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Byline: Deborah Adamson Daily News Staff Writer

Investors who reveled in this year's bull market have a few more things to cheer about: A cut in the capital gains tax rate, changes in laws on individual retirement accounts to allow more people to claim a tax deduction, and the Roth IRA.

Capital Gains

The Taxpayer Relief Act of 1997 cuts the long-term capital gains tax rate from 28 to 20 percent for those in the 28 percent and higher income tax bracket and from 15 to 10 percent for those in the 15 percent bracket. It's effective for the 1997 tax year.

To take advantage of this tax cut, individuals, estates and trusts must have sold the asset on or after May 7, 1997.

The asset must be held long-term - for more than 18 months if the sale occurred on or after July 29, 1997. If the sale was made before July 29, assets must be held for at least a year.

EXAMPLE: Mary bought 100 shares of XYZ Co. at $10 each on June 1, 1995, and sold it for $20 a share on Oct. 12, 1997. She made a profit of $1,000.

Since Mary is in the 31 percent income tax bracket, her capital gains tax is $200 - 20 percent of $1,000.

If an investor sold the asset after July 29 and owned it for more than a year but not more than 18 months, the tax rate of either 28 percent or 15 percent applies.

Let's say Mary also bought 10 shares of ABC Inc. for $80 each 15 months ago and sold them for $100 each on Aug. 1, 1997. The tax on her $200 profit is $56 - 28 percent of $200.

Here's another tidbit: Starting in 2001, the 20 percent rate will drop to 18 percent for assets acquired on or after Jan. 1, 2001, and held more than five years. So the earliest date to take advantage of this break will be Jan. 1, 2006.

For those in the lower income bracket, the rate drops from 10 percent to 8 percent if taxpayers sell the asset on or after Jan. 1, 2001. The asset has to be 5 years old, but ownership can start before 2001.

EXAMPLE: Frank, who falls into the 31 percent income tax bracket, bought 200 shares of TNT Corp. at $15 each on Feb. 1, 2001. He sells it for $25 a share on Aug. 10, 2007. His profit of $2,000 will be taxed at 18 percent. (If Frank were in the 15 percent bracket, his $2,000 would be taxed at 8 percent.)

A twist: Those in tax brackets of 28 percent and higher who have held the asset starting before 2001 can still get the 18 percent capital gains rate.

How? They must assume that the asset was sold on the first business day in 2001 and pay the applicable taxes on any profit realized.

In effect, they are prepaying the taxes. But if the sale later results in a loss, the loss is not tax-deductible.

Once taxes are paid, any future gain on the assets will be assessed at the lower rate of 18 percent, providing these assets have been held for at least five years.


Starting next year, more people can deduct their yearly contributions to individual retirement accounts.

Under current rules, not all taxpayers who have IRAs and belong to a company retirement plan can deduct their full IRA contribution from taxes. Those who make above a certain income see smaller or no deductions. The act will raise the income restriction so more people can take the deduction. Also, a taxpayer who doesn't belong to a company retirement plan will not be restricted if his or her spouse participates in such a plan. The taxpayer who doesn't belong to a plan will be able to take the full IRA deduction.

The rules: Single taxpayers with an adjusted gross income of less than $30,000 can deduct the full IRA contribution from taxes. Starting at $30,000, the tax deduction gradually decreases until it disappears at $40,000.

In the year 2005 and later, the restriction will range from $50,000 to $60,000. A taxpayer who earns less than $50,000 will be able to take the full deduction. It will start decreasing at $50,000 and disappear for those earning $60,000 and more.

EXAMPLE: Mildred, a 401(k) participant, earns $30,000 a year in adjusted gross income. Next year, she will put $2,000 in her IRA. The full $2,000 will be tax deductible. Under the old tax law, only $1,000 would be the allowed deduction.

Remember that adjusted gross income is not how much you make a year. Adjusted gross income is all income - wages, salaries, tips, taxable interest and other income - minus adjustments that are allowed, such as IRA deductions.

For married couples filing jointly, the new range will be $50,000 to $60,000 in 1998. In 2007 and later, it will go up to $80,000 to $100,000.

If one spouse does not participate in a company retirement plan, the phaseout range is $150,000 to $160,000 for married couples filing jointly.

