Tax loopholes are back in. Tax simplification and fairness are out. In the battle to
bestow tax breaks on their constituencies, Republicans and Democrats both shouted victory
last Monday. President Clinton became Santa Claus to the middle-class, while Speaker
Gingrich showered the wealthy with capital gains cuts.
Investors with large capital gains may claim victory under the accord. Small business
or farm owners, and those with complicated estates, will enjoy unprecedented estate
planning opportunities. Losers include wage-earners without children, professional couples
with combined incomes over $110,000, and long-time owners of very expensive residences.
The biggest winners, however, may be the tax and estate planning professionals who now
have an enlarged arsenal of weapons to slash taxes.
The capital gains tax rate is reduced from 28% to 20% for assets (except collectibles)
sold after May 6, 1997, and held longer than 18 months (for sales between May 6 and July
28, the holding period is 12 months). For those in the 15% tax bracket, currently couples
with adjusted gross income ("AGI") of $41,200, the tax is reduced from 15% to
10%. In general, rates drop from 20% to 18% (and from 10% to 8%) for assets held for at
least 5 years and sold after December 31, 2005 (special rules apply to publicly traded
stock held on January 1, 2001). Gain caused by real estate depreciation will be taxed at
25%. These reductions apply to all taxpayers and are not restricted by AGI.
Commencing in 1998, there will be a $400 per child credit (rising to $500 in 1999) for
children under age 17. The credit will phase out for AGIs of $75,000 for individuals and
$100,000 for couples. Low income families earning at least $18,000, but who pay little or
no tax, will receive the benefit of the per-child credit as a refund.
Democrats hail the child care credit as a tax cut for the middle class. But compare
this tax benefit for an eligible family with 2 dependents with the capital gains reduction
championed by the Republicans: If Bill Gates sold just 10% of his Microsoft stock for a
gain of $3 billion, in 1997, he would have an immediate tax cut of $240,000,000, (capital
gains reduction from 28% to 20%) compared to no relief for the middle-class family,
because the child care credit takes effect next year. In 1998, the tax benefit to Mr.
Gates equates to the tax benefit received by 300,000 middle class families (each receiving
an $800 credit). In 1999, the ratio drops to 240,000 when each family receives a $1,000
Families get a maximum credit of $1,500 for a student's first two years of college
(100% of the first $1,000 in expenses and 50% of the next $1,000). For the next two years
and for graduate students, the maximum credit will be $1,000 (20% of the first $5,000 in
expenses). These credits are phased out for individuals with AGI of $50,000 and couples
with $80,000 (which might preclude most full-time working couples in the Bay Area).
Student loan interest, which is repaid during the first 60 months after payments are
required, will now be partially deductible to eligible borrowers -- to a maximum of $1,000
in 1998 (rising to $2,500 in 2001) -- whether or not the taxpayer itemizes his deductions.
The new "IRA Plus" account is an IRA with a twist: Investors cannot deduct
the contributions, but earnings accumulate tax-free. However, unlike a traditional IRA
which had distributions that were tax deferred, the IRA Plus distributions will never be
taxed. Withdrawals must commence at age 591/2 and the account must be at least 5 years
old. The annual contribution limits are $2,000 for individuals and $4,000 for couples.
There is a phase-out of eligibility starting at AGIs of $95,000 for individuals and
$150,000 for couples. Investors with regular IRAs may convert them to IRA Plus accounts.
The conversion will be taxed as an IRA distribution, but without penalty for early
AGI limitations for contributions to IRAs (currently $25,000 for individuals and
$40,000 for couples) will increase at $5,000/year for individuals and $10,000/year for
couples in 1998, 2002, 2003 and 2004. After 2004, the AGI limitations will be $50,000 for
individuals and $80,000 for joint filers. Also, penalty-free withdrawals are permitted for
first-time home purchases or education.
Profits from the sale of a principal residence may be excluded up to $250,000 for
individuals and $500,000 for couples, provided the home was owned and used as a residence
for 2 of 5 years preceding the sale. The exclusion is limited to home sales occurring
every 2 years or longer. Those with profits exceeding these limitations will pay capital
gains on sale. Current tax-free rollover provisions have been eliminated.
The current $600,000 unified estate and gift tax exemption will increase to $1,000,000
over the next 10 years. Next year, the current credit rises to $1.3 million for those with
family farms or small businesses, however, this provision has numerous restrictions.
These new tax changes are substantial and will benefit taxpayers with significant
investment assets and estates. Middle-class taxpayers will receive a modest reduction,
provided they can qualify for them.
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**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**