Please make a selection from the three choices above
The 1997 Taxpayer Relief Act contains tax benefits for almost everyone. Although complex in its entirety, each section has specific benefits that every taxpayer should be aware of. To try to minimize the complexity, we have divided the main features of the bill into sections effecting individuals, those affecting corporations and those affecting estates and trusts. Within each of these sections, the changes affective this year are listed separately from those that take affect in 1998 and beyond. For specific information on these new tax laws, the planning implications they present, and how they affect you, please contact us.
This act contains provisions that affect individuals, business and estates and trusts. The following table summarizes the major tax law changes contained in the act.
| NEW TAX LAW | WHO IT AFFECTS |
Lower Capital Gains
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Home Sale Exemption
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IRA Limitations Relaxed
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New IRA Vehicles Introduced
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Estate Tax Exemption Increase
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Additional Credits and
Write-offs
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The Taxpayer Relief Act of 1997 provides significant tax saving opportunities for many individuals. However, without proper planning, it also contains many provisions that can add to an individual’s tax burden.
In order to present the details of this new tax law in a pertinent and beneficial manner, the provisions of the tax law and their affect on taxpaying individuals are divided into two sections: those changes effective in 1997; and those changes effective in 1998 and beyond. Observations and recommendations are given where appropriate.
Please select a topic from the following list.
1997 TAXPAYER RELIEF ACT - BUSINESSES
Although individuals receive the majority of the tax cuts in this bill, there are a number of changes that directly affect small businesses, partnerships and corporations.
In order to simplify the presentation of these changes, and provide a reader with pertinent information, the description of the bill and its affects on business is divided into two sections: those changes effecting 1997; and those changes effecting 1998 and beyond. Where necessary, possible impacts and examples are given.
Please select a topic from the following list.
1997 TAXPAYER RELIEF ACT – ESTATES, GIFTS & PENSIONS
Although individuals receive the majority of the tax cuts in this bill, there are a few changes relating to estates, gifts and pensions.
All changes relating to estates and gifts take effect in 1998. Changes to Pension take affect in both 1997 and 1998.
Please select a topic from the following list.
The two major changes to the Capital Gains Tax are to the rate and the holding period. Effective for sales after May 6, 1997, the long-term capital gains tax rate for individuals, estates and trusts is reduced to 20% (from 28% for sales prior to this change). The long-term holding period is now defined as greater than 18 months for sales after July 28, 1997.
For sales of capital assets that were held between one year and eighteen months, the medium-term holding period rate is 28%. For capital assets held less than one year, capital gains are still taxed as ordinary income.
For sales between May 7, 1997 and July 28, 1997, the long-term holding period is one year, not eighteen months.
For taxpayers in the lowest tax bracket (15%), long term capital gains are taxed at only 10%, effective for sales after May 6, 1997.
The following summarizes the new Capital Gains Tax Rules for sales AFTER July 29, 1997.
| Long-Term (more than 18 months) | 20% (10% if in 15% tax bracket |
| Medium-Term (between 12 and 18 months) | 28% |
| Short-Term (less than 1 year) | Ordinary Income Tax Rate |
To make things even more complicated, the rates changes for assets purchased after the year 2000 and held for at least five years. The maximum rate changes from 20% to 18% (from 10% to 8% for those in the 15% tax bracket).
For property purchased before year 2001, a 20% tax rate is applicable to the accumulated profit in 2001 and profit after that will be taxed at 18% (8% if in 15% tax bracket) if the property is held for more than five years.
There are some exceptions to these changes. The following assets are not eligible for the new maximum rates.
IMPACT OF CAPITAL GAINS CHANGES
Taxpayers holding capital assets may need to re-evaluate when to sell those assets. Because of the increase in the long-term holding period, a taxpayer may wish to delay a sale to take advantage of the lower rates. There are many provisions of the Taxpayer Relief Act that do not take effect until 1998. Some of these provisions are tied to Adjusted Gross Income. Delaying a sale until 1998, although advantageous regarding the tax rate, may increase AGI such that some of the advantages of the 1998 changes will be minimized. Please contact your financial planner, tax advisor or Maxwell Shmerler & Company for a detailed analysis of your position.
Homeowners may now exclude up to $500,000 in gain from the sale of a principal residence regardless of age ($250,000 for single taxpayers). This differs greatly from the old law that included deferral rules and provided a one-time exclusion of up to $125,000 for taxpayers over the age of 55. This new exclusion applies if you have owned and used the home as a principal residence for at least 2 of the 5 years before the sale. In general, this exclusion can only be used every two years.
