TAX NEWS
	WINTER 1997

1998 ARRIVES WITH NEW TAX LAWS

1998 brings taxpayers new opportunities to save money on taxes, establish new IRAs (ROTH and education), obtain tax credits for children and education, etc. While we deal with the “here and now” we can look forward to the potential for even greater savings if and when we achieve the federal budget surplus in 1998 or 1999.

While the Taxpayer Relief Act of 1997 is responsible for many of the changes that will be implemented in 1998 and beyond, the focus of attention inside Washington in the months ahead will be on system wide reform. It is anticipated that President Clinton will address this issue in his State of the Union address this month. The Republican majority for its part will have its own plan and with any luck perhaps a consensus can be reached on where we need to be headed in the years ahead.

Your tax professional has spent the past few months absorbing the 3,132 pages that produced the Taxpayer Relief Act of 1997 and many of the announcements issued by the IRS interpreting the new laws. Your tax professional stands ready to work for you and with you as we begin the 1998 tax season. Best wishes for a healthy and prosperous 1998!

Editor
The Client Newsletter

NEW IRS COMMISSIONER

President Clinton’s choice to head the IRS has pledged to make the embattled agency a friendlier place for taxpayers. “We have to get the entire organization to think of themselves as taxpayer advocates,” Charles Rossotti told the Senate Finance Committee. Rossotti’s nomination was a departure from tradition in that he is a businessman and manager and not a tax specialist.

CLINTON AND CONGRESS REACH AGREEMENT

While the action will shift to the US Senate when it returns to work in January, the House has passed a tax reform package by a 426-4 vote. Prior to consideration of the measure by the House Ways and Means Committee, President Clinton agreed to some of the provisions that may soon become law. Included in the House measure were the following:

	The creation of an 11 member IRS oversight board of directors.
	A shift of the burden of proving a case in the Tax Court.
	Relaxing the “innocent spouse” rules.
	Providing for the suspension of the statute of limitations in a refund action based on an established hardship.
	Allow taxpayers to recover up to $100,000 in civil damages against the IRS when they can establish “negligence” as opposed to the current standard of willful or reckless misbehavior.
	“Privileged communication” would be extended to tax professionals that are permitted to practice before the government.

Your tax professional will monitor these proposed changes in the months ahead.

HOT TAX TOPICS

One of the hottest topics these days is the new ROTH IRA. Named after Senate Finance Committee Chairman William Roth (R.-Del.), this new IRA is effective on January 1, 1998. Unlike regular IRAs, contributions to the ROTH IRAs are never deductible but they grow 100% tax free, may be left to your heirs tax free and such IRA accounts do not require mandatory distributions at age 70-1/2.

What makes the ROTH IRAs very attractive is the fact that the eligibility levels for taxpayers are far more generous than the existing levels for the traditional deductible IRAs. The otherwise allow contributions to a ROTH IRA are reduced ratably for taxpayers with modified AGI (adjusted gross income) between $95,000 and $110,000 and between $150,000 and $160,000 for married taxpayers filing a joint tax return. No contributions can be made by a married taxpayer who files a separate tax return.

As you can see the determination of one’s AGI for 1998 can only be made after a careful analysis by your tax professional. Even more complicated for 1998 is the fact that certain taxpayers (AGI for 1998 below $100,000) will have an opportunity to rollover all or part of their existing IRAs to a ROTH IRA. Since there are eligibility as well as tax consequences associated with such rollovers, taxpayers are advised to take no action without consulting with their tax professionals. For many taxpayers the best time to consult with their tax professional will be towards the end of 1998 when a more accurate determination of AGI can be made.

A 54 LINE TAX FORM

By now you may have read something about a new 54 line tax form. This is no mistake. The 1997 schedule D (used for capital gains / losses) is more complex this year due to one simple fact-in an effort to help taxpayers - yes, help taxpayers, Congress, in passing changes to the capital gains rates (lower rates) allowed the changes to go back in time. Transactions on or after May 7, 1997 are eligible for the new lower rates. The new law creates a new holding period (more than 18 months) for transactions on or after August 29, 1997. So, since we have new rates, old rates and new and old holding periods, WOW, 54 lines to figure it all out. Your tax professional will have all of the questions ready for your response if you have any 1997 capital gains / loss transactions.

DID YOU SEE THE SHOW?

