The Taxpayer Relief Act of 1997: reinventing the IRA.

The Individual Retirement Account (IRA) has changed dramatically since its creation by the Employee Retirement Income Security Act of 1974. Although it originally had limited application, effective utilization of the IRA as a tax-advantaged retirement savings vehicle was expanded dramatically by the Economic Recovery Tax Act of 1981. This Act made deductible annual IRA contributions of up to $2,000 available to virtually every taxpayer with sufficient earned income. This widespread utilization of the IRA, however, was severely curtailed by changes made in the Tax Reform Act of 1986 which restricted the deductibility of IRA contributions for many taxpayers who participated in employer-sponsored retirement plans. Although the 1986 Act created "nondeductible" IRAs for those who could no longer qualify for deductible contributions, the use of IRAs as retirement savings vehicles declined significantly following the passage of the 86 Act. As a result, Senator William Roth of Delaware and others first proposed a "super IRA" to reinvigorate retirement savings as early as 1989. Now, almost a decade later, Congress and the current Administration, through passage of the Taxpayer Relief Act of 1997, have finally agreed on far-reaching changes in IRAs.

Changes Affecting Traditional IRAs 

In addition to the creation of some entirely new types of Individual Retirement Accounts, the 97 Act contains provisions that significantly modify rules for existing IRAs. Previously, if either spouse participated in an employer-sponsored retirement plan, the deduction for contributions to an IRA was phased out for joint filers with adjusted gross income between $40,000 and $50,000 ($25,000 and $35,000 for single filers). Beginning in 1998, this phase-out range is being gradually adjusted upward over the next ten years, and the range itself is being expanded from $10,000 to $20,000 for joint filers. By 2007, a joint filer who participates in a retirement plan will not completely lose the deduction for an IRA contribution until an AGI of $100,000 is reached. Table 1 includes the phase-out ranges from 1998 to 2007 for single and joint filers.

Previously, even if only one spouse participated in an employer-sponsored retirement plan, both spouses were treated as active participants for purposes of determining the deductibility of IRA contributions. The 97 Act makes it easier to deduct IRA contributions when only one spouse participates in an employer-sponsored retirement plan. Beginning in 1998, the non-participating spouse may make deductible IRA contributions, subject to a phase out at AGI levels between $150,000 and $160,000. For example, a husband and wife each earn $60,000 (AGI) in 1998. The husband is an active participant in an employer-sponsored retirement plan, but the wife is not. The husband would not be able to deduct a contribution to an IRA (the deduction is completely phased out for an active participant with joint AGI above $60,000), but the wife would be able to deduct the full amount of her IRA contribution (the non-participating spouse's deduction is not phased out until joint AGI reaches $160,000). As in the past, taxpayers who do not qualify for a deductible IRA contribution because of the rules related to participation in retirement plans, and due to income levels, may continue to make nondeductible contributions to a traditional IRA.

The new rules also contain some important changes that affect the treatment of withdrawals from existing IRAs. Previously, except under very limited circumstances, withdrawals from IRAs prior to age 59 resulted in a 10% penalty tax, in addition to regular income tax. The new rules will allow penalty free withdrawals from an IRA prior to age 59 for purposes of paying certain higher education expenses, including tuition, fees, books, and supplies. Room and board are also qualified expenses if the student is enrolled at least half time. Qualifying students are defined as the taxpayer and spouse, as well as the child or grandchild of the taxpayer or spouse.

The 10% early withdrawal penalty may also be avoided if the money, up to $10,000, is being withdrawn for a first-time home purchase. Interestingly, in this context, an individual is generally considered a first-time home buyer if they (or their spouse) have not had an ownership interest in a residence for the previous two years. This suggests the provision could be used more than once; however, the $10,000 amount is a lifetime limit. In an unusually generous move, Congress designed this provision to also apply to the purchase of a first-time home for a child, grandchild, or parent of the taxpayer. It is important to note that these rules provide exceptions regarding the application of the 10% penalty tax, not the regular income tax.

