Taxpayer Relief Act of 1997
The Taxpayer Relief Act (TRA) of 1997 provides tax benefits that affect a broad range of taxpayers. Generally, the law lowered rates for capital gains tax; instituted a child tax credit; exempted taxation on the profits from selling a personal residence (with limits); increased the estate tax exemption; and provided for additional exemptions in other areas of the tax code.
Reductions in Individual Capital Gains Rates
The TRA reduced capital gains tax rates in a number of different ways, including:
- For property held over 18 months, the 20% maximum rate applies (10% for those in the 15% bracket).
- A 25% maximum rate will apply to gains on the disposition of real estate assets otherwise eligible for the 20% rate.
- Taxpayers in the 15% bracket are eligible for an 8% maximum rate on capital assets without marking to market property acquired before 2001.
- The 28% maximum rate continues to apply to the sale of collectibles held for more than one year.
- Gains from the sale of certain small business stocks held more than six months can be rolled over tax-free if the seller reinvests the proceeds in new qualifying small business stock. Also, the excluded portion is no longer subject to the alternative minimum tax.
- Capital gains of up to $250,000 ($500,000 for joint filers) on the sale of a principal residence may be excluded from gross income every two years.
- The alternative minimum tax capital gain rates are now the same as the new regular capital gain rates.
Short Sales "Against the Box" Now Immediately Taxed
Any short sale of securities by a taxpayer which the taxpayer already owns (referred to as a "short sale against the box") is treated as an actual sale of the original shares. Under prior law, the proceeds of such a sale were not considered received, and thus no capital gain resulted until the short position was closed out by replacing the securities that were borrowed to make the short sale.
The new constructive sale rule also applies to an "equity swap," a transaction in which the owner of securities exchanges the return on such securities for the return on a pool of securities held by another or for the return on an indexed portfolio for an agreed-upon period of time.
Estate and Gift Tax Relief
1. Increase in the Unified Credit Against Federal Gift and Estate Taxation: The unified estate and gift tax credit was increased in order to permit each U.S. citizen to make tax-free transfers of up to $1,000,000. Thus, with proper planning, a married couple may make otherwise taxable transfers of up to $2,000,000 without paying a federal wealth transfer tax.
2. Family-Owned Business Exclusion: An estate's executor can elect to exclude the value of all or a portion of business interest in excess of the unified credit amount in effect at the time of death from the decedent's estate for federal estate tax purposes (up to a maximum of $1,300,000). In order to qualify for this exclusion, the family-owned business or farm must meet -- among others -- the following requirements:
- Decedent must be a U.S. citizen or resident (at time of death).
- The business must have its principal place of business in the United States.
- At least 50% of the business must be owned by the decedent and his or her family members; and if more than one family owns an interest in the business, either 70% must be owned by members of two families or 90% must be owned by three families.
- No stock or other security of the company can have been publicly traded within three years of the decedent's death.
- The decedent (or a member of the decedent's family) must have owned and materially participated in the business for at least five of the eight years prior to the decedent's death.
- The business interest must pass to a qualified heir.
3. Increase in Gift Tax Annual Exclusion: The annual gift tax exclusion now adjusted for inflation, and based on $1,000 increments.
4. Finality of Gift Tax Valuation: Under the act, the IRS is now precluded from adjusting the value of a lifetime gift which was properly reported on a gift tax return for which the statute of limitations has expired. This rule applies whether an individual actually paid a gift tax or merely used annual exclusions or a portion of the unified credit.
A taxpayer's ability to deduct the fair market value of appreciated publicly traded stock which is donated to a private foundation has been retroactively restored and extended through June 30, 1998. The deductibility of such amounts had previously expired for contributions after May 31, 1997.
Individual Retirement Accounts (IRAs)
The TRA changed the rules governing existing IRAs, expanded the availability of IRAs, created new types of IRAs altogether, and significantly broadened the range of penalty-free IRA distributions:
- Increased Deductibility of IRA Contributions: An individual who is not an active participant in a qualified retirement plan can contribute and deduct up to $2,000 per year to an IRA, even if the individual's spouse is an active participant in a qualified plan.
- Roth IRAs: Contributions to a Roth IRA are nondeductible, but like existing IRAs, earnings on Roth IRAs are not immediately subject to federal income tax. Moreover, a contributor to a Roth IRA may withdraw funds, including both contributions and earnings, from a Roth IRA tax-free beginning at age 59-1/2 if at least five years have passed since the first contribution.
- Education IRAs: Parents may establish an Education IRA for each child and make annual nondeductible contributions of up to $500 per IRA, provided the child for whose benefit the IRA is established is under the age of 18.
- Penalty-Free Withdrawals for Education and First Home Buyers: Withdrawals from traditional IRAs may be made for a taxpayer's qualified higher education expenses and those of the taxpayer's spouse, dependent child, or grandchild without being subject to the 10% penalty tax.
Repeal of 15% Penalty Tax on Excess Distributions and Accumulations
The 15% penalty tax on certain large lifetime distributions from IRAs and other qualified retirement plans was repealed.
Alternate Minimum Tax
The TRA provides an exemption from the corporate alternative minimum tax for small businesses, as defined by the IRS. Additionally, the TRA conforms the depreciable life of property for AMT purposes to the depreciable life of such property used for regular corporate income tax purposes.
Corporate Organizations and Reorganizations
The TRA limits certain previously tax-free "spin-off" transactions in which a corporation distributes to its shareholders stock of a controlled corporation. Gain is recognized at the corporate level on a spin-off which is part of a plan or series of related transactions in which one or more people acquire 50% or more of the vote or value of stock of either the distributing corporation or the controlled corporation. Any such gain is recognized immediately before the distribution equal to the amount which the distributing corporation would have recognized had the stock of the controlled corporation been sold at fair market value on the date of the distribution.
ESOP, Pension, and Employee Benefit Provisions
The application of the unrelated business taxable income rules to S corporation income allocated to an ESOP-shareholder is repealed. Thus, employee stock ownership plans may be shareholders of S corporations. The law also increases the prohibited transaction excise tax for qualified plans and disqualified pensions from 10% to 15%. Further, the TRA requires wider diversification by 401(k) plans and investment of elective deferrals in stock of the 401(k) employer.
Modification of Rules Regarding Net Operating Loss
Subject to certain limited exceptions, the TRA limits the net operating loss (NOL) carryback period to two years rather than the three years permitted under prior law and extends the NOL carryforward period from 15 years to 20 years.
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