The Taxpayer Relief Act of 1997, the first major tax cut legislation in more than 16 years, was passed by Congress on July 31st and signed into law by President Clinton on August 5th, 1997. While the majority of the tax law changes have prospective effective dates there are some provisions which will go back in time (retroactive dates). Because of the demand and need for immediate information regarding the recent changes, the Federal Tax Alert is issuing this “special” issue to announce the most significant changes. All of the 1997 changes will be reported on in subsequent issues as the IRS develops revised forms and procedures and the Treasury Department issues appropriate regulations. In the opinion of Thomas Cooke, Executive Director of the National Society of Tax Professionals, “this is a very exiting and challenging time for the tax profession and taxpayers alike. Congress and the President have taken a long step towards bringing about a balanced budget in combination with significant tax law changes. One would probably not have taken place without the other.

The 1997 tax legislation is very selective- some taxpayers are clearly favored and some will see no changes to their status at all.”

The following is a summary of some of the more significant changes with a review of the scope of the changes and the all important effective dates. The term “Act” refers to the recently passed 1997 tax legislation.

Capital Gain Rate Lowered:
This is a very significant change and long overdue. The new maximum rate goes from 28% to 20% and it has a May 7, 1997 effective date. This change to the law means that some of your capital gains transaction for 1997 may give you a more favorable tax rate.

Child Tax Credit:
Some tax experts have referred to the 1997 legislation as “family friendly” - It is clear that the new law goes above and beyond in offering new tax benefits to parents with children. New to the tax laws will be a Child Credit of $400 per child in 1998 and $500 per child in 1999 and thereafter. The credit is reduced for children under age of 17. The credit is reduced by $50 for each $1,000 of modified AGI above:

$110,000 for joint returns. $75,000 for single filers.
$75,000 for head of household. $55,000 for married filing separately.

Education Incentives:
I. Tax credit: HOPE Scholarship Credits

1. Individuals can elect to take a non-refundable tax credit of up to $1,500 per
student for tuition and related expenses incurred during the first 2 years of college. The credit will apply to expenses paid after 1997 for education furnished in academic periods after 1997.

2. The credit = 100% of the first $1,000 of tuition and related fees and 50% of the
next $1,000 paid for each of the first 2 years of college.

3. Non-academic fees do not qualify.

4. Students (taxpayer, taxpayer’s spouse or dependent) must carry at least a ½
academic load and not have been convicted of a drug felony.

5. Indexing: the $1,000 limits will be indexed for inflation in $100 increment after
2001.

II. Education Savings Accounts

1. Beginning in 1998, taxpayers can contribute up to $500 per beneficiary (until beneficiary reaches the age of 18), to an education IRA, a tax-favored trust, or custodial account created to pay the cost of a beneficiary’s higher education.

2. Contributions are not deductible but withdrawals to pay the cost of a beneficiary’s college tuition and room and board are tax-free.

3. Contributions are not subject to the gift-tax.

4. If the distributions for a year exceed higher education expenses, the excess is taxable after basis is recovered proportionately from the entire distribution.

5. Any amount that is taxable is also subject to the 10% penalty.

6. A taxpayer won’t be penalized if funds in the account are not needed for educational purposes because the beneficiary received a scholarship.

7. Phase-out: the $500 contribution limit phases out ratably at modified AGI levels.

Deduction for Student Loan Interest:
Loan interest due and paid after 1997, taxpayers can deduct certain amounts of educational loan interest.

The maximum deductions allowed are:
1998 $1,000 1999 $1,500
2000 $2,000 2001 and thereafter $2,500

Only interest paid during the first 60 months in which interest payments are required is deductible; Married couples must file jointly return to take the deduction; The deduction phases out ratably for taxpayers with modified AGI between $40,000 and $55,000 ($60,000 and $75,000 on a joint return). The $40,000/$60,000 phase-out threshold will be indexed for inflation after 2002.

Sale of a Residence:
This new law is be far one of the best breaks that taxpayers have received in years. Effective May 7, 1997 you may exclude from taxable income a substantial amount of gain on the sale of your personal residence. The amounts excluded are $500,000 (Joint) and $125,000 (single). Please note that Congress has done away with the home sale rollover rules and the one-time-up-to $125,000 exclusion for qualifying sellers age 55 and older. Clearly, the new exclusions are more favorable than the law has ever been before.

IRA Reform:
One of the biggest surprises coming out of the 1997 tax law changes concerns some sweeping reforms to the IRA rules. For the most part, the changes are very favorable to taxpayers and will give you some interesting new alternatives starting in 1998. You will be reading about the new ROTH IRA named after Senator Roth from Delaware. While the contributions to this new IRA are non-deductible the earnings are being built up tax-free. You will be able to eventually pull your money out plus the earnings without owing any federal income taxes provided that the money has been in the account for at least 5 years. There are still some income limitations.
Please note that the new law does allow you to convert an existing IRA into a ROTH

IRA.
Starting 1998, parents may establish an education IRA (Educational Savings Accounts) for their children and make annual non-deductible contributions of up to $500 per child. This new IRA is above and beyond your ability to make contributions to traditional and ROTH IRAs. Earnings on the educational IRAs will accumulate tax-free and tax-free withdrawals can be made to pay for college or graduate education expenses. Again, there are some income limitations which will need to be reviewed.
Under the new tax laws taxpayers will be able to withdraw up to $10,000 from a traditional IRA as a first-time home buyer. While the withdrawal will be “penalty-free”, the amount withdrawn will be included in income since the funds were previously deducted from income under the traditional IRA rules.

Estate & Gift Tax Reform
Congress and the President have agreed to increase the amount of property that you may either give away or leave through your estate tax free. The increase in exempted property will take place over a number of years. The exempted amount will increase to $1 million per taxpayer by the year 2006. As a point of reference the lifetime amount has been $600,000 since the 1980's.