Another significant change that may affect the tax treatment of withdrawals from an IRA is the repeal of the so called "success tax." This 15% penalty tax applied to retirement plan distributions that exceeded certain thresholds. The tax was widely scorned as unfairly penalizing those fortunate enough to have accumulated significant retirement savings. Although the tax had been recently suspended for a few years, the 97 Act repeals it permanently. An additional 15% "success tax" imposed at death for retirement plan balances exceeding certain amounts is also repealed by the 97 Act.

New Types of IRAs

A new Education IRA will be available for the first time starting in 1998. This special IRA can be established for any child under 18 years of age. Contributions of up to $500 per year per child may be made by individuals, subject to phase-out ranges of $95,000 to $110,000 of AGI for single filers and $150,000 to $160,000 for couples. The contribution limits to other types of IRAs ($2,000 per year) are not affected by contributions to Education IRAs, and apparently, limitations on contributions to Education IRAs are not tied to compensation amounts. While contributions to Education IRAs are nondeductible, all withdrawals are tax free if used for qualifying college expenses (defined as the same qualifying education expenses that avoid [TABULAR DATA FOR TABLE 1 OMITTED] the 10% penalty tax on regular IRA distributions). If the Education IRA funds are not used up paying college expenses, any remaining balance has to be distributed by the time the beneficiary turns 30; however, unused amounts may be rolled over into an Education IRA for another family member. Any distribution not used for qualifying expenses is subject to both the ordinary income tax and a 10% penalty tax on the portion considered earnings. It should be noted that the use of Education IRAs may affect the use of other education-related tax incentives. Specifically, for any year in which an exclusion from income is claimed for a distribution from an Education IRA, neither the "Hope" or "Lifetime Learning" credit may be claimed.

Probably the most significant IRA-related provision of the 97 Act is the creation of a "back-loaded" or "Roth IRA," so named after its champion in Congress, Senator William Roth of Delaware. Unlike the traditional, deductible IRA, the tax benefit associated with the Roth IRA comes at the time a withdrawal is made from the fund (i.e., on the "back end"). The entire amount of qualified withdrawals is free from both the federal income tax and the 10% penalty tax. A qualified withdrawal is defined as one that 1) is made after the account has been in place for 5 years and 2) is (a) made on or after an individual attains the age of 59 1/2, (b) made to a beneficiary after the death of an individual, (c) made to an individual due to a disability, or (d) made for purposes of a first-time home purchase (within the $10,000 lifetime limit).

Another important and distinguishing feature of the Roth IRA is a special ordering rule that applies when withdrawals are made that are not qualified (e.g., before the plan has been in effect for 5 years, etc.). When such withdrawals are made from traditional, non-deductible IRAs, a portion of each dollar withdrawn is deemed to represent a tax-free return of the original invested capital in the account and a portion of each dollar withdrawn is deemed to represent the tax-deferred, accumulated return. Upon withdrawal, this accumulated return is subject to both the federal income tax and the 10% penalty tax. The special ordering rule for Roth IRAs deems non-qualified withdrawals to first come from the invested capital in the account (i.e., tax-free amounts). Only when the entire amount of prior contributions to the Roth IRA account has been withdrawn are subsequent withdrawals deemed to be subject to federal income tax and the 10% penalty tax.

For example, assume Bob contributes $8,000 ($2,000 per year for 4 years) to a non-deductible, traditional IRA. At the end of this 4-year period he has total accumulations of $9,735 ($8,000 contributions plus $1,735 tax-deferred, accumulated returns). If he were to make a withdrawal of $4,000 at the end of 4 years, a portion of this $4,000 would be treated as a tax-free return of invested capital and a portion would be treated as a partial distribution of the $1,735 of returns. This later portion would be subject to the federal income tax and to the 10% penalty.

