The new tax act:




The New Tax Act: Complexity Outweighs Relief

P resident Clinton signed into law on August 5 the Taxpayer Relief Act of 1997 and the Balanced Budget Act of 1997. The bills, intended to balance the budget by 2002 by reducing government spending and providing $95 billion in tax cuts, make up the most comprehensive tax law changes since the Tax Reform Act of 1986. The most notable changes include a reduction in the capital gains tax for individuals, a child tax credit, estate tax relief and tax incentives for education.

To offset these cuts, the bills include $56 billion worth of revenue-raising provisions. At least three- quarters of the offsetting revenues come from the extension of air transportation excise taxes, while the rest comes from closing corporate loopholes.

Clinton also used his recently granted presidential line-item veto authority for the first time on two tax provisions and one spending provision. The tax provisions would have allowed U.S. investment companies to avoid paying taxes on certain income they earn overseas and agricultural businesses to avoid paying capital gains taxes on the sale of certain assets to farmers cooperatives. The vetoed spending provision would have allowed New York State to tax certain hospitals to finance its Medicaid program.


Keeping track
Although a number of tax simplification provisions are in the package, at more than 800 pages and 300-plus provisions—100 of which spell out the tax cuts—the bills do little to alleviate the concerns of those who lament the complexity of the tax code. The legislation is expected to generate new and revised regulations as well as more complicated tax forms.

"Because of its complexity and difficulty, I expect to see another popular movement toward a flat tax," said Janice Johnson, director of D. S. Wolf Associates in New York City. "CPAs will have to study this legislation in small doses, and they must tenaciously access as much information on the changes as possible (see the online research box, below).

Michael E. Mares, a partner of Witt, Mares and Co. in Newport News, Virginia, and chairman of the tax executive committee of the American Institute of CPAs tax division, said the complexity would cost taxpayers, practitioners and the government. "As a source of frustration for taxpayers, the bills could lead to cynicism and disdain for compliance." He also said tax professionals would incur significant costs to learn the new provisions, "not to mention the costs of updated software and publications" reflecting the new law. "While some simplification provisions are worthy, they are far outweighed by the complexities that permeate most of the changes," said Mares.

Research Online

Check out these useful Web sites for more on the Taxpayer Relief Act of 1997.

American Institute of CPAs
http://www.aicpa.org

Bureau of National Affairs
http://www.bna.com

CCH
http://www.cch.com

Ernst & Young
http://www.taxcast.com

Grant Thornton
http://www.gt.com

Joint Tax Committee
http://www.house.gov/ways_means/jtaxsum.htm

KPMG Peat Marwick
http://www.us.kpmg.com

Price Waterhouse
http://www.pw.com

Research Institute of America
http://www.riatax.com

Senate Finance Committee
http://www.senate.gov/~finance/summ.htm

Tax Foundation
http://www.taxfoundation.org


Principal provisions for taxpayers
Capital gains. The bills reduce the top tax rate on capital gains for individuals from 28% to 20%, or to 10% for taxpayers in the lower income bracket. The lower rates apply to assets held for at least 18 months, beginning July 29, 1997. The 28% rate, or 15% for taxpayers in the lower bracket, will apply to the sale or exchange of capital assets held for more than 12 months but less than 18 months.

Patrick G. Heck, senior manager of Ernst & Young in Washington, D.C., told the Journal that although this provision may be beneficial to certain taxpayers, "Congress took something that was relatively simple and created eight tax rates and four different holding periods."

Other specialized capital gains rates and holding periods include those for the alternative minimum tax (AMT) treatment, the treatment of home sales and the sale of qualified small business stock. Taxpayers also will be able to exclude $250,000 ($500,000 for married couples filing joint returns) of gain realized on the sale or exchange of a principal residence.

Child tax credit. The bills provide a $500 credit for each qualifying child under age 17. The credit would start to phase out for single taxpayers with adjusted gross incomes (AGIs) of $75,000 ($110,000 for married taxpayers filing joint returns) and be fully phased out for single taxpayers with one child with AGIs in excess of $85,000 ($120,000 for joint filers). The phase-out maximum increases by $10,000 for each additional child. However, in 1998 the tax credit will be only $400 and will be fully phased out for single taxpayers with AGIs in excess of $82,000 ($118,000 for joint filers).