At the taxpayer’s election, the new exclusion does not apply to home sales before August 5, 1997 and after May 6, 1997. This election may be advantageous if the gain on the home is greater than the exclusion and the new principal residence is purchased for more than was received from the sale of the previous residence. This election may also be advantageous to heirs if the new residence is not sold. Please contact your tax advisor or Maxwell Shmerler & Company for more details.
IMPACT OF CHANGES ON SALE OF PRINCIPAL RESIDENCE GAINS
Most homeowners will benefit from this change because they are not forced to trade up in order to obtain a deferral of gains. Almost everyone is relieved of the burden of keeping paperwork on improvements that add to the basis of the property.
For those with gains over $500,000, the changes are not as favorable since gains over this amount will be taxed at the capital gains rate that applies. The previous law allowed deferral of gains under certain circumstances.
Contributions of Stock to Private Foundations
Earned Income Credit Compliance
Exclusion from income for cancellation of student loans expanded to cover cancellation of loans under non-government sponsored programs.
The following are other changes that affect individuals and are effective in 1997. For more information on these items, please contact your financial adviser or Maxwell Shmerler & Company.
For tax years beginning after 1997, a tax credit is available per child (under 17). This credit is $400 for 1998 and $500 for 1999 and beyond. This credit directly reduces the taxpayer’s tax liability up to the total amount. The credit is available for the taxpayer’s son, daughter, grandchild, or eligible foster child.
The child credit is phased out if Modified Adjusted Gross Income exceeds a set amount. For joint filers, this amount is $110,000. For singles and heads of households it is $75,000. For married filing separately it is $55,000. For credit is reduced by $50 for each $1000 (or part of) above the exclusion limit. For example, if Modified AGI for a single person is $80,010, then the credit in 1999 would be $500 less $300 (50 x 6) or a total of $200.
The credit is generally nonrefundable (cannot exceed the tax liability) but families with three or more children are allowed a refundable credit to the extent of certain employee-paid payroll taxes, less the earned income credit claimed.
Hope Scholarship Credit
This credit begins to be phased out for modified AGI between $80,000 and $100,000 for joint filers and $40,000 to $50,000 for single filers. The credit cannot be claimed if an education IRA distributions is used to pay educational expenses for the same taxable year.
To qualify, the expenses must be paid after 1997 for education furnished in academic periods beginning after 1997. The student must have earned a high school diploma or equivalent degree, carry at least one-half the normal course load for one term during the tax year, and not have been convicted of a federal or state drug felony.
Lifetime Learning Credit
The Lifetime Learning Credit is available for expenses paid after June 30, 1998 for education beginning after that date. Expenses for the taxpayer, spouse and dependents qualify for this credit. The Hope and Lifetime Learning credit cannot be taken for the same student in the same year. Both can be taken in the same year if they are for separate students. The credit cannot be claimed if an education IRA distributions is used to pay educational expenses for the same taxable year.
The credit is phased out for joint filers with modified AGI between $80,000 and $100,000 ($40,000 to $50,000 for single filers). For example, if a single taxpayer has qualified expenses of $4,000 and modified AGI of 45,000, then the credit is 20% of 4,000 or $800 minus one half (for 45,000 modified AGI) or $400 for a total credit of $400.
RECOMMENDATIONS
If the taxpayer qualifies for both credits in a given year, the one that produces the largest benefit should be chosen. For college students, the Hope credit products the maximum tax credit for the first two years of schooling ($1,500 per year versus $1,000)
Unreimbursed job related educational expenses should qualify for the credit to the extent that they are not allowed as miscellaneous itemized deductions due to the 2% of AGI floor.
A taxpayer should consider delaying payment for tuition and fees until 1998, if the school will permit.
Student Loan Interest Deduction
The deduction cannot be claimed by taxpayer’s that are claimed as a dependent on another return nor can it be claimed if AGI is $75,000 and above for joint filers and $55,000 and above for single filers. The phase out begins for joint and single filers at $60,000 and $40,000 respectively.
IRA Withdrawals for Higher Education
Qualified higher education expenses include tuition at an eligible post-secondary educational institution as well as room and board, fees, books, supplies and equipment required for enrollment or attendance. Graduate level course expenses are also covered.