Now assume the same numbers as in the example above (i.e., an IRA with total accumulations of $9,735 of which $8,000 represents Bob's contributions over 4 years and of which $1,735 represents the returns which have accumulated in the account). This time, however, Bob has invested in a Roth IRA. Assuming a partial withdrawal of $4,000 is again made by Bob, none of this amount would be subject to federal income tax or to the 10% penalty tax. This treatment is due to the special ordering rules discussed above. Only when Bob has withdrawn the entire $8,000 of contributions (invested capital) will any subsequent dollars be subject to taxation.

Finally, even when a non-qualified distribution is made, the amount otherwise subject to taxation will not be subject to the 10% penalty tax if the distribution is used for qualified education expense or a first-time home purchase as discussed above. For example, if Bob in preceding example were to withdraw the entire $9,735 after 4 years from a Roth IRA, the $1,735 (i.e., the amount in excess of his $8,000 of contributions) would generally be subject to both the federal income tax and the 10% penalty tax. If this amount were withdrawn for qualified educational expenses or for a qualified first-time home purchase, the 10% penalty tax would not apply.

Subject to compensation limitations, contributions to all IRAs (except Education IRAs) cannot exceed $2,000 per year ($4,000 for a married couple). Contributions may be made to traditional and/or Roth IRAs in the same year, but the overall $2,000 per year limit applies to the total amount contributed. Contributions to a Roth IRA are phased out at AGI levels between $95,000 and $110,000 ($150,000 to $160,000 for couples). Several other aspects of the Roth IRA differ significantly from its traditional counterpart. For example, unlike traditional IRA participants, individuals who qualify to make contributions to a Roth IRA may do so even after reaching age 70 1/2. Likewise, the minimum distribution requirements that begin at age 70 1/2 for traditional IRAs do not apply to Roth IRAs, providing greater flexibility in choosing when to make withdrawals and using the IRA to accumulate assets for transfer to heirs at death. Roth IRA balances remaining at death are apparently subject to basically the same distribution rules as traditional IRAs. Specifically, at death there are apparently three options: first, the entire balance is distributed to the beneficiary within 5 years of the date of death; second, the funds are used to purchase an annuity within one year of the date of death; or, distributions from the IRA are continued at the same or greater rate as before death.

Perhaps one of the most intriguing aspects of the new Roth IRA is the possibility of converting traditional IRAs into Roth IRAs. The 97 Act includes provisions that allow taxpayers with AGI of less than $100,000 to convert traditional IRA accounts into Roth IRAs. This threshold applies to single and joint filers - apparently taxpayers choosing the "married filing separately" status cannot access the conversion provision. Married taxpayers who "live apart" for the entire tax year are not treated as "married filing separately" for this purpose. The downside to conversion of a traditional IRA to a Roth IRA is that deductible contributions and earnings (amounts that have not already been taxed) become taxable. These taxable amounts, however, are not counted when determining whether the individual's AGI is under the $100,000 threshold, and also are not subject to the 10% penalty tax usually assessed on early distributions. In an effort to mitigate the impact of requiring converted amounts not previously taxed to be included in income, the provision does allow for the resulting taxes to be paid over four years if the conversion is accomplished in 1998. The Technical Corrections Act currently before Congress closes a loophole left in the 97 Act by requiring that amounts converted to a Roth IRA must meet the five-year holding period in order to avoid the 10% early withdrawal penalty tax. In other words, for converted amounts withdrawn before the five-year period, any amounts that would be included in income due to the conversion would be subject to the usual 10% penalty tax. The Technical Corrections Act also applies an additional 10% penalty on such amounts attributable to conversions accomplished in 1998. For this specific purpose, the usual Roth IRA ordering rule governing taxation of distributions is modified so that distributions are considered to consist first of taxable amounts.

IRA Tax and Financial Planning Issues

Given the new choices available, a very basic decision faced by many individuals will be determining the appropriate vehicle(s) for retirement savings. If an individual has an opportunity to participate in an employer-sponsored plan, such as a 401 (k), where the employer will match some of the individual's contributions, that option will often be the most beneficial.

