Dear
Clients and Friends,
On
August 5, 1997, President Clinton signed the Balanced
Budget Act of 1997 and the Taxpayer Relief Act of 1997
into law. Heralded by the politicians in Washington as landmark
legislation, these two laws are supposed to balance the federal
budget by 2002 and cut taxes by about $95 billion over a five-year
period. If a balanced budget is achieved, it will be the first
time since 1969. The new legislation cuts federal spending by
about $260 billion over five years, with $115 billion of that
coming from lower Medicare reimbursement to hospitals and doctors.
The
tax law makes more than 800 changes to the already massive tax
code, changes that affect nearly everyone. The effective dates
for the changes vary. Some provisions are retroactive, some
take effect immediately, and many go into effect in 1998 or
later.
Individuals
will get a variety of new tax breaks. The law provides a tax
credit for children under 17, creates college tuition tax credits
and education IRAs, and allows penalty-free withdrawals from
individual retirement accounts for qualified education expenses
and first home purchases. Capital gains taxes are cut, and the
rules for taxing home sales are completely revised. Fewer estates
will be subject to taxes, and special estate tax breaks are
provided for qualifying small businesses and family farms.
Businesses
will see many changes, too, including a revision of the rules
governing home-office deductions, an exemption from the alternative
minimum tax for qualifying small businesses, and an increase
in the health insurance deduction for self-employed.
This
memo is being sent to give you general information on the major
provisions in the new law. Please take a few minutes to read
these pages; then if you have questions about how the new law
will affect you, or if you wish to review your tax planning
in light of the new law, please contact our office.
CHILD
TAX CREDIT
Beginning
in 1998, there will be a $400 tax credit for each child under
age 17. The credit will increase to $500 per child in 1999.
The credit is phased out at higher income levels beginning at
$75,000 for singles and $110,000 for couples.
CAPITAL
GAINS TAX RATES
The
top capital gains tax rate, which had been 28%, is lowered to
20%. People in the 15% income tax bracket will pay 10% on capital
gains. The new rates apply to investments held for more than
a year and sold after May 6, 1997, and before July 29, 1997.
For assets sold July 29th or later, the lower rate will apply
only if the assets have been held 18 months or longer. Assets
purchased in 2001 and later and held for at least five years
will be taxed at an 8% rate for lowest bracket taxpayers and
at 18% for the higher bracket taxpayers. Depreciated real property
is subject to special recapture gradually increase until they
reach $80,000 for married (2007) and $50,000 for singles (2005).
The
new law allows penalty-free IRA withdrawals of up to $10,000
for the purchase of a first home and penalty-free withdrawals
with no dollar limit if the money is used to pay for qualified
higher education expenses.
The
tax law creates a new type of individual retirement account
called a Roth IRA (also called IRA Plus), which allows nondeductible
contributions of up to $2,000 a year. Earnings within the account
accumulate tax-free, and withdrawals are tax-free after five
years if the money is used for retirement (that is, the distribution
occurs after age 59-1/2) or for a first-time home purchase ($10,000
lifetime limit). The distribution can also be tax-free if attributable
to the disability or death of the individual. No more than $2,000
per year may be contributed to the combined IRAs of an individual.
The law eliminates the 15% excise tax on large distributions
from 401(k) or other pension plans. (This tax had been under
a three-year moratorium scheduled to expire at the end of 1999.)
ESTATE
TAX CHANGES
The
current $600,000 estate tax exemption will increase gradually
to $1 million by the year 2006. Family farms and small businesses
may qualify for an exemption of $1.3 million, effective next
year. Starting in 1999, the $10,000 annual gift tax exclusion
(and several other estate and gift tax provisions) will be indexed
for inflation.
MISCELLANEOUS
Numerous
miscellaneous provisions are included in the tax law. Among
them: a change in the airline ticket tax, an increase from 12¢
to 14¢ for the charitable mileage deduction, changes in some
foreign tax provisions, a 15¢ a pack hike in cigarette taxes,
some changes in the estimated tax rules, a tightening of eligibility
for the earned income credit, and some excise tax changes.
BUSINESS
PROVISIONS
The
law extends certain expiring tax provisions:
*
The research credit is extended from June 1, 1997, through June
30, 1998.
*
The work opportunity tax credit is extended through June 30,
1998.
*
The orphan drug credit is permanently extended for expenses
after May 31, 1997.
*
The income exclusion for employer-provided education assistance
is extended through May 31, 2000.
The
corporate alternative minimum tax for small businesses (those
with average gross receipts of less than $5 million) is repealed.
Also, the law con-forms the depreciable lives of property placed
in service after 1998 for calculations of the alternative minimum
tax with the regular tax calculation.
The
deduction for health insurance of self-employed individuals
increases gradually until it reaches a full 100% in the year
2007.
Businesses
that are required to deposit federal taxes electronically will
have until July 1, 1998, before any penalties for failure to
do so will be imposed.
Taxpayers
who work at home may be able to claim a deduction for home-office
expenses more easily than under prior law. The definition of
"principal place of business" is expanded to include
a home office used regularly and exclusively "to conduct
administrative or management activities of the business where
there is no other fixed location to conduct these activities."
This provision becomes effective in 1999.
Generally,
business net operating loss carryback periods are reduced from
three to two years and carryforward periods are increased from
15 to 20 years.
The
law also contains numerous minor changes that will affect some
businesses.
PLANNING
IS ESSENTIAL
Tax
planning becomes more challenging with every new piece of tax
legislation. The 1997 tax law is, to quote the generally accepted
observation of one analyst, "mind-numbing in its complexity."
The law introduces a lot of complexity even for the average
taxpayer because it offers such a variety of new and often bewildering
options in many areas. And it will require careful recordkeeping
by those who wish to enjoy its tax-cutting provisions.
To
take advantage of what the new law offers, you may need to decide
whether to put your retirement savings in a regular IRA or a
new Roth IRA. Since the tax consequences of selling capital
assets have changed, you’ll need to consider new rules
when you sell your mutual fund shares, stocks, other investments,
and even your home. Saving for college and paying college expenses
now provide tax breaks, but finding the best option for you
will take some analysis. Certainly, wills and estate plans,
especially where farms or small businesses are involved, must
be reviewed and updated to take advantage of the new law.
We
want you to get the best tax treatment possible under this new
legislation, and we are ready to assist you in making wise tax
and financial choices. Please call for details on any provision
in the tax law that concerns you or to make an appointment for
a more general review of your tax situation. And please watch
for additional tax-saving information from us in the upcoming
months as we continue to digest and analyze this latest tax
law.
Sincerely,
Scott
Gottlieb, CPA
.
