependent at the time the debt was incurred are entitled to deduct interest paid during the first 60 months interest payments are required. The maximum deduction increases from $1,000 in 1998 to a maximum of $2,500 beginning in 2001. The deductions are phased out for taxpayers whose incomes exceed certain levels.
Deductible IRAs.
The income ranges over which the $2,000 IRA deduction limit is phased out is increased for individuals who are active participants in an employer-sponsored retirement plan. The new phaseout ranges are increased from $30,000-$40,000 of adjusted gross income for single taxpayers in 1998, to $50,000-$60,000 beginning in 2005. For married couples filing joint returns, the phaseout ranges are increased from $50,000- $60,000 in 1998, to $80,000-$100,000, beginning in 2007.
Starting in 1998, the Act also permits spouses of individuals who are active participants in an employer-sponsored retirement plan to make a deductible IRA contribution as long as the couple's combined adjusted gross income is less than $150,000. The deductible amount is phased out from $150,000 to $160,000.
Nondeductible IRAs.
Beginning in 1998, the "Roth IRA" will be available to individuals with adjusted gross income of up to $95,000, phasing out at $110,000, and to married couples filing joint returns with adjusted gross income of up to $150,000, phasing out at $160,000. Contributions to a Roth IRA are not deductible; however, under certain conditions, tax-free distributions can be made 5 years after the IRA has been established. For example, distributions may be made after the individual reaches the age of 59 1/2 or for first-time homebuyer expenses up to $10,000. The maximum annual contribution to a Roth IRA is the lesser of $2,000 or the individual's compensation. The amount is further limited by any contributions made to other IRAs maintained for the benefit of the individual. An individual may continue to contribute to a Roth IRA even after reaching the age of 70 1/2.
Lifetime Learning Credit.
The Act also creates a Lifetime Learning Credit for expenses paid after June 30, 1998, to an eligible educational institution on behalf of the taxpayer, the taxpayer's spouse, and any dependent. The Lifetime Learning Credit is determined on a per taxpayer return basis and is equal to 20% of expenses up to a maximum credit of $1,000 for expenses paid before 2003 and a maximum credit of $2000 after 2002. The same phase out income range applies to the Lifetime Learning Credit as to the College Expenses Tax Credit.
Alternative Minimum Tax for Children Under Age 14.
Beginning in 1998, the Alternative Minimum Tax exemption amount for a child under the age of 14 who has unearned income is increased to the lesser of $33,750 or the sum of the child's earned income plus $5,000.
Payment by Credit Card.
The new Act permits payment to be made by "commercially acceptable means" which includes payment by credit cards.
Increase in Estate Tax Credit.
The Act provides for annual increases in the gift and estate tax unified credit beginning in 1998. The amount that is free from federal gift and estate tax in 1998 is increased to $625,000 and is increased annually until 2006 when the first $1 million of transferred property will be tax-exempt.
Small Business Estate Tax Exclusion.
The Act excludes from the federal estate tax up to $675,000 of the value of the decedent's interest in a family owned business that passes to the decedent's family members. The exclusion amount is reduced as the estate tax credit increases so by 2006, the maximum small business exclusion is $300,000.
Gift Tax Exclusion Indexed for Inflation.
Under current law, a donor can give up to $10,000 per person each calendar year without using any of the donor's federal gift tax credit. After 1997, the exclusion amount is indexed for inflation.
Taxpayer Rights.
The Act increased the odds that a taxpayer who disagrees with an IRS assessment can prevail by changing several provisions relating to the appeal of inaccurate or unfair assessments. The Act also provided a broader spectrum of situations where penalties would be waived.
The Taxpayer Relief Act of 1997 is a massive piece of legislation. This summary has highlighted only some of the provisions which will impact individual taxpayers. Please call us if you have any questions about your particular situation or if you need help to fully assess how the Act may affect your personal and business taxes. §