The choice becomes somewhat less obvious if the individual belongs to a sponsored plan at work and wishes to pursue additional retirement savings (or if the individual does not have access to a plan at work). In such cases, income level becomes an important factor. Specifically, if the individual's (or couple's) participation in a sponsored plan and income level are such that deductible IRA contributions are not possible, but contributions to a Roth IRA would be feasible, the Roth IRA option will virtually always be preferred over a non-deductible contribution to a traditional IRA. For example, a single taxpayer with an AGI of $50,000 who participates in an employer-sponsored retirement plan would not be able to make a deductible contribution to a traditional IRA for 1998. The individual's choices are a non-deductible contribution to a traditional IRA or a Roth IRA. Both types of IRAs would grow tax deferred; however, the Roth IRA is clearly superior since all distributions will be tax free assuming all necessary rules have been satisfied. Distributions from the traditional IRA will be taxable to the extent of earnings. For example, an individual contributing $2,000 per year to a Roth IRA will accumulate $91,524 after twenty years assuming an 8% annual rate of return (i.e., $40,000 of contributions plus $51,525 earnings). The same contributions to a nondeductible traditional IRA under the same circumstances will accumulate the same amount; however, the $51,525 in earnings will be subject to tax upon distribution. At a 28% tax rate, the after tax balance would be $77,097, much less than the $91,524 after-tax amount available from the Roth IRA. Of course, for very high-income individuals who might not qualify for the Roth IRA (AGI over $95,000 for single filers - $150,000 for joint filers), the nondeductible traditional IRA is still a viable option for retirement savings.

While a comparison of results for a deductible traditional IRA and a Roth IRA is not so dramatic, generally, the Roth IRA will provide superior results. For example, assuming an individual contributes $2,000 per year to a Roth IRA, the account will grow to $91,524 after twenty years at an 8% annual rate of return. This entire balance could be distributed tax free. If the same individual were to contribute $2,000 per year to a deductible traditional IRA, the same balance would result, but would be subject to tax upon distribution. At a 28% tax rate, the after-tax balance would be $65,897. Of course, the individual would be able to take a tax deduction for the traditional IRA contribution, resulting in a savings of $560 per year at a 28% tax rate. If that $560 per year were invested at 8% (5.76% after accounting for the annual taxes of 28% on earnings) it would grow to $20,076, resulting in a total balance of $89,973 ($65,897 plus $20,076). Thus, the Roth IRA would provide an additional $1,551 ($91,524 minus $89,973).

Probably the most complex issue created by the advent of the Roth IRA is the possibility of converting existing traditional IRAs to Roth IRAs. Not only is an analysis of such a decision complex, it is fairly sensitive to a variety of factors and assumptions, including but not limited to: time remaining until retirement, return generated by investments, and especially, the assumed tax rate in retirement as compared with the individual's tax rate at conversion. In many instances, however, conversion can be especially beneficial if the individual has sufficient funds from other sources to pay the additional taxes that result from the conversion.

For example, assume an individual that qualified for conversion has a traditional IRA with a $100,000 balance. Assuming further that this entire balance is the result of deductible contributions and plan earnings, the $100,000 would have to be included in income upon conversion. If the individual is in a 28% tax bracket, the resulting tax would be $28,000. Paying the tax from non-IRA sources means that the entire $100,000 balance is converted to a Roth IRA and continues growing. Assuming an 8% annual rate of return, the IRA would grow to $466,096 in twenty years. Of course, this entire balance would be available for tax free distribution. If instead, the individual chose to leave the $100,000 in the traditional IRA, it would still grow to $466,096 in twenty years at 8%; however, distributions would be fully taxable. If the individual is still in the 28% bracket at the time the money is withdrawn, only $335,589 would be available after taxes. To make the comparison more valid, it would be necessary to assume that the individual choosing not to convert the IRA would invest the $28,000 otherwise needed to pay taxes for the conversion. This $28,000 would grow to $85,820 after twenty years assuming an 8% annual return (reduced for annual taxes at 28%). The after-tax value of the traditional IRA balance of $335,589 plus the $85,820 totals $421,409, which is substantially less than the Roth balance of $466,096. This example assumes the individual is in the same tax bracket in retirement as at the time of conversion. The advantage of the Roth IRA would be smaller (or negative) if the tax rate in retirement is lower than at the time of conversion. Unlike traditional IRAs, the Roth IRA does not require minimum distributions beginning at age 70 1/2. As a result, the Roth IRA appears to be a potentially powerful tool for passing significant assets to heirs, providing yet another good reason that some individuals should look closely at the possibility of converting.