IMPACT OF IRA WITHDRAWALS FOR HIGHER EDUCATION
Penalty-free educational distributions cannot be made from qualified retirement plans. If the plan permits, the participant may want to consider transferring funds to an IRA for penalty-free educational distributions
Education IRAs
Earnings from the education IRA not used to pay such expenses are includible in the income of the distributee and are generally subject to an additional 10 percent penalty. The annual contribution limit is phased out for joint filers with modified AGI between $150,000 and $160,000 and single filers with modified AGI between $95,000 and $110,000.
OBSERVATION
WHAT EDUCATION COSTS ARE COVERED
| Provision | Tuition | Limited Fees |
Fees | Books and Supplies |
Room and Board |
| Hope scholarship credit | X* | X* | |||
| Lifetime learning credit | X | X | |||
| Education IRA | X | X | X | X* | |
| Traditional IRA withdrawal without penalty |
X | X | X | X* | |
| Education loan interest | X | X | X | X* | |
| Qualified state tuition programs |
X | X | X | X* |
*Student must attend at least half-time
OTHER EDUCATIONAL PROVISIONS
There are a number of additional provision relating to education that are part of the 1997 Taxpayer Relief Act.
For detailed information on these and all aspects of the new tax law, contact your tax advisor or Ford Levy at Maxwell Shmerler & Co., CPAs.
The 1997 Relief Act brought changes to traditional IRAs as well as introduced two new types of IRAs, the Education IRA (discussed in Education section) and the Roth IRA, described below.
Deductible IRA Contributions Available to More Individuals
Before 1998, if either spouse was active in an employee-sponsored retirement plan, the maximum deductible contribution to an IRA was limited by AGI. For single individuals, the maximum deduction was reduced if AGI was over $25,000, with complete phase-out at $35,000. For married couples the deduction was reduced for AGI over $40,000, with complete phase out at $50,000.
Under the new law, these limits are increased for participants in an employee-sponsored retirement plan. The following table summarizes these new limits and what tax year they take affect. The Phase-out limits are the AGI where reduction of the $2,000 deductible amount starts. To calculate the phase-out amount, take the amount over the limit, divide by $10,000 ($20,000 after 2006), and multiply the result by $2,000, to get the reduced amount that can be deducted.
| For Taxable Year Beginning | Joint Return Phase-Out Limits | Single Return Phase-Out Limits |
| 1998 | $50,000 | $30,000 |
| 1999 | $51,000 | $31,000 |
| 2000 | $52,000 | $32,000 |
| 2001 | $53,000 | $33,000 |
| 2002 | $54,000 | $34,000 |
| 2003 | $60,000 | $40,000 |
| 2004 | $65,000 | $45,000 |
| 2005 | $70,000 | $50,000 |
| 2006 | $75,000 | $50,000 |
| 2007 and beyond | $80,000 | $50,000 |
For example, in 1999, a single taxpayer has AGI of $32,000. This is $1,000 over the $31,000 limit. $1,000 divided by $10,000 multiplied by $2,000 equals 200 reduction. Thus, this single taxpayer can only deduct $1,800 for an IRA contribution. The taxpayer can still contribute $2,000, but the additional $200 will not be deductible.
These limits are only for active participants. If one spouse is not an active participant, other limits apply.
Deductible Contributions for Spouses of Active Participants.
If the spouse of an active participant in a employee-sponsored retirement plan is not an active participant, the limits for the spouse are as follows if a joint return is filed.
If the combined AGI on the return is less than $150,000, a fully deductible $2,000 contribution can be made by the non-participating spouse. For AGI between $150,000 and $160,000, the deductible contribution is reduced using the same formula as for an active participant.
For example, Russ and Rena have a combined AGI of $100,000 in 1998. Rena is an active participant in an employee-sponsored plan, Russ is not. Russ can deduct up to $2,000 for an IRA since the combined AGI is less than $150,000. Rena cannot deduct any amount for an IRA since AGI is above the $60,000 maximum limit ($50,000 + $10,000).
IMPACT
A broader range of taxpayers with higher incomes will not be able to contribute to a deductible IRA for tax-deferred growth along with immediate tax savings from the deduction.
Roth IRA – Nondeductible Contributions
The 1997 Tax Relief Act introduced a new type of IRA, called the Roth IRA. Although the contributions are not tax-free, if certain requirements are met, the withdrawals are entirely tax-free.
Starting in 1998, an individual can make a nondeductible contribution to a Roth IRA up to the excess of lesser of $2,000 or 100% of the individual’s annual compensation. This amount is further reduced by any contribution made to a traditional IRA. Unlike a traditional IRA, contributions can be made after reaching age 70 ½.
