The Roth IRA and Estate Tax Changes

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, December 14, 1997

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



Tax year 1997 ends in just 17 days. Looming in 1998 is the most complicated tax code ever. What strategies are still available in 1997? What last-minute actions in ’97 could maximize your tax benefits in 1998?

The Taxpayer’s Relief Act of 1997 ("Act") has profoundly changed the tax landscape. Year-end tax planning no longer adheres to the simple rule: defer income to next year and accelerate deductions in 1997. Such a strategy could backfire, causing taxpayers to lose benefits in ‘98. Under the Act, many of the tax breaks which kick-in January 1, 1998, will be phased out (reduced ratably over a range of income) when your adjusted gross income ("AGI") reaches certain levels. The accompanying chart illustrates the impact of AGI on various tax incentives.

This article, first of a three-part series, will focus on year-end tax planning strategies. A second column will analyze the new capital gains tax rates and the tax exclusion for gains from the sale of your residence. The final column will explore your retirement account possibilities and changes to the estate tax law.



When calculating your 1997 tax bite, start with total income. From total income, there are certain "above-the-line" deductions (IRA, SEP and Keogh contributions, moving expenses, self-employed health insurance and alimony payments) which may be taken to arrive at AGI. These deductions are permitted whether or not you itemize deductions. Your AGI becomes your focal point for potential tax benefits.

Once AGI is determined, your taxable income is lowered by claiming either standard or itemized deductions ("below-the-line" deductions). Itemized deductions include medical expenses, state and property taxes, home mortgage interest, charitable contributions, casualty and theft losses, job expenses and other miscellaneous deductions.

Itemized deductions reduce your taxable income but not your AGI; consequently, these below-the-line deductions will not help qualify you for those tax breaks pegged to AGI.

To defer or not to defer, that is the question

The Act phases out many so-called "middle-class tax breaks" at relatively modest AGI levels (see chart). If you will approach the upper limit of AGI in 1998 for a particular tax break, you might increase your 1997 AGI to lower your ‘98 AGI and thus qualify for better tax benefits.

Your decisions must be final by December 31, 1997. Year-end tax planning is a four-step process: (1) identify your 1998 tax break(s) and determine their qualifications and limitations; (2) determine your AGI for this year and estimate your AGI for next year; (3) decide whether it is wiser to increase AGI this year and reduce it next year, or vice-versa; and (4) then accelerate or defer those income and deduction items that affect AGI, according.

All income must be received and deductions claimed need to be completed by midnight, December 31st. If you want to file a joint return for 1997, you must be married by midnight of ’97.



Income includes wages, salaries and compensation, interest, alimony, business, farm or investment income, capital gains, unemployment compensation, social security benefits and IRA, pension or annuity distributions. Income can be reduced by deferring salary or bonuses to the following year. Self-employed individuals can reduce income by deferring receipt of outstanding receivables until next year. Retired persons may be able to defer receipt of distributions to the following year.

Investors may reduce their income by selling assets at a loss. Suppose you own a stock that has lost value, but you want to keep it. Can you sell it, recognize the loss, then repurchase it? Yes, if you wait at least 31 days before repurchasing it. This is called a "wash transaction" and the rules state that you cannot acquire "substantially identical securities" within a 61 day period which begins 30 days before the sale and ends 30 days after it.

For wage earners, employee expenses that are later reimbursed under an employer’s accountable plan are not considered gross income; self-employed persons achieve the same result by making business year-end expenditures. If you can, have your employer adopt an accountable plan for employee business expenses.

Remember, if you receive or have legitimate access to a check in 1997, but physically are unable to deposit it, you still have "constructively" received the income in 1997. Therefore, delaying this or other deposits to 1998 will not postpone 1997 recognition of this income.

Lowering AGI in 1998 - Example 1: A married couple with a college-bound child is considering the sale of stock which will produce a $10,000 gain. If their AGI is $80,000 and they expect the same AGI in 1998, then completing the sale this year increases ’97 AGI by $10,000 to $90,000. Their AGI in ’98 remains $80,000; thus, they are eligible for the full Hope Scholarship or Lifetime Learning Credits (available in ’98) because those benefits begin phasing out at $80,000 AGI. Instead of a stock sale, the couple could receive a year-end bonus or other compensation-related payments in 1997.