During the week of September 23rd, the Senate Finance Committee, under the leadership of Senator William Roth (R.-Del.), held three days of hearings on the role that the IRS plays in taxpayers lives. Roth opened the hearings by referring to a “subculture of fear and intimidation." During the hearings (covered live on C-Span), the committee took testimony from a wide range of witnesses including taxpayers, tax professionals, IRS employees, etc.. On September 25th several present and former IRS employees testified behind a screen used to hide their identities. Only time will tell just how serious Congress and the President are in bringing about real and significant reform. [Editor’s Note: As noted in this issue, the action is now in the hands of the United States Senate as the Senators consider the reform measure passed by the House. The Senate may go even further in passing pro-taxpayer relief.

HOME-OFFICE RELIEF

The good news is that the Taxpayer Relief Act of 1997 has effectively restored the right to take some tax deductions in connection with the business use of a home. Many of the new “rights” were disallowed under a decision from the United States Supreme Court in a case by the name of Solomon. By passing the 1997 changes Congress has overruled the Supreme Court. Now, the bad news. The changes will not take effect until January 1, 1999.

HIGHLIGHTS OF NEW TAX LAWS

Before you review and consider any of the highlights of the tax changes facing you please consider some basic terminology facing all taxpayers in 1998. More than ever your Adjusted Gross Income (line 32 on the 1997 1040 tax return) will dictate what if any new tax credits you may be entitled to. As you read the significant highlights below you will see that the new credits / exclusions (adoption credit / exclusion, education credits, child credit, traditional IRAs, education IRAs and ROTH IRAs) are all limited or available based on your AGI for 1998.

For many taxpayers there is a simple solution. Take the time (outside of the tax filing season) to consult with your tax professional and develop a strategy for dealing with the available credits and tax strategies that are best for YOU. At some point in 1998 there may be an opportunity to advance certain tax events or postpone other tax events to impact on your AGI for 1998 and thereafter.

One word of warning before we begin. While a majority of the experts have pointed out the advantages to setting up a ROTH IRA such a plan is not for everyone and you may in fact not be eligible. Before you establish any IRA, contribute money to any IRA or roll money into an IRA, consult with your tax professional. In most cases you will be better off delaying such action until you can act on your professional’s sound and educated advice.

Most of the provisions of the taxpayer relief act of 1997 have a January 1, 1998 effective date. Several provisions have 1997 effective dates. Some provisions will not be effective until mid 1998 and some not until 1999 and beyond.

CAPITAL GAINS

The top long-term rate drops from 28% to 20%. For taxpayers in the 15% tax bracket the maximum capital gains rate is 10%. The exciting news here is that the tax reduction is effective for transactions after May 6, 1997. The old law had a holding period of 12 months. The new law changes the holding period to 18 months. While the new (lower) tax rate is effective for transactions after May 6, 1997, the new holding period (18 months) doesn’t kick in until after July 28, 1997.

Since the changes to the tax law are effective for some 1997 transactions, the Treasury Department and the IRS have been busy preparing a new and very complicated Schedule D for 1997. The final version of the form is 54 lines and this is one time when taxpayers will welcome the assistance of their tax professional.

Conclusion: Amen! Any reduction in the capital gains rates is welcomed news. The fact that the changes are retroactive to 1997 is wonderful. The new netting rules are fantastic. While the 1997 Form 1040 Schedule D will be more complex for 1997 (54 lines) the rewards make it worth it. Yes, lower tax rates will require more work by your tax professional.

HOME SALES

Also effective for 1997 is a change in the rules regarding the sale of a residence. The new tax law exempts from tax the first $500,000 of gain ($250,000 for single taxpayers) from the sale of your personal residence. To qualify for the income exclusion you must have owned and occupied the home for at least two out of the last five years before the sale.

Gone are the old rules that permitted taxpayers to postpone gain from the sale of a residence by rolling the gain into a new residence. The 1997 tax law changes also did away with the once in a lifetime opportunity to exclude from income up to $125,000 in gain for taxpayers 55 years of age or older. Similar to the Capital Gains changes noted above, the sale of a residence changes are effective for sales after May 6, 1997. For taxpayers who had a contract to sell their home by August 5, 1997 (the date that President Clinton signed the Taxpayer Relief Act of 1997), the new law permits the taxpayers to elect either the new tax law or the old tax law. For transactions after August 5, 1997 you have no choice, the new law applies.

