TAX NEWS
	WINTER 1996

CHANGE IS GOOD….

Tax Law Changes May Impact 1996 and Earlier Returns

HIGHLIGHTS OF NEW TAX LAWS

Well, after a significant period of inactivity Congress and the President reached an agreement in August and the net result was a series of four "new" laws which have produced a number of changes in the existing federal tax laws. While 95% of the "new" laws use January 1, 1997 as the effective date there are several measures that have "retroactive" effect. The purpose of this report is not to overwhelm anyone but rather to educate you on the fact that there have been some changes which may benefit you. Be sure to consult your tax professional on such topics as:

	Employer provided educational assistance ($5250) (12/13/94)
	Money damage awards (8/20/96)
	Taxation of pensions paid to non-residents by states in which pensions were earned (1/1/96)
	Expansion of home-office deduction to include storage of product samples (1/1/96)
	Work opportunity tax credit (10/1/96)
	Research and experimentation credit (7/1/96)

In some cases it may be in your best interest to consider filing amended returns. Your tax professional will consider the benefits in filing such a return. Your professional is in the best position to consider the pros and cons of filing an amended return which generally speaking would be due within 3 years from when you filed your original return.

One item of special note here is that now, as part of the Small Business Job Protection Act, up to $5,250 in employer-sponsored education benefits are once again tax-free. The good news is that the new law is retroactive to January 1, 1995…the bad news is that graduate-level courses hat began after June 30, 1996, are not included. Since the tax exclusion is extended retroactively, any employee who had taxes withheld last year on employer-sponsored education benefits, including graduate-level courses, is eligible for a refund. For workers in the top tax bracket of 39.6%, this can translate into a $2,100 windfall for each year of school. Even taxpayers who fall into the 28% bracket are eligible for a potential refund of $1,800 for taxes paid in 1995.

"A BENEFIT OR A HEADACHE"

If your employer withheld taxes on these (employer-sponsored education) benefits in 1995, you will need to file an amended tax return on Form 1040X to obtain a refund. To recalculate your tax your tax professional needs to obtain a revised W-2 (or W-2c) form from your employer. For some taxpayers with more than $100,000 in adjusted gross income your tax professional may need to recalculate your allowable itemized deductions since less income impacts on other calculations as well. In addition to income taxes, your employer likely withheld Social Security. Your employer will receive a refund and this should be passed on to you. Check with your employee benefits department if this issue concerns you. Fortunately, the IRS in working with your tax professional has provided an expedited service to process the amended returns. Your tax professional has been advised toe write "IRC Section 127" on the top of your amended return. By the way this wonderful-retroactive tax break is scheduled to expire on May 31, 1997.

1997 TAX CHANGES ARE SIGNIFICANT IRA REFORM

The most exciting news concerns the tax changes which will take effect in 1997. It is never too early to plan for 1997 tax year savings. Effective January 1, 1997, there will be an increase to $2,000 for a deductible IRA contribution for a non-working spouse. Since some taxpayers will be making their 1996 IRA contributions in 1997 it is very important that your mark your payments for the appropriate tax year. Under the current law the maximum contribution for the non-working spouse was $250 (1996 contribution). Consult your tax professional with any questions that you have.

Adoption Credits/Expenses

Congress and the President have approved some long awaited relief in the area of adoption credits. Effective on January 1, 1997 there is a credit of up to $5,000 per child for certain approved expenses in connection with the adoption of a domestic or foreign child. The credit goes up to $6,000 for "special needs children". The credits are per child and not per year. Unused credits can be carried forward for up to 5 years.

In addition to the "new" adoption credit there is an exclusion available for up to $5,000 of adoption expenses paid by an employer under a nondiscriminatory employer adoption assistance program. The exclusion is up to $6,000 for "special needs adoptees". Both the tax credit and the income exclusion phase out ratably between $75,000 and $115,000 of Adjusted Gross Income (AGI).

Luxury Tax

Congress and the President were able to reach an agreement which produced some long needed changes to the luxury tax and the deductibility of health insurance for the self-employed. The good news is that the luxury tax will be phased out…the bad news is that the total elimination of the tax will take time…the schedule is as follows:

The luxury tax will expire after December 31, 2002.

Self-Employed…Health Insurance Premiums

Similar to the changes to the luxury tax, Congress has increased the deductible percent of health insurance payments for the self-employed taxpayer. During 1996 the rate was 30% (above the line). The rate will go up as follows:

Maximum Amount Expensed Annually

Under the "new" law the maximum amount that can be expensed annually for post-1996 tax years is increased from the $17,5000 amount in effect for 1996.