There are AGI limits. For a joint return, if AGI exceeds $150,000, the maximum $2,000 amount is reduced by $200 for each additional $1,000 over $150,000. If AGI reaches $160,000, the allowable contribution is 0. For a single taxpayer, the reduction begins for AGI over $95,000 with reductions of $200 for each additional $1,500 over $95,000, reaching 0 for AGI over $110,000.
Qualified Distribution
In order for a distribution from a Roth IRA to be tax-free, certain criteria must be met.
For example, on April 15, 1999, a married taxpayer with combined AGI of $155,000 makes a maximum $1,000 contribution to a Roth IRA for tax year 1998. The taxpayer withdrawals the entire account balance on Jan 2, 2005, at age 60. The withdrawal, including all earnings, are tax-free.
For taxpayers with AGI under $100,000, a traditional IRA can be converted into a Roth IRA during 1998. Amounts converted will be included in a taxpayer’s income ratable over four years. There is no requirement that distributions must begin at age 70 ½ for Roth IRAs.
Caution!
Amounts rolled over from a traditional IRA are included in income for purposes of determining total AGI. Care must be taken to assure that total AGI does not exceed the maximum allowed for rollover eligibility.
For example, a taxpayer with AGI before rollover of $50,000 can rollover a maximum of $200,000 since one quarter of this added to $50,000 equals $100,000.
To Convert or not to Convert
If you are eligible to convert your regular IRA into a Roth IRA, the following factors should be weighed when coming to a decision on whether to proceed with the rollover.
Factors such as age, financial status, expected IRA investment earnings and expected marginal tax rate should be considered when weighing the cost-to-benefit relationship.
Remember, distributions from a traditional IRA are taxable to the extent of the earnings, whereas for Roth IRAs, all earnings are tax-free if the distribution requirements are met.
IRA Distributions for First-Time Homebuyers
Under current law, if a taxpayer takes an "early withdrawal" from an IRA, a 10% early withdrawal penalty applies. Under the 97 Relief Act, a "first-time homebuyer" may be able to escape this penalty.
To escape the penalty, the distribution must be made by a "first-time homebuyer" to pay the "qualified acquisition costs" of acquiring a principal residence. The distribution must be used within 120 days. The "first-time homebuyer" can be an individual, spouse, any child, any grandchild, or ancestor of the individual or spouse. The withdrawals cannot exceed $10,000 during the individual’s lifetime.
A "first-time homebuyer" means anyone who has not had an ownership interest in a principal residence during the two-year period ending with the date when the contract of sale is entered into, or the date when construction begins.
"Qualified acquisition costs" means the costs of acquiring, constructing, or reconstructing a residence.
If the 120-day rule cannot be met, the taxpayer can deposit the distribution into the same or another IRA, as long as the limitations on IRA rollover contributions are met.
IRA Distributions to Pay for Higher Education
Penalty-free distributions from an IRA can be made before the age of 59 ½ if the funds are used to pay qualified higher education expenses. The withdrawal will be subject only to regular income tax
Qualified higher education expenses include tuition at an eligible post-secondary educational institution as well as room and board, fees, books, supplies and equipment required for enrollment or attendance. Graduate level course expenses are also covered
Under the prior law, a penalty for underpayment of estimated taxes was imposed if the total tax liability, reduced by any tax withheld, was $500 or more. Under the new law, this amount is increased to $1,000
The new law also changes the requirements for estimated tax payments. Under the old law, if an individual’s AGI exceeded $150,000 for the prior year, estimated tax payments were based on either 90% of the current year’s tax or 110% of the preceding year’s tax. Under the new law, the prior year’s percentage is changed, as follows.
The new law reduces the stringent requirements that had to be met in order to deduct certain home office expenses. Starting in 1999, a home office qualifies as your "principal place of business" if the following are met.
The office must be used exclusively and regularly and, if by an employee, only if that exclusive use is for the convenience of the employer.
Self-Employed Health Insurance Deduction
A self-employed individual may take a deduction in arriving at AGI for a percentage of the amount paid for medical insurance. The percentage changes for the years 1998 through 2007, as follows.
Charitable Mileage Rate – increased from 12 cents to 14 cents
Standard Deduction for Dependents with Earned Income – standard deduction for an individual who can be claimed as a dependent by another taxpayer is the greater of $650 or the sum of $250 plus the individual’s earned income. Under prior law, the alternative standard deduction was earned income, without the $250 addition.
Medicare Eligible Individuals May Choose "Medicare+Choice Medical Savings Accounts (MSAs)" as Medicare Option -The new law provides for this additional choice for those who are eligible for Medicare.
