About this series
Every Monday through April 13, the Enquirer will publish a series of articles to help taxpayers deal with income-tax filing season. Many of the articles will be written by Gary Klott, a nationally syndicated columnist from Louisville and the author of several books about taxes and personal finance.
TODAY - Overview of tax law changes. This season offers some of the most valuable tax breaks in a decade, as well as some of the most complicated new rules ever.
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Thanks to a flurry of tax legislation the past couple of years, this tax-filing season will offer individuals some of the most valuable new tax breaks in a decade - along with some of the most complicated new rules ever.
Embedded in 1997 income tax forms are more than a dozen new tax benefits for individuals, including capital gains tax relief for investors and home sellers.
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Tax relief is also in store for many parents who adopted a child last year, employees who received financial aid from their employers to attend night school, self-employed workers, homemakers, the chronically ill, philanthropists and retirees who made large retirement plan withdrawals.
And almost everyone will benefit to some degree from the annual inflation adjustments to the tax system.
The new tax benefits incorporated in 1997 returns represent the most tax relief for individuals since personal income tax rates were slashed a decade ago by the Tax Reform Act of 1986.
This tax season's benefits are far less sweeping than the cuts of a decade ago.
"Most of the tax breaks are targeted to particular groups, and therefore the average taxpayer won't see much of an impact," said Thomas Ochsenschlager, a Washington, D.C., tax partner at the accounting firm of Grant Thornton.
But for those who are eligible, he said, the impact from some of the new breaks can be substantial.
Investors could see their capital gains taxes slashed by as much as a third. A new adoption credit could yield as much as $5,000 to $6,000 in tax savings. And the home-sale exemption could mean as much as $100,000 in tax savings.
What's more, this tax season's relief is only a prelude to much more sweeping benefits next tax season as a result of the Taxpayer Relief Act of 1997. Most of the new law's benefits - including family tax credits, expanded Individual Retirement Accounts and various new tax breaks for college expenses - didn't take effect until the beginning of 1998.
A few of the new law's benefits, however, did take effect in 1997 and are incorporated in 1997 returns. Among them are lower capital gains rates for long-term investments and a new tax exemption that will protect most homeowners from ever having to pay a cent in tax on their home-sale profits.
Most of the other new benefits incorporated in 1997 returns stem from tax laws passed by Congress in 1996, including the Small Business Job Protection Act and the Health Insurance Portability and Accountability Act.
While this tax season promises to be a less taxing one, it also promises to be a more complicated one for millions of taxpayers.
Tax-law changes always bring new complications, with new rules to learn, new calculations to make and new forms to fill out. But a few of this season's changes might prove particularly confusing.
Chief among them are the new capital gains rules. While many investors will wind up paying less capital gains tax this season as a result of the new law, they'll be forced to fill out a radically revised form, Schedule D, that contains more than twice as many lines as last year's version.
And while the new capital gains rules for home sales should prove simpler in most cases, they can be perplexing in special situations, such as when a residence included a deductible home office.
But taxpayers shouldn't have much difficulty dealing with most of the other tax-law changes.
"Except for capital gains and related things like home sales, I wouldn't see it as being greatly more complicated this year," said Mark Luscombe, principal federal tax analyst for CCH Inc., a major legal publisher based in Riverwoods, Ill.
Here's a summary of the major tax-law changes incorporated in 1997 returns:
Capital gains: A new, lower capital gains rate of 20 percent - 10 percent for investors in the bottom 15 percent income-tax bracket - applies to most types of investments held more than one year if sold between last May 7 and July 28. Investments sold after July 28 must have been held more than 18 months to qualify.
Home sales: For principal residences sold on or after last May 7, up to $500,000 in home-sale profits - $250,000 for single individuals - are generally exempt from capital gains tax.
Employer tuition assistance: The tax exemption for employer-provided educational assistance, which lapsed June 30, was given a three-year extension. As before, up to $5,250 a year in employer educational assistance is tax-free to the employee, but only for undergraduate-level courses.
Adoption credit: To help with the often-considerable cost of adopting a child, parents with adjusted gross incomes of up to $115,000 are eligible for a new tax credit for up to $5,000 in adoption expenses - $6,000 for a "special needs" child.
IRA parity for homemakers: For one-income married couples, the limit on annual contributions to Individual Retirement Accounts has been raised from $2,250 to $4,000, the same limit that has long applied to two-earner couples.
Long-term care: Payments for long-term care services provided to the chronically ill are now eligible for the itemized medical deduction. Premiums paid for certain long-term care insurance policies also become eligible for the medical deduction.
Self-employed health-insurance deduction: Congress increased the special self-employed health-insurance deduction to enable eligible business owners to deduct 40 percent of their health premiums on the front of Form 1040 without having to qualify for the itemized medical deduction. The deductible limit was 30 percent in 1996.
Business equipment: Self-employed individuals and other small businesses can immediately write off up to $18,000 of 1997's equipment purchases rather than having to depreciate their cost over a period of years. The previous limit for first-year "expensing" was $17,500.
Large retirement plan withdrawals: Large withdrawals from IRAs and other retirement plans are no longer subject to an extra 15 percent excise tax. Before 1997, the 15 percent tax was imposed on retirement-plan withdrawals to the extent that they exceeded $155,000 in a single year - $775,000 for certain lump-sum distributions. Car deductions: The IRS standard mileage rate for business use of a car has been increased to 31.5 cents a mile for 1997, from 31 cents in 1996.
Employee taxes: Higher-paid workers will see a bit more of their wages eaten up by Social Security tax. Employees pay Social Security tax at a rate of 6.2 percent on the first $65,400 of their wages for 1997, up from $62,700 in 1996.
Employee parking: For employees who received free or subsidized parking at work from their employer, the tax-exemption for the fringe benefit has increased to $170 a month, from $165 a month in 1996.
Inflation adjustments: As is the case each year, the tax tables, standard deduction, personal exemption, earned-income credit and other elements of the tax system have been adjusted for inflation. For example, personal exemptions for taxpayers and their dependents have increased by $100, to $2,650. And the standard deduction has increased by $200 on a joint return to $6,900, and by $150 on single returns to $4,150.
Medical savings accounts: A new type of tax-sheltered account was created to help eligible workers pay medical expenses that aren't reimbursed by insurance. These Medical Savings Accounts are restricted to self-employed workers and employees of small businesses who are covered by high-deductible health-insurance plans.
Charitable foundations: Congress renewed a tax break allowing philanthropists to deduct the full market value of publicly traded stock donated to their private charitable foundations. Without the extension, foundation donors would have been able to deduct only what they originally paid for the shares. The tax break, which lapsed last May 31, was extended through June 30, 1998.
"SIMPLE" retirement plans: Small businesses with up to 100 employees could establish a new simplified type of retirement plan, called the Savings Incentive Match Plan for Employees, or SIMPLE. The SIMPLE plan allows employees to earmark up to $6,000 of their salary each year to an IRA or 401(k). Employers are also obligated to make contributions.
Penalty-free IRA withdrawals: IRA withdrawals used to pay medical expenses in excess of 7.5 percent of adjusted gross income are no longer subject to the 10 percent "early withdrawal" penalty that usually applies to IRA distributions made before age 59 1/2. The penalty is also waived for unemployed people who withdraw money to pay health-insurance premiums.