Taxpayer Bill of Rights 2

Many taxpayers will come to appreciate one particular piece of legislation. After listening to significant criticism over just how the "tax system" operates, Congress passed what is now referred to as the Taxpayer Bill of Rights 2. This measure contains over 40 changes to the manner in which you and your tax professional will deal with the IRS. Most of the changes are pro-taxpayer so this is relief that was long overdue. One word of advice - always contact your tax professional when you've receive "any" communication from the IRS. Taxpayers have established rights and all too often those rights are lost if you do not act timely. Your tax professional is trained to work on your behalf to bring about the best possible result for you. As a professional your tax advisor is your advocate working through a complicated tax system on your behalf.

Medical Savings Accounts to be Tested: Are You Eligible?

Under the recently enacted health insurance bill, more than 1 million taxpayers may soon become part of an experimental class to test the controversial concept of medical savings accounts (MSAs). Under the new law (January 1, 1997 effective date) a limited number of self-employed individuals and those who are covered only by a high-deductible or catastrophic plan of a small employer may be able to maintain MSAs during the "pilot" project which starts with the 1997 tax year. The pilot project ends in he year 2000. The law defines a "small" employer as one which has no more than 50 employees during either the preceding or the second preceding year. MSAs are private, tax-favored accounts used to pay for routine medical expenses and are coupled with catastrophic policies to cover serious illnesses. Beginning in 1997, MSAs will be available for people who work for companies with 50 or fewer employees, and for people who are self-employed or don’t have insurance. It has been estimated that over 30 insurance companies will be marketing these plans in 1997. The number of policies will be limited to roughly 750,000 in any one year. The total number of participants is expected to reach 1.5 million (including family coverage).

MSAs….The Tax Advantages

Both employers and employees may make tax-deductible contributions to the account…but not in the same year. The contributions will be limited. People with individual policies will be permitted to contribute 65% of the amount of the deductible, while people with family policies will be permitted to contribute 75% of the deductible. The pilot project will set limits on the total out-of-pocket expenses, which include co-payments and deductibles, that a person could face in a given year. The maximum is $3,000 for individuals and $5,500 for families. The "limits" only apply to items covered by the plan.

Earnings on the money in the account aren’t taxed and neither is the money withdrawn to pay medical bills. Withdrawals for nonmedical bills are taxed and they are hit with a 15% penalty for taxpayers under age 65. For taxpayers over 65, withdrawals for nonmedical expenses are taxed but not penalized.

So, what happens after year 2000? Obviously, Congress will have an opportunity to evaluate the "pilot" project and may vote to retain, expand or terminate the program. If Congress decides not to expand the program, those with existing accounts will be permitted to keep them and contribute to them indefinitely.

Postponing Retirement Distributions

The recently enacted Small Business Job Protection Act granted a 3 year reprieve from the 15% penalty tax on excess distributions from qualified retirement plans and IRAs. Unfortunately, the tax still applies to 1996 distributions. You may be able to avoid it by limiting your combined 1996 distributions to no more than $155,000 (or no more than $775,000 for lump sums). But beware, the higher threshold for lump sums doesn’t apply to IRA pay outs.

Starting in 1997 (and 1998 and 1999), you can take unlimited distributions and be completely exempt from the 15% penalty tax. Of course the regular tax rates will apply…you will want to consider whether a particular distribution is pushing you into a higher tax bracket. There remains a 10% penalty for most distributions before age 59-1/2.

Using Your IRA to Pay Medical Expenses

Beginning in 1997, you can withdraw from your IRA (no 10% penalty) to pay for your medical expenses or those of your spouse or dependents that are in excess of 7.5% of your Adjusted Gross Income. Any withdrawals continue to be subject to regular income tax.

Buy Airline Tickets for Travel AFTER January 1, 1997

The Small Business Act reinstated the 10% tax on domestic airline tickets. The good news is that he tax (enacted again in August ’96) expires on December 31, 1996. Look for Congress to revisit this tax and restore it during 1997….but any tickets in your hands will be free of the 10% federal tax. When purchasing tickets for travel after January 1, 1997 be sure that you are not being charged a tax that has been repealed. It has been reported that some airlines are refusing to recognize that the tax is gone. NOTE: The above discussion only highlights "some" of the many changes that your tax professional will be reviewing with you.

Miscellaneous Tax Items of Interest

MY IRA ACCOUNT…SHOULD I BE MAKING ANY NONDEDUCTIBLE CONTRIBUTIONS?

