Tax Relief Act of 1997

• This single bill contains 36 retroactive provisions.
• It has 114 changes that became effective as soon as the President signed the Act into law.
• There are 69 changes that go into effect with the new year.
• Five changes come about strictly after 1998.

Capital Gains Tax Cuts

Rate Cuts

• Maximum capital gains tax rate lowered to 20 percent from the current 28 percent. For individuals in the 15 percent bracket the capital gains tax rate has been lowered to 10 percent.
• Rate changes are retroactive to any sale made after May 6, 1997. Installment payments made after the effective date are eligible for the new rates, even though the sale took place earlier.
• New rates also apply in computing the alternative minimum tax.

• Capital gains tax rate applies only to assets held "long-term". For assets sold after July 28, 1997, long-term means more than 18 months rather than one year.
• Assets sold after May 6, but before July 29 qualify for the new 20 percent rate if they were held for more than one year.
• Assets sold after July 29 with a holding period of more than a year but less than 18 months will be taxed as "mid-term" gain at the old 28 percent rate.

• A new rate structure has been created for assets held more than five years.
• Gain on assets purchased after December 31, 2000, will be taxed at 18 percent
• For those in the 15 percent bracket the rate is 8 percent on assets sold after December 31, 2000.

• Gain from collectibles continues to be taxed at a maximum rate of 28 percent.
• Maximum rate for real estate depreciation recapture will be 25 percent.
• Gain from small business stock remains limited to the existing 50 percent exclusion (for an effective maximum rate of 14%).

• As a result of these changes, gain from the sale of assets may be taxed at 8, 10, 14, 15, 18, 20, 25, 28, 31, 36, or 39.6 percent, depending on holding period, date sold, type of asset, and the amount of other income.

• Homeowners may now exclude up to $500,000 of gain from the sale of a principal residence ($250,000 for single taxpayers).
• New rule applies to sales after May 6, 1997.
• Old rules (deferral of gain and age 55 exclusion) have been repealed. However, taxpayers with sales or contracts signed after May 6, but before the date of enactment may use either the new rules or the old rules.
• Exclusion may be used every two years, subject to complicated rules on five-year ownership, "unforeseen events," and marital status.

Child Tax Credit

Per Child Credit

• $500 per qualifying child ($400 for 1998).
• Reduced in $50 steps for each $1,000 (or fraction thereof) over threshold.
• Threshold is $110,000 for joint returns, $75,000 for single or head of household returns, and $55,000 for married filing separate returns.
• Interacts with other non-refundable credits and with the earned income credit. It may also be affected by the amount of Security Security and self-employment taxes paid.
• Special rules for taxpayers with three or more children.
• Not based on earned income.

• Must be your dependent under the age of 17.
• Must be your child (or a descendent of your child), stepchild, or foster child.
• No limit on the number of qualifying children.

Education Incentives

Credits
Two new credits are provided:

Hope Scholarship Credit (Effective date: expenses after December 31, 1997)

• A credit is allowed for 100% of the first $1,000 of qualified tuition and fees paid during the tax year plus 50% of the next $1000 for a maximum credit of $1500 per eligible student. Qualified tuition includes only those amounts for academic periods beginning in the year.
• This credit applies only for the first two years of post-secondary education.
• This credit can be elected for any eligible student for only two taxable years.

• This credit equals an amount up to 20% of the qualified tuition and related expenses not to exceed $5,000 ($10,000 for years after December 31, 2002). Thus, the maximum allowable credit is $1,000.
• The Lifetime Learning Credit allows additional expenses with respect to any course of instruction at an eligible educational institution to acquire or improve job skills of the individual.
• There is a coordination with the Hope Scholarship credit. Any qualified expenses allowed for the Hope Scholarship credit are not allowed for the Lifetime Learning credit.

