by Alfred Giovetti

The Taxpayer Relief Act of 1997 (the Act) contains the most sweeping changes to the nation's tax laws since 1986. Major provisions of the Act include capital gains reform, expanded tax breaks when selling a home, expanded Individual Retirement Accounts (IRAs), a child credit, education tax breaks, and estate and gift tax reform. The effective dates of these changes are phased-in over the next 10 years.

Capital gains tax rates are cut under the Act, but under a complicated set of rules. For assets bought before the year 2001, long-term capital gains generally will not be taxed at a rate higher than 20%. Assets sold after July 28, 1997 must be held for 18 months in order to qualify for the new rates; otherwise, the old capital gain rules apply (maximum 28% rate). For assets purchased after the year 2000 and held for at least 5 years, the capital gain rates are lowered to a maximum 18%.

For sales after May 6, 1997, the new law allows you to exclude from income gain on the sale of your principal residence of up to $250,000 ($500,000 if you are married and file a joint return). Old rules regarding rollover of gain into a new residence and the one-time $125,000 exclusion of gain have been repealed. In order to qualify for the new exclusion, you must have used the home as your principal residence for at least 2 of the 5 years before the sale. You can use the exclusion once every 2 years. The exclusion is not available for any part of the residence you deducted as a home office or as rental property.

The deductibility of IRAs has been expanded for taxpayers covered by an employer pension plan. Previously, if your adjusted gross income (AGI) was between $25,000 and $35,000 (single) or $40,000 and $50,000 (joint), the deduction for your IRA was gradually eliminated. Staring in 1998, these AGI "phase-outs" are slowly increased, until they reach a range of $50,000 to $60,000 for single filers in 2005 and $80,000 to $100,000 for joint filers in 2007. More IRA changes: beginning in 1998, when one spouse is covered by an employer's pension but the other isn't, the "non-covered" spouse can deduct his or her IRA contribution. The deduction for the non-covered spouse phases-out when joint income is between $150,000 and $160,000.

A new type of IRA, called a Roth IRA, begins in 1998. After a 5-year holding period, withdrawals from Roth IRAs are tax-free and penalty-free if the distribution is made after age 59½ or on account of death, disability, or first-time home purchase. AGI phase-out limits apply. Unlike most other IRAs, taxpayers over age 70½ can contribute to a Roth IRA. The maximum total contributions to all IRAs -- deductible, nondeductible, and Roth -- is $2,000 per year. The law creates a new credit for children under age 17; $400 per child in 1998, and $500 thereafter. The credit phases-out once AGI exceeds $75,000 (single filers) or $110,000 (joint).

The Act contains two new credits for education expenses. Beginning in 1998, taxpayers can claim a HOPE tax credit of up to $1,500 per student (yourself, your spouse, and your dependent children) per year for tuition and related expenses during the first two years of post-secondary education. The Lifetime Learning credit allows taxpayers to take a tax credit of 20% on up to $5,000 ($10,000 after 2002) of qualified tuition and related expenses. AGI phase-out limits apply. Education IRAs are available in 1998 to help save for college expenses. Contributions are nondeductible and limited to $500 per year for each child under age 18. Distributions are tax-free as long as they do not exceed education expenses. AGI phase-out limits apply and funds remaining in the account at age 30 must be distributed with any earnings on the account subject to tax and penalty. However, remaining funds can be transferred before age 30 to an education IRA for the benefit of another family member.

The unified estate and gift tax credit, which exempts the first $600,000 of a decedent's estate from federal estate taxes, is gradually increased beginning in 1998. The credit exempts $625,000 in 1998 and gradually rises until it exempts $1,000,000 in 2006.

This information is provided as a public service, and should not be construed as individual accounting or tax planning advice. For information on how these general principles apply to your situation, please consult an accounting or tax professional.

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