Individuals considering conversion of traditional IRA balances should be careful to ensure that they will fall below the $100,000 threshold in the year of conversion since there are apparently no provisions in the law that allow a conversion to be "undone." In fact, some taxpayers may need to employ tax planning techniques that will shift income out of the year conversion is planned in order to ensure that their AGI will be less than the prescribed threshold.

Conclusion

The 1997 Tax Act contains numerous complex features. As a result of its passage, however, there are now more options for tax-advantaged retirement savings than ever before. Unfortunately, this bounty of options comes at a cost. Taxpayers will have to be much better informed and more vigilant to take advantage of the options available to them. In several instances, the appropriate choice among alternatives will not be readily clear. In such instances, the need for complex analysis will present opportunities for accountants and financial planners. Additionally, taxpayers will have to maintain accurate detailed records of contributions, etc., in order to comply with the requirements associated with the various tax provisions, i.e., the amount and timing of contributions to various IRAs, as well as the amount and timing of distributions.

(Editor's Note: The following checklist compiled by NSA member Jeanne Nicholson is reprinted here to provide a quick reference guide as you maneuver through this tax season's changes to the tax law.)

Taxpayer Relief Act Of 1997 - Checklist Reference Guide

On August 5, 1997, President Clinton signed the Taxpayer Relief Act of 1997. The bill's targeted tax cuts are designed to help taxpayers who have children, who own closely-held businesses, college students, investments, and estates in the planning stage.

The complicated legislation has been described as "one of the biggest nightmares in the accounting world." Accountants should heed the advice to please be careful At this date and time, the new tax rules come only from statutory language and Congressional committee reports. A Technical Corrections Act has been introduced by the House Ways and Means Committee, but has not been enacted into law. Tax practitioners must carefully study the provisions relating to this filing season.

A) SUMMARY OF THE TAXPAYER RELIEF ACT OF 1997:

Capital Gains

Effective May 7, 1997, the largest approved capital gains tax.

Tax brackets for capital gains in 1997 are subject to date of the asset sale, then to holding periods.

Examples are:

1) Long-term capital gains recognized before May 7, 1997, will be taxed at a maximum 28% rate if held a total of more than 12 months.

2) Net long-term capital gains recognized after May 6, 1997 and before July 29, 1997, are taxed at the maximum 20% rate, if the capital item has been held more than 12 months.

3) For taxpayers below the 28% tax bracket, the capital gains rate will be 10%, if the asset has been held a total of more than 18 months.

4) A capital asset bought after year 2000, and held for more than five years, will be taxed at 18%, or only 8% for taxpayers in a tax bracket below 28%.

5) Collectibles (i.e., art, rugs, antiques, metal, gems, stamps, coins, alcoholic beverages and so forth) sold before May 7, 1997, which had been held for 12 months or less, are taxed at the maximum tax rate. Held 12 months, but not more than 18 months, tax rate maximum 28% rate. Items held more than 18 months will be taxed at a maximum 28% rate.

6) Depreciable real estate, with depreciation previously taken, will be taxed at a maximum tax rate of 25%.

