Congress and the President have made their mark on history by passing the largest piece of tax legislation since 1986. Many of the provisions will affect you personally, either now or in the years to come. Here are some of the changes as well as prior law changes that take effect now. How will the Taxpayer Relief Act of 1997 affect you? The new act contains extensive changes that will have an immediate impact. Here are some highlights of the bill:
Child Tax Credit - This nonrefundable credit begins in 1998 at $400 per qualifying child and increases to $500 for 1999 and later years. In most cases you need to have a tax liability to benefit from the credit. The credit phases out beginning with modified AGI (adjusted gross income) levels of $75,000 ($110,000 for Married Filing Joint or $55,000 for Married Filing Separate). The credit is reduced by $50 for every $1,000 of income over the threshold amount. For individuals filing jointly, that threshold amount is $110,000.
Special provisions apply to taxpayers with 3 or more qualifying children. If you have three or more children, you may qualify for an additional credit that is refundable, meaning you could get more money back than you paid in.
A qualifying child is an individual:
Roth IRAs - A new Roth-IRA begins in 1998. Contributions are nondeductible and qualifying distributions are nontaxable. Contributions must remain in the fund for at least 5 years. This new type of IRA allows you to put nondeductible contributions into an account to grow tax-free. This probably doesn’t sound like anything new; however, the difference is you can take this money out tax-free as long as you meet the guidelines. You may even be able to roll your current IRA into the Roth IRA. The benefit of the Roth IRA is you’re trading the tax deduction today for the free withdrawal tomorrow. The Roth IRA has a phase-out limit beginning at $150,000 for the married taxpayer filing jointly.
Regular IRA - The regular IRA still exists. You are allowed to have a higher income and still make a deductible IRA contribution beginning in 1998. The phase-out begins at $50,000 for the married taxpayer. In addition, if your spouse is covered under a qualified pension plan but you’re not, you may still be allowed to make deductible IRA contributions. The phase-out will begin at $150,000 for this purpose.
Beginning in 1997, both you and your spouse can make contributions of $2,000 to an IRA even if only one of you is employed.
Withdrawals from Retirement Plans for First Time Home Buyers - First-time home buyers can take distributions from their retirement plans without paying the extra 10% penalty for early withdrawals. The definition of a first-time homebuyer is extremely liberal, someone who has not owned a home in the last two years.
The distributions must be used to acquire, construct, or reconstruct a principal residence of the taxpayer, taxpayer's spouse, or any child, grandchild, or ancestor of the taxpayer or taxpayer's spouse.
When you’re a first-time homebuyer you may want to tap into your IRA account to help with the financing. The Taxpayer Relief Act of 1997 makes it possible to withdraw up to $10,000 over your lifetime without paying the 10% penalty, for withdrawals made after December 31, 1997. However, you will still be taxed on the withdrawal amount.
Capital Gains Tax Rate Maze - There is good news for the investor--capital gain rates have decreased. Unfortunately, it’s not that simple. The old maximum rate of 28% on property held long term has blossomed into four new rates. Long-term capital gains (gains on assets held over 18 months) will not be taxed at a rate higher than 20% for transactions after May 6, 1997. Mid-term property sold after July 28, 1997, and held more than 1 year but not more than 18 months, will be taxed at a maximum 28% rate. To further complicate matters, the rates depend on when you sold the property in 1997. In general, the maximum rate for property held more than 18 months is 20%. However, you don’t have to be in the 28% tax bracket to benefit. The maximum rate for a person in the 15% tax bracket, without considering capital gain income, is 10%.
Sale of Principal Residence - Up to $250,000 of gain from the sale of a principal residence can be excluded for sales after May 6, 1997 if the taxpayer has owned and lived in the property for 2 years of the previous 5 years. This is increased to $500,000 if the taxpayer is married filing a joint return (MFJ) and both the taxpayer and spouse meet the use test.
Fewer people will be paying taxes on the sale of their home. Gain, up to $250,000, can be excluded if you have owned and occupied your home for two out of the last five years. If you’re married filing a joint return that amount may be $500,000. You no longer have to wait until age 55 for the exclusion and you can even use the exclusion more than once in your lifetime. In fact, you can use the exclusion every two years. This exclusion is available to you if you sold your home anytime after May 6, 1997.
