Taxpayer's Relief Act of 1997: A Mixed Bag of Blessings

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, Sunday August 17, 1997

Copyright 1995-7 Robert L. Sommers, all rights reserved.

Taxpayer's Relief Act of 1997: A Mixed Bag of Blessings

With the newly legislated capital gains cut, education credits, principal residence sales and child care credits grabbing headlines, little has been made about additional significant tax breaks (the good news) and traps (the bad news).

The Good News

Home Office Deduction. A home office may be established for administrative and managerial activities of the taxpayer's business, provided he does not use another location. This provision overrules the Supreme Court decision in Soliman, which disallowed a home office deduction to an anesthesiologist who practiced at several hospitals, but used a room in his home exclusively for administrative and managerial activities related to his profession.

Potential trap: Given the adverse taxation of real estate deprecation, taxpayers should exercise caution regarding the home office deduction. Depreciation deductions incurred through a home office deduction (or other business use) will be taxed at a 25% rate upon sale, but gain from the sale of a principal residence will be untaxed up to $500,000 for couples ($250,000 for individuals) under the new rules.

IRAs: If one spouse actively participates in an employer-sponsored retirement plan, the other spouse is now eligible for an IRA deduction to a maximum of $2,000. This benefit phases out for couples with AGI between $150,000 and $160,000. Additionally, the 15% excise tax on excessive IRA distributions or accumulations at death has been repealed.

Beginning January 1, 1998, the prohibition against IRA investments in collectibles has been lifted for certain platinum coins and gold, silver, platinum or palladium bullion.

Repeal of the Alternative Minimum Tax for Small Business: The dreaded alternative minimum tax has been eliminated for corporations with average gross receipts of less than $5 million ("small business corporation") for the 3-year period commencing January 1, 1994. A small business corporation will continue this status until its average gross receipts reach $7.5 million. This provision is effective for tax years beginning after December 31, 1997.

Installment Payments of Estate Tax for Closely Held Businesses: A new non-deductible interest rate of 2% will apply to the first $1 million in taxable value of the closely held business (computed after all applicable credits are considered) for estate taxes paid in installments. The interest rate on businesses worth more than $1 million will be 45% of the rate applicable to underpayments of tax. These rates are effective for decedents dying after December 31, 1997.

The Bad News

Transactions That Eliminate Risk of Loss: With the new 18-month holding requirement for capital gains treatment, many taxpayers might be tempted to lock-in gains and wait the 18-month period by selling "short against the box" (selling short the identical securities) to eliminate a risk of loss during the holding period. The new law requires gain recognition (but not loss recognition) upon the constructive sale of any "appreciated financial position" in stock, a partnership interest or debt other than certain straight debt instruments. In general, a taxpayer engages in a constructive sale when he enters into a short sale, or a futures or forward contract, with respect to the same or substantially identical property. This provision will apply to transactions occurring after June 8, 1997.

Continuous IRS Levies: Social security benefits are now subject to an IRS continuous levy (present and future amounts owed to the taxpayer) for past due tax liabilities. Also, a continuous levy could now apply to worker's compensation benefits, unemployment benefits and means-tested public assistance, if the Secretary of the Treasury or his delegate approves. These levies would attach to as much as 15% of the payment amount, and are effective for levies issued after the date of enactment.

Reporting of Certain Payments to Attorneys: Evidently, attorneys receiving client settlement payments have not always paid taxes on their share of the proceeds. After December 31, 1997, all payments (including settlement checks) from a business to an attorney, including corporations providing legal services, must now be reported on Form 1099-B.

Additional Perks

The exclusion for employer-assisted educational benefits of up to $5,200 has been extended for 3 years for undergraduate studies. The 35% excise tax (code section 1491) on transfers to foreign entities has been repealed. The minimum threshold for filing estimated taxes increased from $500 to $1,000 of tax liability. Beginning in May, 1998, you may now pay your federal tax bill, by credit or debit card.


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