7) Dates are very important when reporting long-term capital gains using the installment sales method. Principal payments after May 6, 1997, will qualify for the new tax rates, even if the original sale occurred before May 7, 1997. If you have a pass-through entity, you qualify for the new capital gains treatment, if the entity-sold asset or recognized the gain under the installment method, after May 6, 1997.

8) Qualified small business stock issued after August 10, 1993 held less than 12 months will be taxed at the maximum rate. Held more than 12 months, but not more than 18 months, taxed at the maximum rate of 20% if sold after May 6, 1997 but before July 29, 1997; if sold after July 28, 1997, taxed at the maximum rate of 28%. If stock is held over 18 months, but not more than five years, after May 6, 1997 tax, rate maximum rate will be 20%. More than five years the maximum rate of 14% applies. Note: All capital gains subject to the 20% maximum rate are taxed at a 10% rate to the extent they would be in the 15% tax bracket.

9) Taxpayers who sell their home after May 6, 1997, can no longer rollover their gain in two years, nor take the $125,000 over age 55 exclusion. Taxpayers selling a principal residence after May 6, 1997 may exclude $250,000 if filing single, and $500,000 if married filing jointly, of the gain from taxable income. The only limit and exceptions are, you must have owned and occupied your home as your principle residence for at least two of the five years preceding the sale. The advantage of this exclusion is you may use this exclusion every two years. Again watch the dates bought and sold of each capital gain.

Child Tax Credit

10) Effective 1998, Tax Credit for Children under age 17:

For taxpayers filling a joint return with modified adjusted gross income of $110,000 or less will be entitled to a $400 tax credit for each child who is under age 17 (adjusted gross income of $75,000 for taxpayers filing single or head of household). Effective 1999 the credit increases to $500. The credit phases out once modified adjusted gross income exceeds $110,000 on a joint return, and $75,000 on a single return. As of this date there is no Technical Correction for this credit.

Home Office Deductions

11) Effective 1999, Home Office Deductions definition of a qualifying home office for tax purposes are easier. Congress has expanded the rules of a qualifying home office for tax purposes. This new rule should substantially increase the number of taxpayers who can deduct depreciation, insurance, utilities, and repairs and maintenance for home office. As of this date there are no Technical Corrections for this new definition of home office.

Education Credits

12) Effective 1998, the mileage rate of 14 cents per mile may be used for a charitable purpose. Effective 1998, the Hope Tuition Credit, for post high school education expenses for yourself, your spouse, or a dependent child. A credit of up to $1,500 per student, per year. This credit only applies to qualifying expenses during the first two years of post secondary education in a degree or certification program. This tax credit phases out if your modified adjusted gross income is between $80,000 and $100,000 on a joint return; $40,000 and $50,000 for a single taxpayer. Tuition and fees paid after December 31, 1997 for academic periods after that date. As of this date there is not Technical Corrections for this credit.

13) Effective July 1, 1998, through to January 1, 2003 besides the Hope Tuition Credit, we have a new law creating a Lifetime Learning Credit of up to $1,000 per return. This credit equals 20% of the first $5,000 of qualified tuition and fees per year, with the same income phase out range as the Hope Tuition Tax Credit. After 2002, the credit will be increased.

14) Effective 1998, a new Education IRA will be available. This new IRA will allow someone to save for college expenses. Nondeductible contributions of up to $500 annually for each beneficiary of an Education IRA will be allowed to help fund future education expenses. Phase out amounts of gross income is between $150,000 and $160,000 on a joint return, and $95,000 through $110,000 on a single return. All earnings on your contributions held in the Education IRA, will be tax exempt. When the beneficiary withdraws these funds, he or she will have to pay income taxes and a 10% penalty on the income portion of the distribution unless the beneficiary incurs qualified post secondary education expenses for the year. Distribution will be tax free to the extent the distribution does not exceed the beneficiary's qualified education expenses (tuition, fees, books, supplies, room and board).