This is a question that many tax professionals hear every tax season. While there are good reasons for building up a nest egg there are some practical considerations which you need to consider. When your "nondeductible" contributions are withdrawn, you don’t have any taxes on them. But guess what…the IRS expects you to assume that every dollar withdrawn is a mix of nondeductible contributions and other money and it may be a headache for you to determine what portion of a withdrawal isn’t taxable. A recent article in the Wall Street Journal concluded that "once you’ve done it, you might a well keep at it…but if you haven’t made any nondeductible contribution, think long and hard before you start."

NOTICE TO NEW PARENTS

If your child was born earlier this year (before December 1, 1996) be sure to get a Social Security number if you want to claim him/her as a dependent on your 1996 return. If your child is born on or after December 1 you do not "officially" need one (Social Security number) but it would probably be a good idea to have one and use it on your return. The IRS does make it a practice to look for Social Security (tax identification) numbers.

CBO REPORT

A new CBO (Congressional Budget Office) Report suggests a $150 billion federal deficit. Higher-than-expected Medicare/Medicaid spending account for the more positive forecast. Are we any closer to a balanced budget? Only time will tell. Did you know that 35 states have enacted some form of a constitutional requirement for a state balanced budget….others have a statutory requirement. Three states (Alabama, Florida, and Louisiana) have rescinded their resolutions.

BACK IN WASHINGTON, DC

Now that the dust has settled down, the Administration and the GOP leadership are drawing up their "proposed" budgets. The President isn’t expected to release his plan until February and the GOP sometime later. Republican insiders have hinted that the GOP plan will have no more than $150 billion in tax cuts over 5 years. Look for the GOP proposal to include a $500 child care credit as well as capital gains relief.

CONSUMER PRICE INDEX

Recent reports from Washington, DC have suggested that the Consumer Price Index (CPI) consistently overstates inflation by 1 to 1.25% percentage points. Changing the CPI calculation could cause a reduction in the annual cost-of-living-adjustments for some federal benefits such as Social Security. Some experts believe that changing the formula could help reduce the federal budget deficit up to $261 billion or more over six years. Any such changes should require both Congressional and White House approval. According to a spokesperson for the President he "is open to reviewing what the best technical experts could broadly agree on". Keep in mind that the impact any changes would be felt by:

	47 million Social Security recipients
	27 million food-stamp recipients
	4 million military and civil service retirees
	26 million children who get aid for school lunches
	2 million private workers covered by union wage agreements

AFTER JANUARY 1997…WHAT TAX CHANGES ARE LIKELY?

As you can imagine it is simply anyone’s guess as to what "tax reform" measures will find their way to the President during 1997. Frankly, the average tax professional didn’t expect as much action as Washington produced in 1996. While it probably helped that 1996 was a national election year many tax experts are predicting "some" moderate reform based on the current rather positive political atmosphere in Washington. A smaller package of tax breaks is likely and much of it will rest on what progress, if any, is made in the budget negotiations. Certainly, a change in the CPI formula will allow more room for tax reductions. One subject that certainly merits your careful attention is a possible reduction in the capital gains rates. Again it is anyone’s guess as to whether any laws enacted in 1997 would be "retroactive" to January 1, 1997 or start from a later date during the year.

During the Presidential campaign there appeared to be genuine agreement that Congress should work towards major tax reform in the "sale of a residence" area. Both candidates Clinton and Dole advocated increasing the amount of gain that would be excluded from income. It will be interesting to see where this idea goes in post-election Washington. Look for a proposal to replace the existing $125,000 one-time exclusion for sellers age 55 and older. The larger gain exclusion would eliminate the need for many taxpayers to buy more expensive "replacement" homes to "roll over" gains and postpone taxes under the current tax rules. The Dole proposal called for a $250,000 exclusion ($125,000 for singles) and up to $500,000 for taxpayers who occupied their homes for a longer period of time. President Clinton advocated a $500,000 exclusion ($250,000 for singles). Just think of the savings in record-keeping alone!

Finally, you can look for all sides to agree to a commission to study the Big 3 "entitlement" programs (Social Security, Medicare and Medicaid).

MEDICARE REFORM

According to a 1995 report, the Medicare Hospital Insurance Trust Fund will face insolvency by the year 2002. Now, it appears that the trustees are more pessimistic than before. In 1995 the Fund’s expenditures exceeded income. 1995 was the first year the fund had a deficit since it was established in 1965. Revenue is collected in the Trust Fund from a 2.9% tax on wages - the tax is split evenly between employer and employee. The 1995 report concluded that to keep the fund solvent for the next 25 years the Medicare payroll tax would have to be increased immediately to 4.86% - 2.43% each for employer and employee. The Fund’s trustees have not recommended increasing the payroll tax to bail out the program.

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