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The Taxpayer Relief Act of 1997 - Donít Make Any Financial Decisions Before Reading This Article

On August 5, 1997, President Clinton signed the Taxpayer Relief Act of 1997 into law. We suggest that you don't make any major financial decisions before reading this article and following-up on the particular areas that might impact you. The scope of the legislation encompasses measures ranging from a child care tax credit for low and moderate-income families to new tobacco taxes. The Act will certainly affect the way some families fine-tune their family financial planning, such as whether less money can be set aside for college because of tax breaks.

The IRS is still in the process of developing documentation of how some the new rules will be implemented and also clarifying some of the phase-out limits. Nevertheless, if you are in the process of divorcing, its definitely worthwhile to pay attention to some of the nuances of the Act, as there may be issues that you should bring to the table that your lawyer or mediator may not be aware of. If you are already divorced, there may be issues that you need to raise with your ex-spouse, such as how college tax credit will be allocated. Some of the provisions have already been implemented such as the rules on capital gains for home sales and investments.

Some major highlights of the Act impacting intact and divorced families with children are included below. There are additional provisions covering estate taxes, tobacco taxes, airline ticket taxes, Medicare-medical savings accounts, welfare, immigrants and SSI, health care premiums for the self-employed and Medicaid uninsured children, which we have not included due to space considerations.

Details of the Major Provisions of the 1997 Taxpayer Relief Act

Child Tax Credit
Current Law: No provision.
Agreement: $400 tax credit for each dependent child (including stepchildren and eligible foster children), up to age 17 in 1998, $500 in 1999 and thereafter. Phase-out will begin at up to $75,000 for single parents and $110,000 for married couples filing jointly (the credit is gradually eliminated after those income points). The credit is a rebate on taxes.

College Tuition Credit (HOPE Scholarship)
Current Law: US Savings Bond interest is tax-exempt if used for education.
Agreement: For each student, the HOPE credit covers the first $1,000 and 50% of the next $1,000 in college tuition incurred in the first and second years of college, reduced by scholarship or fellowship grants already excluded from income. It will not be available if the student is convicted of a felony drug offense during the year in which the credit applies. The student must be enrolled on at least a half-time basis and be attending an accredited college, university, or vocational school leading to a bachelor's degree, an associate's degree, or another recognized post-secondary credential. The credit is a rebate on taxes. Effective for payments made after 12/31/97.

Lifetime Learning Credit
Current Law: US Savings Bond interest is tax-exempt if used for education.
Agreement: Credit available for any taxpayer in any taxable year (provided the taxpayer, the taxpayer's spouse, or dependent of the taxpayer is not eligible for the HOPE credit). This credit equals 20% of the first $5,000 in education expenses (a $1,000 maximum) and increases to 20% of the first $10,000 in expenses, or $2,000, after 2002. The credit will be phased-out for singles with income over between $40,000 and married couples filing jointly with income over $80,000. The credit is a rebate on taxes. Effective for payments made after 6/30/98.

Education - Interest Deduction
Current Law: No provision.
Agreement: The Act provides for a tax deduction for interest paid on qualified education loans incurred to pay expenses for undergraduate- and graduate-level tuition, room and board, and related expenses (reduced by scholarships or fellowship grants). The deduction will be allowed for interest paid during the first 60 months in which interest payments are required and will not be allowed if the taxpayer can be claimed as a dependent on another taxpayer's return. The limit on the deduction is $1,000 in 1998, $1,500 in 1999, $2,000 in 2000, and $2,500 in 2001 and thereafter. The deduction will be phased-out for singles with incomes over between $40,000 and married couples filing jointly with income over $60,000.

Educational IRA
Current Law: No provision.
Agreement: The Education IRA is a trust or custodial account established to help pay the higher-education expenses of your child, grandchild or other designated beneficiary. This account is funded with after-tax (nondeductible) contributions. Contributions of up to $500 annually are allowed per student (in addition to the $2,000 limit for a separate IRA). Qualified distributions are not taxed as income unless they exceed qualified higher education expenses, in which case amounts in excess of qualified expenses will be taxable as income and subject to the additional 10% penalty. Phase-out begins at $95,000 for singles and $150,000 for married couples filing jointly. 1998 will be the first year for the program.

Capital Gains - Investments
Current Law: Tax rates of 15% to 28% depending on income.
Agreement: Tax rates of 8% to 20% depending on income for investments held for at least 18 months (12 months if sold before 7/29/97); 10% for assets bought after 2000, and held for at least five years. Effective for sales after 5/6/97.

Capital Gains - Home Sales
Current Law: No taxes on profits if sellers buy another home within two years that costs at least as much. Singles or married couples age 55 and older can exempt up to $125,000 of profits.
Agreement: Taxpayers can exclude up to $250,000 ($500,000 in the case of a married couple filing a joint return), of gain realized on the sale or exchange of a principal residence. Only taxpayers who have owned and occupied a principal residence for at least two of the five years prior to any sale or exchange may take full advantage of the exclusion. Effective for sales after 5/6/97.

Traditional IRA
Current Law: Each individual or spouse can deduct from income $2,000 a year for IRA contributions if neither has a employer-sponsored retirement plan or their income falls below $25,000 for singles and $40,000 for married couples filing jointly. Contributions are not deductible for other taxpayers.
Agreement: Under the Act, these income levels will gradually increase to $30,000 for individuals on 1/1/98 to $50,000 by the year 2005, and $50,000 for married taxpayers filing jointly on 1/1/98 to $80,000 by the year 2007. The restriction preventing an individual from making a deductible IRA contribution if his or her spouse participates in an employer-sponsored retirement plan has also been removed, provided the couples' joint income is less than $150,000. The Act also provides for penalty-free withdrawals from IRAs for higher education expenses and first-time home buyers. 1998 will be the first year for the program.

IRA for After-Tax Contributions - Roth IRA
Current Law: Contributions are not tax-deductive and distributions incur capital gains tax upon withdrawal.
Agreement: The new Roth IRA is funded solely with after-tax (nondeductible) contributions, but offers the possibility of tax-free earnings which are not taxed as income when later withdrawn as part of qualified distributions. Income limitations for contributions begin at $95,000 for single taxpayers and $150,000 for married taxpayers filing jointly.

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