15) Effective 1998, you can deduct annually, whether or not you itemize deductions, up to $1,000 of interest on student loans. This phases up to $2,500 by year 2001. Limitations on deductions paid during the first 60 months those interest payments are required on the loan. For pre-existing qualifying loans, interest payments will be deductible to the extent if the 60-month period has not expired. The interest payment is phased out with adjusted gross income between $60,000 and $75,000 on a joint return, and $40,000 and $55,000 on a single return.

IRAs

16) Effective 1998, the new Roth IRA, will become another savings option, you may contribute up to $2,000 for your self and an additional $2,0000 for your spouse, if your combined compensation is at least equal to the contributed amount. Phased out if your adjusted gross income is between $150,000 and $160,000 for joint filers, and $95,000 and $110,000 for single filers. If Roth IRA is maintained for at least five years, you can withdraw funds completely tax free if you meet these conditions, (1) Age 59 1/2, (2) distribution results from your death or disability, or (3) distribution is for first time home buyer expenses.

17) Effective 1998, the phased out amounts will increase to $50,000-$60,000 for joint filers, and $30,000-$40,000 if single for IRA deductions if you are an active participants in your employer's retirement plan. Increased amounts up to $80,000-$100,000 on a joint return and $50,000-$60,000.00 if single by 2007.

18) Effective 1998, married taxpayers, if your adjusted gross income does not exceed $150,000, you will be able to contribute to your IRA if you are not covered by your employer's plan, even if your spouse is covered. IRA deduction is phased out between $150,000-$160,000 of adjusted gross income.

Other Provisions

19) Effective 1997, 40% of self-employed taxpayers the health insurance deduction will increase after 1998, 1998-1999 45%, 2000-2001 50%, 2002 60%, 2003-2005 80%, 2006 90%, 2007 100%.

20) Effective 1998, corporations will qualify for AMT Relief for Businesses. To qualify for this exemption, you must have gross receipts of five million or less for the preceding 3-year period beginning after December 31, 1994. If the corporation originally meets the five million tests, it will continue to be exempt from AMT so long as its average gross receipts do not exceed 7.5 million. For property placed in service after December 31, 1998, the new law states that all taxpayers use the same depreciation recovery periods for AMT and regular tax purposes.

21) Effective June 1, 1997 till June 30, 1998 the research and experimental tax credit are extended.

22) Effective June 1, 1997 till June 30, 1998 the special tax break for charitable contributions of qualified appreciated stock to private foundations is extended.

23) Effective October 1, 1997 till June 30, 1998 the work opportunity tax credit is extended.

24) Effective May 31, 1997 and is extended permanently for expenses for the orphan drug credit.

25) Effective June 30, 1997 till May 31, 2000 is extended for the qualified education assistance fringe benefit.

26) Effective July 1, 1998 extended deadline for EFTPS form 9779.

27) Effective January 1, 1998 and before May 1, 1999 the new welfare to work tax credit. Workers who previously received welfare benefits, may be entitled to a new tax credit of up to $8,500 per qualified employee. The credit is 35% of the first $10,000 of eligible wages in the first year of employment, and 50% of the first $10,000 of eligible wages in the second year.

28) The effective subjects for the tax year 1997 are:

Capital Gains Sale of Personal Residence Short Sales of Appreciated Stock Extension of Business Credits

Employer Education Assistance Extended 15% Excess Pension Distribution Increase

Health Insurance Deduction Increase NOL Carry back/Carryforward Inventory Shrinkage Clarification

B) SUMMARY OF THE TAX TECHNICAL CORRECTIONS ACT OF 1997:

1) Capital Gains: The Act seems to say those capital gains netting proceeds will work as first described with the original Taxpayer Relief Act of 1997, it amends statue 1223 (11)(b) to provide that property acquired from a decedent has a holding period of more than 18 months.

a) Example: Any property inherited, by taxpayer must be held more than 18 months to qualify for this tax cut.

