Capital gains tax rates were substantially reduced by the 1997 Tax Act. Capital assets held for 18 months and sold after after July 28, 1997 are eligible for the new 20% tax rate. The old 28% rate continues to apply to long-term capital gains property held for more than a year but less than 18 months. Short-term capital assets (i.e., holding period less than a year) will continue to generate ordinary income. A special rule applies to capital assets sold between May 7 and July 28 of 1997: The 20% rate applies if they were held for one year (rather than 18 months).
The new capital gains rules relating to home sales will help most taxpayers, but certainly not all. A $500,000 exclusion for capital gain realized on the sale of a principal residence is now available to joint filers ($250,000 a single filer). The home must have been the primary residence of at least one spouse for the previous 2 years. (The 2-year rule can be finessed if “unforeseen circumstances” necessitated the move. However, the exclusion amount will be reduced, pro rata, to reflect the actual amount of time spent in the home.) Note that couples selling a home and realizing a gain of more than $500,000 ($250,000 for single filers) will no longer be permitted to “roll over” that gain by purchasing a more expensive new home within 2 years. [The new law applies to sales or exchanges of primary residences after May 6, 1997. However, taxpayers may elect to apply the old law with respect to sales or exchanges between May 7 and July 28, 1997.]
The 1997 Act also addresses estate and gift taxes. The lifetime exemption amount will rise to $625,000 in 1998. It is scheduled to reach $1 million in 2006, after yearly increments. The $10,000 annual exclusion has been indexed for inflation, in $1,000 increments. Small businesses are eligible for an estate tax exemption of up to $1.3 million, which amount includes the regular exemption. Estate tax attributable to small businesses may also be paid in installments for up to 14 years.
Other important provisions in the 1997 Tax Act:
¶ Self-employed individuals may deduct 40% of health insurance premiums in 1997. This amount is targeted to rise to 50% in 2000, and 100% by 2007.
¶ Doctors and others who conduct most of their business away from home will no longer see home office deductions fall prey to the “principal place of business rule.” The definition of principal place of business now includes “a place of business which is used by the taxpayer for the administrative or management activities of any trade or business of the taxpayer…”
¶ IRA rules have been changed:
First, rules relating to current IRAs have been modified. The 1997 Act raises the phase-out range to $30-40k for individuals, and $50-60k for joint filers, for taxpayers (or their spouses filing jointly), who are covered by a pension plan at work.
The new “Roth” IRA allows no deductions for contributions, but neither are withdrawals taxed if the account has been held for at least 5 years and the individual is at least 59 years old. Income limits of $95-110k for individuals and $150-160k for couples apply.
The new “education” IRA allows nondeductible contributions of $500 per child under 18 per year, in addition to contributions made to other IRAs. Withdrawals for higher education expenses are not taxed. Phaseout levels are the same as for the Roth IRA.
¶ A controversial provision governing independent contractors was dropped from the 1997 Tax Act. Critics claimed that the law would make it too easy for employers to classify workers as independent contractors, thus denying them health and pension benefits, as well as wage, hour and workplace safety protections.