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Summary of New Income Tax Rules for 1998

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(Extracted from IRS data)

In a ceremony at the White House on August 5, 1997, President Clinton signed into law two bills passed by Congress (HR 2014, The Taxpayer Relief Act of 1997, and HR 2015, the Balanced Budget Act of 1997). These acts include provisions with special significance for families, students, homeowners, and investors.

Note:

The Internal Revenue Service will issue further guidance on the new tax provisions and will revise tax forms, instructions, and publications, as necessary, to address the changes in the tax law. Some of these changes already appear on the IRS W-4, Employee's Withholding Allowance Certificate (available for download at IRS Form and Pubs ).
      Click on a Topic 
    
     1. Child Tax Credit
     2. Education Incentives
     3. The HOPE Scholarship Credit
     4. The Lifetime Learning Credit
     5. Education Individual Retirement Account
     6. Deduction for Interest on Education Loans
     7. Deductible IRAs - Increased Phase-out Ranges
     8. Roth IRAs   
     9. Transfers from a Deductible IRA
    10. Capital Gains - For Individuals
    11. Gain from Sale of a Principal Residence
    12. Estate Taxes
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Child Tax Credit

Starting in 1988, there will be a maximum credit of $400 allowed for each dependent child under 17 years in age. In subsequent years the credit will increase to $500 per qualifying child. This credit is phased out by $50 for each $1,000 of the taxpayer's modified adjusted gross income ("AGI") in excess of $110,000 for taxpayers filing jointly, $75,000 for single taxpayers, and $55,000 for married taxpayers filing separately. To claim the credit, you are required to provide the name and identification number of the qualifying child on the return.

Education Incentives

HOPE Scholarship and Lifetime Learning Credits

The Act provides taxpayers two new nonrefundable tax credits for payments made for qualified tuition and related expenses (tuition and fees, but not books) for post-secondary education -- the HOPE Scholarship Credit and the Lifetime Learning Credit.

The HOPE Scholarship Credit

Allows taxpayers to claim a maximum credit of $1,500 (100 percent of the first $1,000 of tuition and fees and 50 percent of the next $1,000 of tuition and fees) for expenses paid on behalf of the taxpayer, the taxpayer's spouse, or a dependent for the first two years of post-secondary education at an eligible institution. The student must be enrolled on at least a half-time basis for at least one academic period during the year for the expenses to be qualified. The HOPE Scholarship Credit applies to expenses paid after December 31, 1997, for education furnished in academic periods beginning after that date.

The Lifetime Learning Credit

Allows taxpayers to claim a maximum credit equal to 20 percent of up to $5,000 of expenses ($10,000 beginning in 2003) incurred during the taxable year for qualified tuition and fees for eligible students for post-secondary education, including any course of instruction to acquire or improve job skills. The Lifetime Learning Credit applies to expenses paid after June 30, 1998, for education furnished in academic periods beginning after that date.

Both credits limit qualified expenses to the expenses of the taxpayer, the taxpayer's spouse, or a dependent of the taxpayer. Additionally, both credits are phased out for taxpayers with modified AGI between $40,000 and $50,000 (between $80,000 and $100,000 for joint filers). For each qualifying student, taxpayers must choose to claim either the HOPE Scholarship Credit, the Lifetime Learning Credit, or the exclusion for certain distributions from an education IRA for the taxable year. They cannot claim more than one of these benefits for a student for any year. To claim the credits, taxpayers are required to provide the name and taxpayer identification number of the student on the return. Educational institutions are required to report information related to higher education tuition and related expenses, including refunds of such expenses, paid during the taxable year.

Education Individual Retirement Account

The Act also creates a new educational funding vehicle, called an Education Individual Retirement Account (education IRA), for the purpose of paying the qualified higher education expenses of a designated beneficiary. Qualified higher education expenses include tuition, fees, books, supplies and equipment, and room and board. Contributions are non-deductible, and earnings on the amount held in the IRA will be non-taxable until distributed. Annual contributions are limited to $500 per beneficiary under the age of 18. The contribution limit is phased out as a taxpayer's modified AGI increases from $95,000 to $110,000 ($150,000 to $160,000 for joint returns). Distributions from an education IRA are excludable from income to the extent the amount does not exceed the qualified higher education expenses of the eligible student during the year. If the distribution from the education IRA exceeds the qualified higher education expenses, only a portion of the distribution is excludable. In addition, distributions not used for higher education are subject to a 10 percent addition to tax. The Act requires any balance remaining in an education IRA at the time a beneficiary becomes 30 years of age to be distributed and taxed to the beneficiary (and subject to the 10 percent addition to tax). However, the balance may be rolled over tax free to another education IRA benefiting another family member. This provision is effective for taxable years beginning after December 31, 1997.

Deduction for Interest on Education Loans

The Act provides an above-the-line maximum deduction for up to $2,500 of interest paid by taxpayers on qualified education loans. The $2,500 limit is phased in over 4 years (i.e., the maximum deduction is $1,000 in 1998, $1,500 in 1999, $2,000 in 2000, and $2,500 in 2001). Taxpayers may take a deduction on qualified education loans for the benefit of the taxpayer, the taxpayer's spouse, or any dependent of the taxpayer as of the time the indebtedness was incurred. Deductions are allowed only for the first 60 months that interest payments are required. The deduction is phased out for taxpayers with modified AGI between $40,000 and $55,000 ($60,000 and $75,000 for joint filers). Married taxpayers must file jointly to take the deduction, and the credit may not be claimed on the return of anyone who is claimed as a dependent on another person's return. This provision is effective for interest due and paid after December 31, 1997.