EXAMPLE: Rudy makes an adjusted gross income of $130,000 a year. His wife, Heather, is a homemaker. She will be able to deduct the full $2,000 IRA contribution from her taxes. But Rudy won't do the same because his income will exceed the $60,000 limit for married couples in 1998.

Another gift from Congress: The 10 percent penalty for withdrawal of IRA funds before the age of 59-1/2 will be waived if the money is used for qualified higher education costs and first-time home-buyer expenses up to $10,000.

However, the IRA withdrawal will still be subject to income taxes.

Taxpayers will be able to tap their IRAs for tuition, books, supplies, fees and equipment at any educational institution beyond high school, such as a university, community college, vocational or postgraduate school. The money can be used for educational expenses of the taxpayer or his spouse, child or grandchild.

The amount of expenses that can be paid out of the IRA, however, must be reduced by any amount from a scholarship or other assistance that normally is not counted as part of gross income.

EXAMPLE: Sherry wants to withdraw from her IRA to help pay for her son's college education. His tuition, books and fees total $5,000 a year in a four-year college. He has a $1,000 annual scholarship, not counted as income.

The qualified educational expense is $4,000 annually - $5,000 minus $1,000 - or $16,000 for four years. Sherry can withdraw $16,000 without paying the 10 percent penalty. She still has to pay income taxes on the $16,000, however.

As for home buyers, a maximum $10,000 can be withdrawn penalty-free, but it must be used within 120 days to buy, build or rebuild the house. This privilege can only be used once in a lifetime. To qualify as a first-time home buyer, one cannot have owned another residence within two years before buying the house.

EXAMPLE: The Jordans bought a house in 1998. They previously owned a house in 1992, but moved out of it into an apartment. Their $10,000 IRA withdrawal is still free from the 10 percent penalty. Their new house qualifies as a first purchase because they weren't homeowners from 1996 to 1998.

Roth IRA

Named after the U.S. senator who introduced it - William V. Roth Jr., a Delaware Republican - the Roth IRA is a new type of individual retirement account available to taxpayers starting next year.

Unlike a regular IRA, the Roth IRA will be open to withdrawals, free of taxes and penalties, once a taxpayer has held the account for five years and met one of these conditions:

The taxpayer is at least 59-1/2 years.

The taxpayer dies and the money goes to a beneficiary.

The taxpayer becomes disabled.

The taxpayer uses the money to pay up to $10,000 toward first-time home purchase.

In addition, contributions will be allowed by an account owner past 70-1/2 if the taxpayer still works. Also, the taxpayer will not be forced to make withdrawals after 70-1/2 as required with a regular IRA.

The catch: Yearly contributions of up to $2,000 per person cannot be deducted from taxes.

To make the full $2,000 contribution, single taxpayers must have less than $95,000 in adjusted gross income. Those who make $95,000 to $110,000 can make limited contributions. The taxpayer cannot contribute to a Roth IRA if he makes more than $110,000.

Married couples filing jointly must earn less than $150,000 to put in $4,000 total per year. The contribution diminishes between $150,000 to $160,000. There is ineligibility past $160,000.

Taxpayers who already have a regular IRA can roll their money over to a Roth IRA unless they are married couples filing separately or, whether single or married, have an adjusted gross income of more than $100,000. They have to pay taxes on a rollover, but not the 10 percent penalty.

If the rollover is done in 1998, the taxable amount will be spread over four years and counted as income in each of those periods.

For example, if $50,000 in the IRA is rolled over, then $12,500 per year is counted as income in 1998, 1999, 2000 and 2001.

Remember that the yearly contribution to all IRAs should not exceed $2,000.

EXAMPLE: On his 40th birthday, Bob opens a Roth IRA and puts in $2,000 a year for 20 years. By the time he reaches 60, he will have accumulated $100,000 - $40,000 in contributions and $60,000 in earnings. He will be able to withdraw the money tax-free after becoming 59-1/2 and holding the account for at least five years.
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Article Details
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Title Annotation:BUSINESS
Publication:Daily News (Los Angeles, CA)
Article Type:Statistical Data Included
Date:Dec 15, 1997

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