The 1997 Tax Act: Feedback

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Answers to Your Questions
A Tax News & Views Special Report:
Promises Kept: The 1997 Tax Law

Guide to
Promises Kept

Tax Cuts for Individuals

Principal Tax Increases

Other Key Provisions

Table of Contents

till have questions? E-mail Us. We'll post answers here to questions surrounding these new investments, as well as the impact of inflation on investing and other issues.

We cannot promise answers to all questions. Please note that these responses is intended to provide general information, but does not constitute and is not intended to be legal, accounting, tax, investment or other professional advice or services. Please also read our legal disclaimer.

Questions on:

Education IRAs

QUESTION: I read your article regarding Education IRA and it is not clear to me about tax and beneficials. My questions are:

1). What is the qualified higher education expenses?

2). The family has 3 kids, ages 8, 4 and 3. Should we have one IRA for all the kids, or three IRAs -- one for each kid?

3). Do the income tax and the 10% surcharge apply to all distributions, or to extent the distribution exceeds the qualified higher education expense?

ANSWER: Here are your answers, one at a time:

1.) Under the Taxpayer Relief Act of 1997 (Act), qualified higher-education expenses include tuition, fees, books, supplies, room and board, and equipment expenses.

2.) Under the Act, an account may be established for each of your designated beneficiaries. Alternatively, if you establish an account for one of your children and it is not completely used up for that child, it can be rolled over for another qualified family member. Consult your tax advisor or IRA provider for structuring considerations for your specific situation.

3.) Under the Act, withdrawals from an Education IRA are not included in income (for income tax) or subject to the 10% additional tax to the extent they are used for qualified higher-education expenses.

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IRA Deductions for 1997

QUESTION: Under the new tax bill, can a married couple with no children who make gross income approximating $60,000, deduct IRA Contributions made in 1997, even though the husband is a participant in a company sponsored 401(k) retirement plan?

ANSWER: The Taxpayer Relief Act of 1997 (Act) removes the restriction that prevents an individual who is not an active participant in an employer-sponsored retirement plan from making a deductible IRA contribution if his or her spouse is an active participant. That portion of the Act is only effective for tax years beginning after December 31, 1997. Therefore, the current law restriction remains in place for 1997 contributions.

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Capital Gains

QUESTION: Concerning the recent tax legislation, are there any publications that explain how the netting process will work if an individual has both long term capital gains on assets held longer than one year and less than 18 months, and assets held longer than 18 mos.?

ANSWER: Although the 1997 Tax Act modifies the capital gains rate structure, Congress did not change the capital gains netting rules. Therefore, for purposes of determining whether a taxpayer has a net capital gain or a net capital loss, as those terms are defined in the Internal Revenue Code, a mid-term gain is treated as a long-term capital gain for netting purposes.

Outside of the basic netting rules, the new Act creates confusion about the classification of property as either short-term, mid-term, or long-term, when the holding period is statutorily defined. For example, if a person acquires property from a decedent, the Revenue Code would treat the property as long-term property (defined as held "for more than one year"), if, among other things, the property is sold or otherwise disposed of within one year after the decedent's death. The 1997 Tax Act provides no explicit guidance on whether such gain is either mid-term or long-term. Consequently, we anticipate that technical corrections may be required.

Publication 550, Investment Income and Expenses (Including Capital Gains and Losses), explores the basic netting rules. Taxpayers may retrieve government forms and other information on the World Wide Web at: http.//www.irs.ustreas.gov.

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Effective Date

QUESTION: I have a client who sold his business in January 1997. He received payment in January subject to a "net worth adjustment." As a result of that adjustment, he is now going to receive $1 million dollars extra in September.

The first versions of the new law made the changes to cap gains rates effective for payments received after May 7, 1997. The final law just says the effective date is May 7. Most of the summaries out there are saying that the post May 7, 1997 installment would get new law treatment, apparently in conflict with the language of the new law. What's the right answer?

ANSWER: Section 311(a) of the 1997 Tax Act (new sections 1(h)(8) and 1(h)(10) of the Code) provides transition rules for "gains and losses properly taken into account for the portion of the taxable year before May 7, 1997." Given the definition of "installment method" in section 453(c) of the Code, the new Act would tax any gains from installment-sale payments received after May 6, 1997, at the new capital gains rates. [NOTE: This may mean that the 28% mid-term rate applies to installment payments.]

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Capital Gains: Which rate?

QUESTION: I am having trouble getting an answer on the new tax law.

A couple has wages of $40,000 and would be in the 15% tax bracket. They plan in November 1997 to sell stock they have held for 7 years which will generate a gain of $75,000.

Will they pay 10% on the gain since they are in the 15% bracket without regards to the gain? Or will they pay 20% on the gain since it pushes their adjusted gross income is higher and they would be considered in the 28% bracket?

ANSWER: The rule is, if the income would otherwise be taxed at the 15% rate, it would be eligible for the 10% capital gains tax rate. Once that bracket is used up, then welcome to the 20% capital gains tax rate for the rest of the gain!

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Capital Gains and Precious Metals

QUESTION: I am wondering how the new tax law just passed handles capital gains on precious metals (coins/bullion)? Do these qualify for the 8%-20% maximum cap gains rate? Would coins be considered collectibles (28% rate)? What requirements would gold/silver coins need to meet to not be considered a collectible? Is the 28% rate on collectible limited by a person's tax bracket? For exampe, if they are in 15% bracket, would a 15% rate apply?

ANSWER: The rule for capital gains for collectibles includes coins and bullion. The 1997 Act change allowing IRA investments in coins and bullion does not help with capital gains.

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Capital Gains and Real Estate

QUESTION: I understand that the new tax law just passed reduces the capital gains rate on real estate to the 8%-20% range. However, it I heard that that portion of gain attributable to prior depreciation would be subject to a 25% rate. What are the impacts of tax brackets and recapture on taxation of real estate capital gains?

Does this 25% rate apply, if the tax payer is in the 15% bracket? Or would the recapture portion be at 15%, with the rest at 8% or 10%.

How is the capital gain calculated if the tax payer is normally in the 15% bracket, but the gain places him in the 28% bracket?

ANSWER: The taxpayer in this situation generally has a choice:

1. Pay the tax at the regular rates (i.e., 15% and 28%).

OR

2) Have ordinary income taxed at the regular rate and tax the capital gains subject to the real estate rate at 25%.

There does not appear to be an option to pay the 15% rate on some and the 25% rate on others.

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Tax News & Views is produced by the Financial Counseling Specialists and the Legislative & Regulatory Services Group at Deloitte & Touche LLP.