AGI-based phaseout of earned income credit – Two items of nontaxable income are added to the definition of AGI used for phasing our the earned income credit. (1) Tax-exempt interest, and (2) Amounts received as a pension or annuity, and any distributions or payments received from an individual retirement plan during the tax year, to the extend not included in income. The definition of AGI for Earned Income Credit phase-out disregards certain losses. The new law increases from 50% to 75% the amount of disregarded net losses from business, computed separately with respect to sole proprietorships.
Simplified Foreign Tax Credit Limitations May Be Elected for AMT - The 1997 Act permits a taxpayer to use foreign source regular taxable income in computing their AMT foreign tax credit limitation. It is based on the proportion that (a) the taxpayer’s regular taxable income from sources outside the U.S. bears to (b) the taxpayer’s entire AMTI for the tax year. This eliminates the need to allocate and reapportion every deduction.
A taxpayer must elect to use the simplified limitation for the first tax year that begins after December 31, 1997 for which the taxpayer claims an AMT foreign tax credit. Once made, the election applies to all later tax years, unless revoked with consent of the IRS.
The Net Operating Loss (NOL) carry-back and carry-forward periods have been changed. Under the new law, the carry-back period is now reduced to 2 years. The carry-forward period is increased to 20 years. This change is affective for tax years beginning after August 5, 1997.
The reduction in the NOL carry-back period doesn’t apply to NOLs for certain "eligible losses". In the case of an individual, "eligible losses" includes losses on property arising from fire, storm, shipwreck, or other casualty, or from theft. For these losses, the three year carry-back period remains. "Eligible losses" for a small business include Presidentially declared disasters.
The 97 Act also doesn’t modify the carry-back period for specified liability losses (10-year carry-back) or for REITs (no carry-back) and excess interest losses (no carry-back) and corporate capital losses.
The increase in the carry-forward period applies with respect to specified liability losses, REITs and excess interest losses.
For example, a NOL for 1997 can be carried back three years to 1994, but NOLs for 1998 can only be carried back to 1996.
IMPACT
Taxpayer’s who paid tax in 1995 and anticipate losses in 1998 may want to, if possible, accelerate the 1998 losses into 1997 so that the losses can be carried back to 1995.
To encourage venture capital, a rollover feature has been added to protect gains from the sale of qualified small business stock from tax if the gain is reinvested in other qualified small business stock.
The 1997 Act makes available to taxpayers an elective rollover of capital gain from the sale of qualified small business stock held for more than six months. If the election is made, capital gain from the sale of qualified small business stock is recognized only to the extent that the amount realized from the sale exceeds:
Example
On March 1, Corporation A sells qualified small business stock in corporation S, held by A for more than six months and a capital asset on A’s books, and realizes an amount of $500,000 from the sale. A’s basis in the stock sold on March 1 is $100,000. The gain is $400,000
On April 30, A purchases qualified small business stock in corporation U at a cost of $700,000. No other qualified small business stock is purchased by A in the period from March 1 to April 31.
If A elects to rollover the gain from the sale on March 1, none of the $400,000 of gain from the sale will be recognized because the amount realized ($500,000) does not exceed purchase cost of $700,000.
Further, under the 1997 Act, the amount of net capital gain taken into account in computing the alternative minimum tax on capital gains for corporations will not exceed the taxable income of the corporation.
Electronic filing of payroll and other federal tax payments is now available. Using either telephone or computer software, payments can be electronically transferred from the employer's bank directly to the IRS. This system is called the Electronic Federal Payment System (EFTPS).
Companies required to convert to the Electronic Federal Tax Payment System because their federal tax deposits in 1995 exceeded $50,000 will not be penalized for failure to use the system until June 30, 1998. This is an extended date.
The holding period for dividends-received deductions that are received or accrued after September 4, 1997 (not coming under a special two-year transitional rule) is lengthened.
A corporation that receives a dividend from another corporation is generally allowed to deduct a portion of the dividend. This deduction is available if a specified holding period is met. Under the old law, the holding period cannot include any period during which the shareholder is protected from the risk of loss of the ownership of the stock (such as from a short sale)
The new law makes it more difficult for a corporation to protect itself against a risk of loss and still qualify for the dividends-received deduction. Subject to a transition rule for dividend paying stock held on June 8, 1997, for dividends paid or accrued after September 4, 1997 to be entitled to dividends-received deduction, a corporation must satisfy the holding period for the dividend-paying stock over a period immediately before or immediately after it becomes entitled to receive the dividend.
