INTRODUCTION

   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. Many of the new provisions are phased out at differing income levels.

   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-employeds.

   This page is intended 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.  Filetax has a new tax tip each week, bookmark the page and come back again. Return to Index

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. Return to Index

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 more than 18 months. Depreciated real property is subject to special recapture provisions.

   Assets purchased in 2001 and later and held for more than five years will be taxed at an 8% rate for lowest bracket taxpayers and at 18% for the higher bracket taxpayers. To utilize the 18% and 8% rates on capital gains on property held more than five years, you can elect to treat certain property held prior to January 1, 2001 as having been sold and repurchased. You would be required to pay taxes on any gain. Losses are not deductible. Return to Index

HOME SALES

   The law exempts from taxation profits on the sale of a personal residence of up to $500,000 for married couples filing jointly and $250,000 for singles. To qualify, sellers must have owned and used the home as their principal residence for at least two of the last five years before the sale. Effective for sales after May 6, 1997, this new provision replaces the prior rollover provision on home sales and the $125,000 exclusion of gain for those 55 and over. There was no change in the rule that prohibits taxpayers from deducting losses on home sales.

   This new $500,000 ($250,000 for singles) exclusion will not benefit those whose profit exceeds the limit. Compare these two cases:

1. Fred and Zelda are in the 31% tax bracket. They sold their primary residence for a profit of $300,000. Since the profit was less than $500,000, they pay no tax on the home sale.
2. Bob and Judy are also in the 31% tax bracket. They sold their primary residence for a profit of $600,000. They owe $20,000 in capital gains tax ($600,000 - $500,000 exclusion x 20%).

EDUCATION SAVINGS

   Two new tax credits will be available for higher education expenses. The HOPE tax credit gives up to $1,500 of credit for each of the first two years of college (100% of the first $1,000 in expenses and 50% of the next $1,000). "Lifetime learning credits" are available for expenses paid after June 30, 1998. The maximum credit is $1,000 through 2002, and then the maximum increases to $2,000. Both the HOPE credit and the lifetime learning credit phase out for higher income taxpayers.

   Interest paid on qualified education loans will be deductible even by those who don't itemize deductions on their tax returns, beginning in 1998. The maximum deduction allowed will be phased in over four years as follows:
      1998      $1,000
      1999      $1,500
      2000      $2,000
      2001      $2,500

   The maximum deduction is phased out for individuals with "modified" Adjusted Gross Income of $40,000 to $55,000 ($60,000 to $75,000 for joint filers). Income levels will be indexed for inflation after 2002.

   Starting next year, taxpayers will be allowed to contribute annually up to $500 to an education IRA for each child under 18. The contributions are nondeductible, but withdrawals are tax-free if used to pay qualified higher education expenses. The annual contribution limit is phased out for married filers once income reaches $150,000 ($95,000 for single filers). Return to Index

RETIREMENT ACCOUNTS

   Under prior law, couples with company pension plans could only make the full $2,000 IRA deductible contribution if their income was $40,000 or less ($25,000 or less for singles). Beginning next year, these limits increase to $50,000 for marrieds and $30,000 for singles. These amounts gradually increase until they reach $80,000 for marrieds (2007) and $50,000 for singles (2005).

   An individual is no longer considered to be an active participant in an employer-sponsored retirement plan merely because the individual's spouse is an active participant. Starting in 1998, a non-working spouse can make a tax deductible IRA contribution even if his or her spouse is covered by a plan. This provision is phased out for couples with Adjusted Gross Income between $150,000 and $160,000.

   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. The maximum contribution allowed to a Roth IRA is phased out for individuals with Adjusted Gross Income between $95,000 and $110,000 ($150,000 and $160,000 for joint filers). 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.

   Taxpayers with Adjusted Gross Income of less than $100,000 are eligible to rollover or convert a regular IRA to a Roth IRA. Amounts that would have been includable in income had the amounts converted been withdrawn are includable in income ratably over four years. The 10% tax on early withdrawals does not apply.

   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.) Also repealed is the 15% estate tax on excess retirement accumulations. Return to Index

ESTATE TAX CHANGES

   The current $600,000 estate tax exemption will increase gradually to $1 million by the year 2006. The increases are as follows:

      1998      $625,000
      1999      $650,000
      2000      $675,000
      2001      $675,000
      2002      $700,000
      2003      $700,000
      2004      $850,000
      2005      $950,000
      2006      $1,000,000

   Family farms and small businesses may qualify for an exemption of $1.3 million, effective in 1998.

   Starting in 1999, the $10,000 annual gift tax exclusion (and several other estate and gift tax provisions) will be indexed for inflation. Return to Index

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. Return to Index

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 (with some minor changes).
• 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 conforms 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. The percentage deductible changes are as follows:

      1997      40%
      1998      45%
      1999      45%
      2000      50%
      2001      50%
      2002      60%
      2003      80%
      2004      80%
      2005      80%
      2006      90%
      2007     100%

_ 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.  If you have changed tax preparers since your loss happened, you should check your carryforward amounts.

_ The law also contains numerous minor changes that will affect some businesses.  Our free newsletter will cover more of the new tax law and how it effects your business and family. Return to Index

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 in person or by phone 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. Return to Index for Taxpaer Relief Act

This material is provided for general and educational purposes only, and is not intended to provide legal, tax or investment advice. Individuals who wish to invest in retirement plans should contact their tax and financial advisors regarding their specific legal or tax situation.