Tax Guide: Top 20 Tax Changes for 1996

20 big tax changes in 1996

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Changes in
the tax bills
passed in
1996 may be
important to
your return.

You're Required to Supply Your Dependent's Taxpayer Identification Number (TIN), or you may face more taxes. The IRS is now authorized to deny a personal exemption and the dependent care credit if you file a return without a TIN for your dependent. Generally, for an individual, the TIN is a Social Security number, and denial of either a personal exemption or the credit, or both, would increase the taxpayer's tax. Failure to provide a required TIN is now treated as a mathematical or clerical error, which means that the IRS can immediately assess tax without conducting an audit.

Contribute More to a Spousal IRA. For 1997 and later years, the amount that joint filers may deduct for individual retirement account (IRA) contributions in one year has increased to up to $2,000 for each spouse, as long as the combined compensation of both spouses is at least equal to the contributed amount.

Excess-Distribution Excise Tax Is Temporarily Repealed. A 15% excise tax that applied to individuals who received distributions from pension and 401(k) plans in excess of specified amounts (adjusted annually for inflation) has been repealed. (The 1996 threshold is $155,000.) The repeal is only temporary, applying to distributions between Jan. 1, 1997, and Dec. 31, 1999, and it applies only to the excise tax. Normal income tax consequences of distributions and the 15% estate tax on "excess retirement accumulations," payable at death and based on the death value of such plans, continue to apply.

Five-Year Forward Averaging Won't Be Available After 1999. Five-year forward averaging, a tax break now available for certain lump-sum distributions from pension plans, has been repealed, effective for distributions made after Dec. 31, 1999.

States Can't Impose Income Tax on Retirement Income of Nonresidents or Nondomiciliaries. Federal law now provides that a state cannot impose an income tax on any retirement income of an individual who is not a resident or domiciliary of that state. This rule applies to amounts received after 1995. As the law contains a nine-part definition of "retirement income" and state law also affects how particular benefits are treated, consultation with an expert is advisable.

IRA Withdrawals for Certain Medical Expenses. After 1996, there will be an exception to the 10% penalty tax on early withdrawals from an IRA if the funds are used to pay for medical expenses in excess of 7.5% of adjusted gross income. Also, the 10% tax will not apply to distributions used to pay for medical insurance (without regard to the 7.5% floor) if the individual has received unemployment compensation under federal or state law for at least 12 weeks.

Self-Employeds' Health Insurance Deductions Are to Increase. For 1997, a self-employed person will be able to deduct 40% of the amount of his or her health insurance premiums. The deductible amount is to gradually increase to 80% by 2006.

Long-Term Care Insurance. For 1997 and later years, the cost of qualified long-term care services and premiums for qualified long-term care insurance subject to an annual limit will be treated as medical expenses (which are deductible to the extent they exceed 7.5% of adjusted gross income). Moreover, benefits paid under such an insurance policy will generally be exludable from income, subject to a per diem cap.

Medical Savings Accounts. New Medical Savings Accounts (MSAs) permit employees of certain small businesses to cover routine medical expenses with pretax dollars. A test program for businesses with fewer than 50 employees and self-employed individuals is effective January 1, 1997. Employer contributions will not be included in the employee's income, and amounts in an MSA accumulate tax free. Tax- and penalty-free withdrawals from an MSA can be made for medical expenses. Penalty-free withdrawals for any purpose can also be made after age 65.

Full Deduction for Contributions of Appreciated Stock to Private Foundations Is Temporarily Restored. A full fair market value deduction for contributions of appreciated stock to private foundations will apply to contributions made after June 30, 1996, and before June 1, 1997.

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