• The credits are phased out for taxpayers with modified AGI between $40,000 and $50,000 ($80,000 to $100,000 for joint returns).
• Qualified tuition and expenses are reduced by amounts that are excluded from income under any other provisions of the law. For example, excludable scholarships and educational assistance allowances which are not taxable.
• A person who can be claimed as a dependent is not allowed the credit. The taxpayer claiming the dependency exemption would be entitled to claim the credit. Qualified expenses paid by the dependent are treated as paid by the taxpayer claiming the exemption. Thus, parents would be allowed to claim the credit for tuition amounts paid by their dependent child.
• The credits are not allowed if married individuals file separate returns.
• The credits are not allowed if a taxpayer is a nonresident alien for any portion of the tax year.

• Taxpayers allowed to deduction interest on education loans. The deduction is allowed whether or not the taxpayer itemizes.
• The maximum deduction of $2,500 is phased in over several years starting in 1998. The amount allowed for 1998 is $1,000.
• The deduction is allowed only for interest paid during the first 60 months in which interest payments are required.
• Limitations are based on modified AGI. The deduction is phased out for modified AGI between $40,000 and $55,000 ($60,000 and $75,000 for joint filers).
• Dependents are not eligible for the deduction but similar to the education credits the taxpayer claiming the dependency exemption would be allowed the deduction. Thus, parents would be eligible to claim the interest paid on childÍs educational loan if the child is a dependent. ´Married couples must file joint return to take the deduction.

• Cash contributions up to $500 per year can be made for a beneficiary until age 18
• Contributions are not deductible.
• The trust is exempt from taxation.
• Distributions are not taxable if used for qualified educational expenses
• Limitations based on modified AGI.

• An exception applies to the early withdrawal penalty on distributions from a regular IRA. This exception is provided for distributions used to pay higher education expenses. This can be expenses paid for the taxpayer, spouse, child, or grandchild.
• Modifications are made to Qualified State Tuition Programs to encourage saving.
• The exclusion for employer-provided educational assistance is extended to May 31, 2000

Savings/IRAs (Individual Retirement Accounts)

Tax deductible IRAs

• New IRA rules make IRA benefits available to more middle and upper-middle class taxpayers. ´Incremental increase in income limits for active participants. For 1998, joint filers have a phaseout limitation of $50,000 to $60,000 (single filers $30,000 to $40,000). By year 2007, joint filers have a phaseout limitation of $80,000 to $100,000 (single filers phaseout between $50,000 and $60,000).
• Effective January 1, 1998, spouses contributions are no longer limited by the other spouseÍs active participation in a qualified plan for couples earning less than $150,000.

• No deduction is allowed for contributions
• Limits based on modified AGI - (Joint $150,000 to $160,000 and singles $95,000 to $110,000).
• Maximum amount allowed as a contribution limited to IRA contribution limit ($2,000). with contributions to other IRA accounts take into consideration
• Contributions allowed after age 70 1/2
• Qualified distributions are not included in income nor subject to 10% penalty
• Made after individual attains age 59 1/2
• Made to a beneficiary on or after death of the individual
• Made because the person is disabled
• Is a qualified special purpose distribution.
• Allows tax-free buildup and withdrawal
• Tax on withdrawals from deductible IRA can be spread over four years if the distributions are rolled over into a Roth IRA. Only taxpayers with AGI of $100,000 or less are eligible for this type of rollover.

• An exception to penalty for early withdrawal (10% penalty) provided for certain plan distributions for the purchase of a first home. Exception includes distributions from both tax deductible IRAs and Roth IRAs.
• Distributions must be used to pay qualified acquisition costs within 120 days.

• Exception to 10% penalty for qualified higher educational expenses.

Estate and Gift Taxes

• Increase in the unified credit phased up to $1,000,000 by 2006
• Exclusion for family owned businesses and farms of $675,000 (total with unified credit is $1.3 million)

• $10,000 annual exclusion
• $750,000 special use valuation
• $1 million generation-skipping tax
• $1 million in property value eligible for special interest rate on installment payment of estate tax.
• No gift revaluation for estate tax purposes after expiration of the statute of limitations
• Repeal of throwback rules
• Expansion of exception from generation-skipping transfer tax to collateral errors

This information is not intended for use without professional advice.