Deductible IRAs - Increased Phase-out Ranges

for Deductible IRAs Under the Act, the AGI phaseout ranges for deductible IRAs of active participants in employer-sponsored retirement plans will increase annually beginning in 1998 until they reach double the current phaseout ranges in 2007. In 2007, the phaseout ranges will be between $50,000 and $60,000 for single filers and between $80,000 and $100,000 for married taxpayers filing jointly, double the current ranges of $40,000 to $50,000 for married couples filing jointly, and $25,000 to $35,000 for single filers. An individual is not an active participant in an employer- sponsored retirement plan merely because the individual's spouse is an active participant. However, in such cases, the individual's deductible amount is phased out for married couples with AGI between $150,000 and $160,000.

Roth IRAs

The Act provides for a new individual retirement account beginning in 1998 called a "Roth IRA". Key features are:
  1. contributions to the account are not deductible,
  2. qualified distributions from the account are not taxable, and
  3. earnings on the account are taxable only if and when there is a distribution which is not a qualified distribution.
A "qualified distribution" is a distribution:
  1. made after the taxpayer attains age 59½;
  2. made to a beneficiary after the taxpayer's death;
  3. made because the taxpayer is disabled; or
  4. used by a first-time home buyer to acquire a principal residence.
No payment can be a qualified distribution unless it is made after the 5-taxable-year period beginning with the taxable year in which the taxpayer first contributed to a Roth IRA. Annual contributions to the Roth IRAs are limited to $2,000 less the taxpayer's deductible IRA contributions. Unlike deductible IRAs, there is no prohibition on making contributions after attaining age 70½. The $2,000 limit is phased out as AGI increases from
  1. $150,000 to $160,000 in the case of a married couple filing jointly or
  2. $95,000 to $110,000 in the case of a single filer.

Transfers from a Deductible IRA

Amounts in deductible IRAs may be transferred to Roth IRAs provided the taxpayer's AGI for the transfer year is $100,000 or less. Transferred amounts are includible in income but exempt from the early withdrawal tax. If the transfer occurs in 1998, income from the transfer is spread out over four years (i.e., 1/4th of the transferred amount is includible in 1998, 1999, 2000 and 2001). No payments allocable to the transferred amounts can be a qualified distribution unless it is made more than 5 years after the transfer.

Capital Gains - For Individuals

The maximum tax rate on net capital gain from sales or exchanges occurring after May 6, 1997, will be reduced to: A maximum tax rate of 20 percent for sales made after May 6, 1997, if the property had been held for more than 18 months at the time of sale. This 20 percent rate also is available for property sold after May 6, 1997, and before July 29, 1997, if the property had been held for more than 12 months (even if it had not been held for 18 months). A maximum tax rate of 18 percent for sales of property acquired after December 31, 2000, that had been held for more than 5 years at the time of the sale. 25 percent for real estate depreciation recapture treated as capital gain. The current 28 percent maximum capital gain rate will continue to apply to
  1. sales of collectibles,
  2. sales before May 7, 1997, and
  3. sales after July 28, 1997, of property held for more than one year but not more than 18 months.

Gain from Sale of a Principal Residence

The Act allows taxpayers to exclude up to $250,000 of gain ($500,000 for married couples filing a joint return) realized on the sale or exchange of a principal residence occurring after May 6, 1997. Unlike the "one time" exclusion provided under prior law, the exclusion is allowed each time a taxpayer sells or exchanges a principal residence, although the exclusion generally may not be claimed more frequently than once every two years. Also unlike prior law, the taxpayer is not required to reinvest the sales proceeds in a new residence to claim the exclusion. To be eligible, the residence must have been owned and used as the taxpayer's principal residence for a combined period of at least two years out of the five years prior to the sale or exchange. The taxpayer must recognize gain to the extent of any depreciation allowable with respect to the rental or business use of such principal residence for periods after May 6, 1997.

Estate Taxes

Beginning in 1998, the unified estate and gift tax credit will increase annually, until the maximum value of estates exempt from tax reaches $1 million in 2006. The current limit is $600,000. Beginning in 1999, the $10,000 annual exclusion for gifts, the $750,000 ceiling on special use valuation, the $1 million generation-skipping transfer tax exemption, and the $1 million ceiling on the value of a closely-held business eligible for the special low interest rate will all be indexed annually to reflect inflation. The provisions apply to estates of taxpayers dying and to gifts made after December 31, 1997. Beginning in 1998, executors may elect special estate tax treatment for qualified "family-owned business interests" if these interests comprise more than 50 percent of a decedent's estate and certain other requirements are met. Because the Act limits the combined value of this credit and the unified estate and gift tax credit to $1.3 million, the amount of this exclusion that will be available each year will decrease as the value of the unified credit increases during its phase-in period. In 1998, the provision will exclude up to $675,000 of value in qualified family-owned business interests from a decedent's taxable estate (i.e., $1.3 million minus the $625,000 unified credit available in 1998).

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