2) Sale of Principal Residence in the Tax Technical Corrections Act of 1997, to the taxpayer who owns their home on August 5, 1997, and sells the home before the two year use and ownership requirement is met or where someone sells their home because of illness, change of employment, or other unforeseen circumstances. The 1997 Act, amends this to say to say that the maximum exclusion is prorated.

a) Example: If a single taxpayer has a $100,000 gain on a residence they owned on August 5, 1997 and they have only owned and used the residence for one year at the date of sale, the entire gain would be excluded. The Technical Corrections Act of 1997, says that this taxpayer would be entitled to an exclusion up to 1/2 the maximum $250,000 exclusion, 1/2 of $250,000 is $125,000.00, making the entire exclusion excluded.

3) Roth IRAs, is amended so that penalties apply if amounts rolled from a regular IRA to a Roth are attributable to amounts withdrawn within the 5-year period beginning with the year of conversion, the amount withdrawn would be subject to the 10-percent early withdrawal tax, and in case of conversions to which the 4-year income inclusion rule applies, an additional 10 percent. This closes the door to the loophole in the original Act. The penalty of 20% makes withdrawing from the Roth Rollover Account within five years of rollover not favorable to the taxpayer, and makes the idea of savings and not withdrawing a better choice for the taxpayer.

4) Effective after 1997, hardship withdrawals from 401K plans may not be rolled to an IRA. The Act provides that distributions from cash or deferred arrangements made because of hardships of the employee are not eligible rollover distributions and may not be rolled over to any IRA.

5) Recently released Revenue Procedure 97-48 automatically allows a late S election without requiring the taxpayer to file a private letter ruling request, pay a user fee, or demonstrating "reasonable cause" for the late S election. Rev. Proc. 97-48 applies if you have the following conditions:

a) The corporation fails to qualify as an S corporation solely because the Form 2553 was not filed timely.

b) The corporation and all of its shareholders reported their income consistent with S corporation status for the year the S corporation elections should have been made, and for every subsequent taxable year.

c) The corporation has at least six months of time since the date on which the corporation filed its tax return for the first year the corporation intended to be an S corporation.

d) Neither the corporation nor any of its shareholders were notified by the IRS of any problems regarding the S corporation status within six months of the date on which the Form 1120S for the first year was timely filed.

6) Procedure Requirements for Automatic Relief, the corporation must file with the applicable service center, a completed Form 2553, signed by an officer of the corporation authorized to sign and all persons who were shareholders anytime during the period that the corporation intended to be an S corporation. On the top of Form 2553 you must state: "Filed Pursuant to Rev. Proc. 97-48." Attached to the Form 2553 there must be a dated declaration, signed by an authorized officer of the corporation, and all persons who were shareholders anytime during the period that the corporation intended to be an S corporation, attesting that.

a) The corporation and the shareholders reported their income consistent with S corporation status for the year the S corporation election should have been made, and for every subsequent taxable year, and

b) "Under penalties of perjury, to the best of my knowledge and belief, the facts presented in support of this election are true, correct, and complete."

A study of this Procedural Requirement required study in depth.

- Jeanne C. Nicholson Accredited Tax Advisor, Accredited Tax Preparer Member of the National Society of Accountants, NSA's Editorial Review Board and the North Carolina Society of Accountants.

John L. Crain, PhD, CPA (left), is the Charles Wesley Merritt Distinguished Professor of Accounting at Southeastern Louisiana University. He holds a doctorate in Accountancy from the University of Mississippi and has authored numerous accounting, taxation, and business-related articles that have been published in academic and practitioner journals.

William R. Simpson, PhD, CPA, is an Assistant Professor of Accounting at Southeastern Louisiana University where he primarily teaches taxation. He holds a doctorate in Business Administration with a major in Accounting from the University of Houston and has previously published tax-related articles.

Shawn Mauldin, PhD, CPA, CMA, CFP, is an Assistant Professor of Accounting at Southeastern Louisiana University. He holds a doctorate in Accountancy from the University of Mississippi.