Earned Income Credit - Beginning with 1997 returns, taxpayers will not be eligible for the earned income credit (EIC) if they have previously claimed EIC fraudulently or recklessly.
Do you ever wonder why some people get bigger refunds than you? Some of these large refunds may be due to the Earned Income Credit (EIC). This credit allows you to get a refund even if you haven’t paid anything in during the year. The amount of the credit is based on the size of income and the number of children you have. In one respect, it’s "free money". This "free money" is so attractive that some people have been known to fabricate circumstances in order to qualify. The new tax law is attempting to protect our rights as citizens. Those who are caught fraudulently or erroneously claiming EIC will not be eligible for the benefits in the coming years, even if they meet the qualifications. These people will be prohibited from collecting EIC for two or ten years depending on the seriousness of the offense.
Estate and Gift Tax Credit - There are two things in life that we can be sure of, death and taxes. But a good thing to avoid is paying taxes at death. This can be done with proper planning. Throughout your lifetime you work hard to accumulate wealth to pass on to your heirs. With proper planning, you can minimize the amount that the IRS will keep. The Taxpayer Relief Act of 1997 made that task a little easier. Beginning in 1998, a tax credit based on the first $625,000 of value will replace the current credit based on $600,000. By the year 2006, estates will be able to accumulate $1,000,000 without incurring estate tax. Estates with eligible family owned businesses will be able to exclude $1,300,000 if death occurs after December 31, 1997.
Education Wins - Education came away a winner in this year’s tax law changes. Two education credits were born, the employer assistance program was renewed, interest on student loans became deductible, the Educational IRA was founded, and penalty free withdrawals from an IRA are now available to pay for educational expenses. Each program has its own timetable and set of rules. These programs work hand in hand so that there is no double dipping.
The HOPE Scholarship Credit - This credit provides a maximum credit of $1,500 per student for the first two years of post-secondary education. This maximum per student is available if you have qualifying expenses for that student of $2,000 or more. Qualified educational expenses include tuition and fees required for enrollment. Books, meals and lodging, transportation, and athletic and activity fees are not qualified educational expenses. The student must be enrolled at least 1/2 time at an institution of higher learning to take this credit. This credit is available for expenses paid and classes taken after December 31, 1997.
The Lifetime Learning Credit - This credit provides a credit of 20% of the first $5,000 of educational expenses. This credit is available per taxpayer, not per student. You can take a credit for qualified expenses paid during the year for yourself, your spouse, and any of your dependents. The qualified educational expenses are the same as the expenses listed above for the HOPE Scholarship Credit. You may use this credit to obtain or enhance job skills rather than specifically to obtain a degree. This credit is available for expenses paid or classes taken after June 30, 1998.
You can claim the HOPE Scholarship Credit or the Lifetime Learning Credit for yourself, your spouse, or your dependent child. However, you will have to decide which credit is most beneficial for you since you may only claim one credit per year.
Interest on Education Loans - Beginning in 1998, interest paid on education loans will be deductible, subject to limitations ($1,000 in 1998). A phase-out begins at modified AGI of $40,000 ($60,000 MFJ). You don’t even have to be in school to benefit from this educational endorsement. The interest required to be paid during the first 60 months of the student loan repayment period will be deductible beginning in 1998. The good news is that you can benefit without having to itemize. You can deduct a maximum of $1,000 of interest paid if your income is less than $40,000 ($60,000 for joint filers). The deduction will increase each year until it reaches $2,500 in the year 2001.
Withdrawals from IRAs for Education - To the extent of qualifying higher education expenses, IRA withdrawals will avoid the 10% penalty beginning with distributions received in 1998. Expenses used to qualify for the scholarship exclusions cannot be used to qualify for the IRA penalty exclusion.
Employer-Provided Educational Assistance - Reinstated through May 31, 2000. Congress has once again renewed the employer provided educational assistance program. As an employee, you are allowed to exclude up to $5,250 from your wages when the money is used to pay for undergraduate education. The classes do not have to be job related to qualify. This program is effective January 1, 1997, and is scheduled to terminate June 1, 2000.