Complexities abound in this provision as well. According to the tax divisions Mares, a taxpayers ability to use the full child credit depends on his or her AMT liability, because the credit cannot be used to reduce the AMT. "To determine whether the credit is of any benefit, taxpayers must calculate their AMTs and compare their regular tax liabilities, reduced by the child credit, with the minimum tax liability," said Mares.

Estate taxes. A unified credit increases the value of assets exempt from the gift and estate tax from the present $600,000 up to $1 million by 2006. The changes will be effective for decedents dying, and gifts made, after December 31, 1997.

The bill also allows an executor to elect special estate tax treatment for qualified family-owned business interests. However, the interests must comprise more than 50% of a decedents estate.

The provision excludes the first $1.3 million of value in qualified family-owned business interests for a decedents taxable estate.

Other provisions in the bills that affect small business include

  • An accelerated phase-in of health insurance deductibility for the self-employed.

  • An expansion of the home office deduction.

  • An exemption from the AMT.

  • An extended deadline of July 1, 1998, for small business owners who do not file taxes electronically under the Electronic Federal Tax Payment System.

Expanded IRAs. A new type of individual retirement account, named after Senate Finance Committee chairman William V. Roth, Jr. (R-Del.), allows individuals to opt to contribute to a special "backloaded" IRA—contributions are not deductible, but qualified distributions of the earnings are tax free. Again, this provision has a number of eligibility requirements.

The rules on deductible IRAs also have been liberalized to make the investments available to more people. For example, the phase-out ranges for deductible IRA contributions have increased. "CPAs must be very careful about many of the specific eligibility requirements in the IRA provisions," said Johnson, citing as an example taxpayers who start contributing to the Roth IRA when they are age 58 but are not eligible for distributions at 5912. "Those taxpayers must wait five years before they can remove their money tax free," said Johnson.

Other changes of interest to individuals include education tax incentives such as the HOPE scholarship tax credit, which provides a nonrefundable credit for eligible higher education expenses, and a lifetime learning credit, which is equal to 20% of qualified tuition and fees incurred by the taxpayer, the taxpayers spouse or any dependents.

Estate Tax Relief

EFFECTIVE TRANSFER-TAX
EXEMPTIONS

For decendents dying and gifts made in Effective exemption
1998 $ 625,000
1999 650,000
2000-01 675,000
2002-03 700,000
2004 850,000
2005 950,000
2006 and after 1,000,000

Both bills extend several tax provisions that were slated to expire this year, such as the

  • Research and development credit.

  • Charitable contribution deduction for gifts of stock made to private foundations.

  • Exclusion from income of qualifying employer-sponsored educational benefits.

  • Work opportunity credit.

Managing the changes
Many provisions actually do simplify current tax policy. For example, many foreign tax credit rules, including new holding period requirements and translation rules, have been clarified to reduce compliance costs. According to Mares, while most of the provisions are intended to serve different, useful tax policies, the question is "whether Congress gave any thought to a simpler way to achieve the same goals." Nonetheless, practitioners and taxpayers will find theyll need a lot of time to digest the massive changes Congress and the Clinton administration have enacted.


TAX NEWS

New IRS Restructuring Bill

L egislation was introduced in both the House and the Senate to implement the recommendations of the National Commission on Restructuring the Internal Revenue Service. The legislation (HR 2292 and S 1087), introduced by a bipartisan group of lawmakers, would significantly change the way the IRS is governed. The commission published its recommendations on June 25 (see "IRS Restructuring Commission Calls for Independent Oversight Board; Treasury Strongly Disagrees," JofA, Aug.97).

Treasury's point of view

The Treasury Department has criticized the proposal to create an independent board, arguing that it would remove the Internal Revenue Service from executive branch oversight. The Treasury is expected to introduce its own legislative proposal later this summer that would establish an IRS advisory board to act as public trustees and issue an annual report on the state of the IRS.