Reducing Your AGI

Once your total income has been minimized or maximized, as the case may be, you are entitled to: IRA deductions, spousal IRA deductions (these must be made prior to the deadline for filing your tax return, including extensions), moving expenses, self-employed health insurance, Keogh retirement plans (the plan must be in effect prior to the end of the year) and payments of alimony. The balance after these adjustments is your AGI.

For example, a wage-earner or retiree may increase AGI by accelerating income by receiving bonuses or retirement distributions, or selling gain property this year, and by deferring alimony payments, moving expenses and sales of loss property until next year.

A self-employed taxpayer may reduce business income by deferring accounts receivable billings until next year and by increasing business purchases this year. Pay employee bonuses next year.

Note, you can deduct expenses of equipment in the aggregate amounts up to $18,000 this year, but the equipment must be in service by the end of this year. Self-employed individuals may reduce AGI by making maximum contributions to Keogh plans and deductible health insurance plans.


Even if AGI is increased by income items that would have otherwise been reported next year (thereby increasing your potential tax this year), you can reduce your taxable income by increasing your below-the-line deductions. Remember, taxpayers in the alternative minimum tax ("AMT") may not want to accelerate deductions this year if those deductions will not reduce the AMT.

Example 2: In Example 1 above, the taxpayers could off-set their $10,000 increase in taxable income by increasing their ’97 itemized deductions. Prior to the end of ’97, the couple could give to charity, prepay their January mortgage, pay state or local taxes, pay for routine medical expenses (eye exams, physicals, dental examinations) or pay the second real estate tax installment.

Note: Itemized deductions are subject to a phase-out for AGI exceeding $121,200 (married filing separately - $60,600). Also, the medical and miscellaneous deductions must exceed 7.5% and 2% of AGI, respectively.

Specific Itemized Deductions

Charitable Contributions: Empty your house of old clothes, furniture and other "garage sale" items, estimate their fair market value (make an inventory and take pictures as part of your records), then donate them to Goodwill or your favorite charity to claim a charitable deduction. Items over $250.00, require a receipt.

Contribute appreciated property to public charities and receive a deduction for the full fair market value on the date of the donation. The Tax Act restored the provision allowing a full charitable deduction for gifts of publicly traded stock (held more than 18 months) to a private foundation for the full fair market value of the stock.

Taxes and Mortgage Interest: Pay your fourth quarter state income tax estimate and prepay your January mortgage payment this year. Pay your second property tax installment due in 1998, by the end of 1997.

Medical Expenses: Schedule medical and dental work prior to the end of this year and pay all medical expenses prior to the end of ‘97. These expenses are deductible to the extent they exceed 7.5% of AGI.

Itemized Miscellaneous Deductions: Itemized miscellaneous deductions must exceed 2% of AGI. Employee expenses not part of an employer’s accountable plan are considered itemized miscellaneous deductions. These include uniforms, travel expenses, automobile expenses, meals and entertainment expenses (these have strict requirements), certain education expenses for maintaining skills, union and professional dues and expenditures for equipment (up to $18,000) placed in service in 1997, supplies and publications. Note: special rules might apply to computers, automobiles and other mixed-use equipment.

Paying Deductible Expenses

Payments by check and credit card made in 1998 count as 1997 deductions, even though the credit card charges are paid in 1998. If you are considering several large expenditures, obtain a less-expensive (than credit cards) home-equity line of credit (or use one you already have) to pay the expenses in 1997. Generally, interest on the first $100,000 borrowed against a home-equity line is deductible.


Whether to reduce your income in 1997 or 1998 depends on the income restrictions for those tax breaks you desire and your AGI estimate in 1998. You lower your income in 1998 by deferring AGI adjustments or accelerating income into 1997. Itemized deductions reduce your taxable income but not your AGI.


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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.**