Education IRAs - Taxpayers can now establish a special education IRA account for each child, grandchild, or other your person under the age of 18 to invest funds for his/her future education expenses. Taxpayers can contribute up to $500 per year for each designated child beneficiary. (A phase-out begins at modified AGI of $95,000 or $150,000-MFJ. If the taxpayer is not eligible, some else may make the contribution on his/her behalf.).
The contributions are not tax deductible, but the withdrawals will be tax-free as long as they are used for educational expenses. No contributions can be made after the beneficiary has reached age 18.
Interest or other earnings accumulated in an Education IRA grows free of taxes. This is an excellent way to save for education expenses.
Distributions from an Education IRA are excluded from gross income if the funds are used for qualified higher education expenses. These include tuition, fees, books, supplies and equipment for the attendance of the student in an eligible educational institution, as well as the minimum room and board allowance determined by the institution. These expenses relate to both undergraduate and graduate level courses of the designated child beneficiary.
All funds in the Education IRA must be distributed before the child beneficiary turns age 30. If funds are withdrawn for non-education purposes a 10% penalty, as well as ordinary income taxes, will be assessed on the earnings portion of the distribution. The account can, however, be transferred tax-free to an Education IRA benefiting another family member (assumed to be a sibling).
Some other changes - - Here are some other changes that go into effect based on prior law or rules changes:
Dependent's Standard Deduction - This is changed to the greater of $500 (indexed) or the dependent's earned income plus $250, beginning with 1998 returns.
Standard Mileage Rate - Each year the standard mileage rate for business travel, medical travel, and moving is reevaluated. The business standard mileage rate for 1998 is 32.5 cents per mile while the moving and medical mileage rate is 10 cents per mile.
Charitable Mileage Rate - Taxpayers can use 14 cents per mile for charitable mileage beginning in 1998.
Office in Home Expenses - Beginning in 1998, an office-in-home can qualify as a "principal place of business" if used for administration and management purposes, is used exclusively and regularly as a place of business and there is no other fixed location where the taxpayer conducts substantial administration or management activities. This restores the offic-in-home deduction for many taxpayers who were not able to utilize it over the last several years following the "Solomon decision". The restoration of the office-in-home deduction alo allows qualifying taxpayers to deduct mileage from their office-in-home to their first stop and from their last stop to home and not count it as commuting mileage.
Health Insurance for Self-employed Individuals - The rate increases over the next few years until it reaches 100% in 2007.
Meal Expense Deductions - Taxpayers in the transportation industry (those subject to federal hours of service) will be able to deduct a larger percentage of their business meals beginning in 1998. The deductible percentage for meals in 1998 will be 55%, gradually rising until it returns to 80% in 2008. The per diem meal allowance for all taxpayers was increased to $36 per day for tax year 1997.
Underpayment Penalty - If you owe the government too much money, it not only costs you the tax, but also an underpayment penalty. Under the current law, owing the government $500 or more meant an underpayment penalty was due unless you had 90% of the current year’s tax already paid in, or 100% of last year’s taxes paid. Beginning in 1998 the penalty will not be assessed until you owe $1,000.
Pay Your Tax with a Credit Card - The Taxpayer Relief Act of 1997 has made it easier for you to pay your tax bill by allowing you to use a credit card. Regulations will be written to work out all of the bugs. The earliest date this option will be available is May 5, 1998, contingent upon the writing of the regulations.
Quick Facts
Fact 1 - The personal exemption for 1997 is $2,650. The phase-out of personal exemptions begins at $121,200.
Fact 2 - The sale of collectibles (stamps, coins, etc.) does not qualify for the new lower capital gains rate.
Fact 3 - Charitable contributions made before the end of the year may increase your itemized deductions for the year.
Fact 4 - Social Security numbers are required for all dependents regardless of age.
Fact 5 - When you buy a new vehicle, consider using a home equity loan to fund the purchase in order to make the interest deductible.
Fact 6 - Maximizing your 401(k) contribution lowers your taxable income and saves money for retirement.
This is not a comprehensive list of tax changes, only the provisions which are applicable to most taxpayers. Check our homepage for links to other sites with more details.
For more information, eMail: taxinfo@electrofile.com