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Taxpayer Relief Act of 1997

The Taxpayer Relief Act (TRA) of 1997 was a key piece of tax reform legislation. It changed the tax treatment of investment income, gave homeowners a tax break on the profits from the sale of their residences, and increased the tax incentives for saving for retirement. Its tax cuts benefitted a broad range of taxpayers.

The Act implemented tax policies intended to spur the country's economic development. It was also notable as the first fast-track reconciliation act passed by Congress.

Generally, the TRA:

  • Lowered rates for long-term capital gains tax rate
  • Instituted a child tax credit
  • Provided homeowners with an exemption on the profits from the sale of their principal residence
  • Increased the estate tax exemption
  • Provided for additional exemptions in other areas of the tax code

The TRA only changed the federal tax code, but many states have passed their own versions of the Taxpayer Relief Act. These versions apply to state taxes and taxes imposed by local governments, such as state and local property taxes.

The following is an overview of the most significant tax provisions of the TRA. See FindLaw's Tax Law section for more articles and resources, including Tax Exemptions and Ten Ways to Lower Your Taxes.

Reductions in Individual Capital Gains Rates

The TRA reduced the tax rates for long-term capital gains. Long-term capital gains are the profits you earn from an asset you have owned for more than one year. The TRA made a series of changes to capital gains rates:

  • For property held for more than 18 months, the 20% maximum tax rate applied (10% for those in the 15% bracket)
  • Applied a 25% maximum rate to gains on the disposition of real estate assets otherwise eligible for the 20% rate
  • Made taxpayers in the 15% bracket eligible for an 8% maximum rate on capital assets without marking to market property acquired before 2001
  • The 28% maximum rate continued 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 could be rolled over tax-free if the seller reinvested the proceeds in new qualifying small business stock. Also, the excluded portion was no longer subject to the alternative minimum tax
  • Capital gains of up to $250,000 ($500,000 for joint filers) on a sale of a principal residence could be excluded from gross income every two years
  • The alternative minimum tax capital gain rate was set to the same amount as the new regular capital gain rates

Estate and Gift Tax Relief

1. Increased the Unified Credit Against Federal Gift and Estate Taxation: The unified estate and gift tax credit was increased to permit each U.S. citizen to make tax-free transfers of up to $1,000,000. Thus, with proper planning, a married couple could 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 could 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 needed to meet several requirements:

  • The decedent must be a U.S. citizen or resident (at the 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 their family members. 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 materially participated in and owned the business for at least five of the eight years before the decedent's death.
  • The business interest must pass to a qualified heir.

3. Increased Gift Tax Annual Exclusion: The TRA provided that the annual gift tax exclusion be adjusted for inflation.

4. Finality of Gift Tax Valuation: The act precluded the IRS from adjusting the value of a lifetime gift properly reported on a gift tax return for which the statute of limitations had expired.

Student Loans

The TRA provided a tax deduction for the interest paid on student loans.

Individual Retirement Accounts (IRAs)

The TRA changed the rules governing existing IRA investment products and savings accounts to increase their accessibility, expand the availability of IRAs, create new types of IRAs, and significantly broaden the range of penalty-free IRA distributions a taxpayer could take:

  • Increased Deductibility of IRA Contributions: An individual who was not an active participant in a qualified retirement plan could contribute up to $2,000 per tax year to an IRA and claim a deduction.
  • Roth IRAs: Contributions to a Roth IRA were not deductible, but earnings on Roth IRAs were not immediately subject to federal income tax. Moreover, a contributor to a Roth IRA could withdraw funds, including both contributions and earnings, from a Roth IRA tax-free beginning at age 59-1/2 if at least five years had passed since the first contribution.
  • Education IRAs: Parents could 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 was established was under 18.
  • Penalty-Free Withdrawals for Education and First Home Buyers: Withdrawals from traditional IRAs could 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.

Child Tax Credit

The TRA provided a $500 per child tax credit for parents with children under 17 that was phased out for higher-income taxpayers. For taxpayers with one or two children, the credit should be calculated before the earned income tax credit to provide for the maximum possible tax benefit.

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 provided an exemption from the corporate alternative minimum tax (AMT) for small businesses, as defined by the IRS. Additionally, the TRA conformed the depreciable life of property for AMT purposes to the depreciable life of similar property used for regular corporate income tax purposes.

ESOP, Pension, and Employee Benefit Provisions

The application of the unrelated business taxable income rules to S corporation income allocated to an employee stock ownership plan (ESOP) shareholder was repealed. Thus, ESOPs could be shareholders of S corporations.

The law also increased the prohibited transaction excise tax for qualified plans and disqualified pensions from 10% to 15%. Further, the TRA required broader diversification by 401(k) plans and investment of elective deferrals in stock of the 401(k) employer.

Changes To Net Operating Loss Rules

Subject to certain limited exceptions, the TRA limited the net operating loss (NOL) carryback period to two years rather than the three years permitted under prior law. It also extended the NOL carryforward period from 15 years to 20 years.

Lifetime Learning Credit

The lifetime learning credit could be claimed for qualified tuition and related expenditures paid to an institution of higher education for an undergraduate, graduate, or professional degree.

Can the TRA Benefit You? An Attorney Can Help You Find Out

Tax law can be very confusing and mistakes can cost you an enormous amount of money. Contact a local tax attorney to discuss whether you could benefit from any of the changes in tax law implemented by the TRA to ensure you are receiving the greatest possible tax savings.

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