For Farmers
For tax years beginning after 1987, the 1997 Act retroactively repeals the rule requiring AMTI to be computed without regard to the installment method for cash-basis farmers.. Thus, for purposes of computing alternative minimum taxable income (AMTI), cash-basis farmers who dispose of property connected with the business may use the installment method to compute AMTI.
For Other Businesses
Effective for tax years after May 6, 1997, AMT preference for portion of gain on sale of qualified small business stock is reduced from 50% to 42%. The result is that the AMT preference is now 21% of the total gain versus 25% under the old law.
Prohibition of Suspense Accounts
A corporation engaged in farming must use an accrual method to account for taxable income if gross receipts exceed $1 million. If gross receipts increase to above the $1 million threshold, the corporation is required to change its method of accounting if it is not using the accrual method.
For family corporations engaged in farming, gross receipts must exceed $25 million to be required to use the accrual method of accounting for tax purposes.
Under the previous law, if a family corporation engaged in the business of farming was forced to change its method of accounting, the corporation had to establish a suspense account. The initial balance equaled the lesser of (1) Code Sec 481 adjustment otherwise required for the year of change or (2) the Code Sec. 481 adjustment computed as if the change in method of accounting had occurred as of the beginning of the tax year preceding the year of change.
Under the new law, suspense accounts are prohibited. Thus, any family corporation required, because of the $25 million rule, to change to an accrual method of accounting for any tax year ending after June 8, 1997, must restore the Code Sec. 481 adjustment applicable to the change in gross income ratably over a 10-year period beginning with the year of change.
Basis Allocation Rules (more to 1997)
For partnership distributions after August 5, 1997, the basis allocation rules for distributee partners has been modified.
A distributee partner’s basis adjustment is allocated among distributed assets first to unrealized receivables and inventory items in an amount equal to the partnership’s basis in each such property and remaining basis is allocated first to the extent of each distributed property’s adjusted basis to the partnership. Any remaining basis adjustment, if an increase, is allocated among properties with unrealized appreciation in proportion to their respective amounts of unrealized appreciation and then in proportion to their respective fair market values. If the remaining basis adjustments is a decrease, it is allocated among the properties with unrealized depreciation in proportion to their respective amounts of unrealized depreciation , and then in proportion to their respective adjusted bases, taking into account the adjustments already made.
EXAMPLE
A partnership distributes both its assets, A and B, in liquidation of a partner whose basis in its interest is $55. Neither asset consists of inventory or unrealized receivables. A has a basis to the partnership of $5 and a fair market value of $40. B has a basis to the partnership of $10 and a fair market value of $10. Basis is first allocated $5 to A and $10 to B (their adjusted bases to the partnership). The $40 basis increase (the partner’s $55 basis minus the partnership’s total basis in distributed assets of $15) is first allocated to A in the amount of $35, its unrealized appreciation, and the remaining basis adjustment of $5 is allocated according to the assets’ fair market value, i.e., $4 to A (for a total basis of $44 for A) and $1 to B (for a total basis of $11 for B).
This is a very complex provision of the new tax law. For more information on how this new law may affect you, contact your tax advisor or Ford Levy at Maxwell Shmerler & Co., CPAs.
There are other provisions in the 1997 Tax Act that affect businesses in the year 1997. These include the following.
For more information on the above provisions, contact your tax advisor or Ford Levy at Maxwell Shmerler & Co., CPAs.
For 1998 and Beyond
AMT repealed for small business corporations
The 1997 Act repeals the corporate AMT for small business corporations for tax years beginning after 1997. A small business corporation is one that had average gross receipts of less than $5 million for the three-year period beginning after 1994.
The Act provides that the tentative minimum tax of a corporation is zero for any tax year if the corporation: (1) meets the $5,000,000 gross receipts test and (2) would meet that test for the tax year and all prior tax years beginning after such first tax year if that test were applied by substituting $7,500,000 for $5,000,000.
A corporation that fails to meet the $7.5 million gross receipts test will become subject to AMT only with respect to preferences and adjustments that relate to transactions and investments entered into after the corporation losses its status as a small business corporation.
Net Capital Gain Limitation
The amount of net capital gain taken into account in computing alternative tax on net capital gain for corporations is limited to taxable income. The prior law did not limit the gain by taxable income.
Alternative Minimum Tax Adjustment for Depreciation of Property
The AMT adjustment for depreciation of property placed in service after 1998 is computes using the 150% declining balance method. This eliminates the depreciation adjustment that existed under the old law.