Conclusion: For most taxpayers (but not all) the new rules are more beneficial in the long run. As in the case of Capital Gains, the good news is that the changes are effective for 1997 as well.

EDUCATION INCENTIVES

Effective for 1998, the new tax law creates several credits for education. Since credits are a direct subtract from your tax liability they are much better than tax deductions. Taxpayers will be eligible for a $1,500 tax credit for the tuition expenses associated with the first two years of college. The HOPE credit is available for payments made after January 1, 1998 for dependents who are enrolled in college on at least a half-time basis. The credit is per student and not per tax return. If you have two children attending college (1st and 2nd year) your credit could be as high as $3,000.

The new lifetime learning credit takes effect after July 1, 1998. This credit is available for most post-secondary education (tuition) regardless of whether the taxpayer or dependent is enrolled in school half-time or part-time. A course here or there will qualify if it is taken at an “eligible educational institution” to improve your skills or to acquire new skills. This tax credit cannot exceed $1,000 per tax return. The credit is calculated by multiplying 20% by the total amount of tuition and fees paid. For 1998, the maximum credit is obtained by spending at least $5,000 on tuition. The credit is scheduled to increase to $2,000 a year in 2003.

Note: Both the Hope credit (January 1, 1998) and Lifetime Learning credit (July 1, 1998) are “nonrefundable” credits. Similar to other tax credits enacted for 1998, the Hope and Lifetime Learning credits will “phase out” for taxpayers with $80,000 on a joint return and at $40,000 for the return of a single taxpayer.

Conclusion: Here is one situation in which President Clinton was able to deliver on his promise to support higher education. While some taxpayers were hoping that the new credits would extend to high school as well as college, any tax support for post-secondary education is long overdue. The Lifetime Learning credit offers taxpayers a great opportunity to take courses at any level (except high school) and obtain a tax credit.

STUDENT LOAN INTEREST

Effective for 1998 (you will see this on your 1998 tax return) interest on the first five years of a student loan is deductible, up to one thousand dollars for 1998. The deduction is subject to income limitations but for those who are eligible it is an “above the line” deduction, it serves to lower a taxpayer's Adjusted Gross Income (AGI).

CHILD CREDIT

Effective for 1998 is a new Child tax credit. The credit for 1998 is $400 per child for each child under the age of 17 . In 1999, the Child tax credit will increase to $500 per child. The credit will phase out when the parents’ adjusted gross income reaches $110,000 on a joint return and $75,000 on the return of a single taxpayer. Unlike the new education credits, the Child tax credit is somewhat refundable. Your tax professional can guide you on your particular situation.

Conclusion: Again, this topic was a very high priority for President Clinton and he even won out on the issue of a refundable tax credit.

IRAs

One of the major areas targeted for reform is that of the Individual Retirement Accounts. The Congressional response was to expand this area to include a new form of retirement savings known as the ROTH IRA. The ROTH IRA is available on January 1, 1998. Under a ROTH plan no deduction is allowed on deposits of up to $2,000 a year (4,000 in the case of an eligible couple), but the growth on the investment is tax free. One of the more attractive features of the Roth IRA is the fact that the principal can be withdrawn at any time without tax consequences.

Also effective on January 1, 1998 is a new Educational IRA. Eligible taxpayers may contribute up to $500 a year for each eligible child. As in the case of all IRAs, not every taxpayer is eligible since Congress elected to will impose Adjusted Gross Income caps.

[Editors Comment: $500 - per child - per year isn’t much in the way of savings. Let’s hope that Congress and the President revisit this area and come up with an amount that is more realistic.]

SOCIAL SECURITY

People receiving Social Security benefits will receive a 2.1% increase in 1998. The low 2.1% change is the product of a low cost-of-living index. The increase translates into a total monthly benefit $765 for the average single retired taxpayers, up from $749. For a retired couple, the average $1,288, up $1,251.

Taxpayers ages 65 to 69 will be allowed to earn $14,500, up from $13,500, without paying income tax on Social Security benefits. But, working taxpayers will feel a bigger bite out of their paychecks to finance the Social Security system. In 1997, the tax was 6.2% of an individual’s first $65,400 in income. For 1998, the 6.2% tax will be imposed on the first $68,400 of income.

QUOTE OF THE SEASON

“Criminals in this country have more rights than taxpayers.”

Congressman Bill Archer (R.-Tex.)
Chairman House Ways and Means Committee

Millions of TradeBanners Served!