The Internal Revenue Service Restructuring and Reform Act of 1997 spans a broad range of IRS operations, including internal management, taxpayer rights, tax law complexity and hiring flexibility. Its sponsors, Senators J. Robert Kerrey (D-Neb.) and Charles E. Grassley (R-Iowa) and Congressman Rob Portman (R-Ohio) and Benjamin L. Cardin (D-Md.), have high hopes for passage of the measure this year.


New oversight proposal
The legislation would establish within the Department of the Treasury a nine-member oversight board, including the secretary of the treasury and a representative from the National Treasury Employees Union along with seven members from the private sector. The oversight board would govern the IRS but would not involve itself in tax policy decisions, law enforcement activities and procurement issues. The board also would appoint the IRS commissioner to a five-year term and require the commissioner to consult with the board on major operational and management decisions. "The oversight board is an important mechanism for ensuring the taxpayer service improvements weve recommended are implemented and sustained over time," said Senator Portman.

The legislation also would establish a performance management system to provide more flexible guidelines for hiring and firing. It would give the commissioner additional freedom to bring in a new team and give upper management more incentives for good performance. According to a restructuring commission spokesperson, the point of this performance-based system is to reward people for achieving the IRSs objectives.


Help for practitioners and taxpayers
The legislation would require the IRS to implement a plan to eliminate barriers and provide incentives to increase electronic filing over the next 10 years. This includes a requirement to accept electronically filed returns without signatures until the IRS develops procedures for the acceptance of digital signatures. Also, form 1040 schedules that cannot be received electronically would be treated as worksheets that would not have to be submitted. Instead, taxpayers would hold them as records in the event of audits. The legislation also would mandate the formulation of an electronic commerce advisory group.

Taxpayers also should benefit from a number of new taxpayer rights provisions. For example, the IRS taxpayer advocate would be authorized to issue taxpayer assistance orders (TAOs) to help in certain situations, such as in liens and the recovery of certain costs and fees. The legislation also would eliminate the differential in the interest rates for overpayments and underpayments.

To reduce the complexity of the tax code, the legislation would require Congress to perform a tax complexity analysis when drafting new legislative proposals. It also would require the Joint Committee on Taxation to study the feasibility of developing an estimate of taxpayers compliance burdens to be used when future legislative proposals are introduced.

For more information on the IRS restructuring and reform act of 1997, visit the IRS restructuring commissions Web site at http://www.house. gov/natcommirs/main.htm/ .

IRS Implements Taxpayer Rights Bill

T he Internal Revenue Service released final rules implementing a number of miscellaneous provisions of the Taxpayer Bill of Rights 2 and an amendment in the Personal Responsibility and Work Opportunity Reconciliation Act of 1996 that affect filing of returns, court costs, payments, deposits and collections.

The final rules alter sections of the Internal Revenue Code relating to joint returns, property exempt from levy, penalties, interest, offers in compromise and the awarding of costs and certain fees. The IRS received only one comment regarding the changes and, according to language in the final rules, the amendments should not have a significant economic impact on small businesses.

The regulations were made effective July 22, 1997. Copies of the amendments are available on the IRS Web site at http://www.irs.ustreas.gov .


TAX FILES

United States and Ireland Agree

  • The United States and Ireland signed a new income tax treaty and protocol in Dublin. Although the treaty is similar to ones the United States has with other countries, the United States preserves the right to impose a tax on U.S. branches of Irish corporations. The agreement also provides for the deductibility of cross-border contributions by a temporary resident of one country to certain pension plans in the other.

Payment Overdue

  • The collection financial standards used by the Internal Revenue Service to help determine a taxpayers ability to pay a delinquent tax liability are now available online. Standard allowances for food, clothing and other items apply nationwide, except for Alaska and Hawaii. Taxpayers are allowed the total national standards amount for their family size and income level without questioning the amounts actually spent. The standards are available on the IRS Web site at http://www.irs.ustreas.gov .



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