IMPACT
Calculation of the AMT adjustment is now much simpler.
Foreign Tax Credit Reduction of AMT Exception
Under the new law, the exception to the limitation on using foreign tax credits to reduce MT is repealed. An AMT is imposed on a corporation to the extent that the corporation’s minimum tax liability exceeds its regular income tax liability. A corporation can use the AMT Federal Tax Credit (AMTFTC) to reduce its AMT liability. However, the reduction is subject to the limitation that the corporation’s net operating loss carryover and AMTFTCs cannot reduce the corporation’s AMT liability by more than 90% of the amount determined without these items.
IMPACT
For all corporations, the combination of the corporation’s net operating loss carryover and AMT Foreign Tax Credits cannot reduce the AMT liability by more than 90% of the amount determined without these items.
The new law reduces the stringent requirements that had to be met in order to deduct certain home office expenses. Starting in 1999, a home office qualifies as your "principal place of business" if the following are met.
The office must be used exclusively and regularly and, if by an employee, only if that exclusive use is for the convenience of the employer
Clarification of De Minimis Fringe Benefit Rules to No-Charge Employee Meals
The new law states that business meals that are excludable from employees' incomes because they are provided for the convenience of the employer at an employer-operated eating facility are excludable as a de minimis fringe and therefore fully deductible by the employer.
Income Averaging Over Three Years
Beginning in tax years after 1997, the new law adds a new Code section that allows farmers to average all or a portion of farm income over the three previous years. The averaging is only available for tax years after 1997 and before 2001.
At the election of an individual engaged in a farming business, he tax impose will be equal to the sum of (1) a tax computed under Code Sec. 1 on taxable income reduced by "elected farm income" plus (2) the increase in tax imposed by Code Sec. 1 which would result if taxable income for the three prior tax years were increased by an amount equal to one-third of the "elected farm income.
The election, except as provided by the IRS, is irrevocable.
Inventory
This provision eliminates the requirement that inventory be substantially depreciated in order to give rise to ordinary income under the rules relating to sales and exchanges of partnership interest.
Gain on the sale or exchange of a partnership interest is ordinary income to the extent attributable to inventory. This change applies to sales and exchanges after August 5, 1997, except for sales under binding contract in effect on June 8, 1997.
Death of Partner
Under the old law, the tax year of a partnership was closed with respect to a partner whose entire interest was sold, exchanged or liquidated, but did not terminate with respect to a partner upon the death of the partner. Thus, a deceased partner’s share of partnership for the partnership year in which he or she dies was taxed to his successor, rather than on the deceased partner’s final return.
Under the new law, the partnership year terminates with respect to a partner whose interest terminates by death, liquidation, or otherwise.
IMPACT
If the partnership tax year is not a calendar year, the closing of the partnership tax year with respect to the deceased partner may cause a "bunching" of income as the return may contain income from more than one full year.
Other Partnership Tax Law Changes
There are a number of other tax law changes affecting partnerships. These include but are not limited to the following.
For more information these and other provisions affecting partnerships, please contact your tax advisor or Ford Levy at Maxwell Shmerler & Co., CPAs.
Credit Extensions - Work Opportunity Credit (with modifications) and the Research Tax Credit (with one exception) is extended through June 30, 1998. Also, the tax credit for orphan drugs has been made permanent.
S Corporation ESOPs – An ESOP maintained by a S Corporation doesn’t have to give participants the right to demand employer securities upon distribution, as long as participants are entitled to receive their distribution in cash equal to the stock’s fair market value.
Welfare-to-work credit – For wages paid or incurred to long-term family assistance recipients who begin work for an employer after December 31, 1997 and before May 1, 199, employers will be eligible for a credit on eligible first and second year wages. The credit is 35% of the first $10,000 of eligible wages in the first year of employment and 50% of the first $10,000 of eligible wages in the second year of employment. If an employer takes the welfare-to-work credit for an employee, the work opportunity tax credit is not available for wages paid to that employee.
Payments to Attorneys – The new law requires reporting of gross proceeds on all payments to attorneys made in the course of a trade or business. Prior law did not require reporting if the gross amount was not known.
For information on these and other provisions of the 1997 Taxpayer Relief Act, contact your tax advisor or Maxwell Shmerler & Co., CPAs.
