Tax legislation affecting individuals in 1996.

While Congress did not enact a "major" tax bill during 1996, it did pass several pieces of tax legislation that will affect individual taxpayers in many ways. Under one provision, the adoption credit, taxpayers may now be eligible for a credit of up to $5,000 ($6,000 for certain U.S. special-needs children) for qualified adoption expenses. Included are reasonable and necessary adoption fees, court costs, attorneys' fees, travel expenses, certain expenses for a birth mother's prenatal care, certain home construction and renovation costs and other expenses directly related to the legal adoption of an eligible child. Qualified expenses are taken into account in the year after the year first paid or incurred and in the year the adoption becomes final. No credit is allowed for the adoption of a taxpayer's spouse's child or a surrogate parenting arrangement. In addition, the credit is phased out for taxpayers with modified adjusted gross incomes above $75,000, with full phase-out at $115,000.

MEDICAL EXPENSE PROVISIONS

There are several new provisions affecting taxpayer medical care.

Medical savings accounts. For employees of small employers (that is, those who employed an average of 50 employees or fewer in either of the two preceding years) or self-employed individuals with high-deductible health plans (those with $1,500-$2,250 deductibles for individual coverage or $3,000-$4,500 deductibles for family coverage), tax-favored medical savings accounts similar to individual retirement accounts may be set up to fund health benefits and medical care expenses.

Generally, the maximum annual deductible contribution an individual can make to a medical savings account is 65% of the annual deductible for individual coverage or 75% of the annual deductible for family coverage.

Long-term health care. Several provisions related to long-term care (ETC) were enacted. The tax treatment of LTC insurance was made comparable to that of accident and health plans. LTC proceeds received on account of personal injuries or sickness are generally excludable, subject to a per diem cap; employer contributions to an LTC insurance plan are excludable from an employee's gross income, as are benefits paid by an indemnity-type LTC policy.

In addition, certain LTC insurance premiums and unreimbursed expenses for qualified ETC services (such as nursing home services) are now deductible medical expenses, subject to an annual limit and the normal 7.5%-of-adjusted gross income floor.

Accelerated death benefits. Accelerated death benefits from life insurance policies are now excludable from income if paid on account of a terminally or chronically ill individual; such individuals can now cash in their life insurance policies before death without having to including in income the excess of the policy's cash value over the premiums paid. In addition, these new rules also apply to the sale or assignment of a terminally or chronically ill individual's life insurance policy to a qualified viatical settlement company (one that typically purchases those policies for a percentage of face value).

IRA withdrawals. The 10% IRA early-withdrawal penalty is waived for withdrawals used for medical expenses, to the extent the withdrawal exceeds 7.5% of adjusted gross income.

SPOUSAL IRAs

Previously, the nonworking spouse in a one-earner couple could make a deductible contribution of only $250 to his or her IRA. After 1996, a one-earner couple can contribute and deduct up to $4,000 ($2,000 per spouse) as long as the couple's combined compensation at least equals their total contributions.

EMPLOYER-PROViDED EDUCATIONAL ASSISTANCE

The $5,250 exclusion for employer-provided educational assistance was extended retroactively for years after 1994 to tax years beginning before June 1, 1997. Note that the exclusion for graduate-level education applies only to courses beginning before July 1, 1996; therefore, graduate school courses are no longer eligible.

For a discussion of these new provisions, as well as others that were enacted in 1996, see "1996 Tax Legislation Offers Planning Opportunities," by Ward Bukofsky and Eileen Reichenberg Sherr, in the March 1997 issue of The Tax Adviser.