Beginning in 1998, the estate and gift tax unified credit is gradually increased from the existing exemption level of $600,000 to $1,000,000 in year 2006 (see table below). After 1998, the $10,000 annual exclusion for gifts and several other estate and gift tax provisions (including the $1,000,000 generation-skipping transfer tax exemption) are indexed for inflation.
| Tax years beginning in | Applicable Unified Credit Exclusion Amount |
| 1998 | $625,000 |
| 1999 | $650,000 |
| 2000 and 2001 | $675,000 |
| 2003 and 2003 | $700,000 |
| 2004 | $850,000 |
| 2005 | $950,000 |
| 2006 and after | $1,000,000 |
After 1998, the $10,000 annual exclusion for gifts and the $1 million generation-skipping tax exemption will be indexed for inflation.
IMPACT
Given the current rate of inflation, it will be a number of years before the $10,000 gift exclusion reaches $11,000.
Under the old law, there were no special estate tax rules for qualified family-owned businesses. Under the new law, effective for estates of decedents dying after 1997, an additional estate tax exclusion is available for the value of an estate attributable to a "qualified family-owned business interest".
When combined with the unified credit exclusion ($625,000 in 1998), the exclusions in total may not exceed $1.3 million.
A "qualified family-owned business interest" is (1) an interest as a proprietor in a trade or business carried on as a proprietorship, or (2) an interest in an entity carrying on a trade or business, if at least 50% of the entity is owned by the decedent and members of the decedent’s family or, 70% of the entity is owned by members of two families or, 90% of the entity is owned by three families.
Example
The estate of a decedent who dies in 1999 (when the amount is $650,000) includes a qualified family-owned business interest with an adjusted value of $1 million. The amount that may be excluded from the gross estate under the exclusion for family-owned business interest is $650,000 ($1.3 million minus $650,000).
Recapture of Exclusion
Under certain circumstances, the family-owned business exclusion may be recaptured if certain events happen within 10 years after the decedent’s death and before the death of a qualified heir. Material participation by the qualified heir or at least one member of his or her family is required. If material participation by a heir or family member ceases within 10 years, an additional tax is imposed on the date of the event.
These changes in the estate and gift tax laws, along with changes in capital gain rates and home sales, means that many people will have to modify their existing estate plans. Contact your estate advisor or Maxwell Shmerler & Co., CPAs, for more information.
For closely held business an farm owners, the 4% interest rate for installment payment of tax under Section 6166 is lowered to 2%, and the formula for computing the reduced rate portion is improved, generally effective for estate of decedents dying after 1997.
The interest on installment payments will no longer be deductible.
IMPACT
This provision eliminates the need to file supplemental estate tax returns and make complex computations to claim an estate tax deduction for interest paid.
Effective after December 31, 1996, the 15% estate tax on excess retirement accumulations and the currently suspended 15% excise tax on excess distributions have been repealed. Prior to this change, certain retirement plan distributions made after death were subject to an excise tax equaling 15% of any excess retirement accumulations. This excise tax was originally designed to place limitations on the total amount that a person could keep in tax-deferred savings .
The full-funding limit for defined benefit plans (the lesser of the plan's accrued liability based on projected benefits or 150% of the plan's current accrued benefit liability) is liberalized in stages for plan years beginning after 1998. The changes are listed below
| Year | Percentage Limit |
| 1998 | 150% |
| 1999 and 2000 | 155% |
| 2001 and 2002 | 160% |
| 2003 and 2004 | 165% |
| 2005 and beyond | 170% |
Matching contributions of self-employed individuals are not treated as elective employer contributions - The treatment of matching contributions for self-employed individuals is the same as for other employees. Thus, matching contributions on behalf of self-employed individuals are not subject to the elective contribution limit ($9,500 for 1997)
Modification of 10% tax on non-deductible contributions - A 10% nondeductible excise tax is imposed on qualified plan contributions that exceed the deduction limit. There are two exceptions, The new law imposes a third exception.
Increase in tax on prohibited transactions - Certain transactions between a qualified plan and a disqualified person are prohibited in order to prevent persons with a close relationship to the qualified plan from using that relationship to the detriment of plan participants and beneficiaries. A two-tier excise tax is imposed on certain transactions between qualified retirement plans and disqualified persons. Under the new law, the first tier is increased from 10% to 15%. If the transaction is not corrected within the taxable period, a second tier tax of 100 percent of the amount involved may be imposed. The 100% second tier amount remains from the previous law.
Involuntary cash-outs of pensions - The limit on involuntary cash-outs of pension plan participants whose plan participation terminates is increased to $5,000 (from $3,500) for plan years after August 4, 1997. The $5,000 is not indexed for inflation
Maxwell Shmerler & Co. would like to thank the following sources for providing pertinent information used for this web page.
