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Near-Term Planning for Savings
- You Can Underpay Your Estimated Tax by $1,000 without Owing More to Uncle Sam.
For 1998 and later years, an individual may underpay estimated tax by $1,000 and still
avoid an addition to tax (an "underpayment penalty"). That is, the taxpayer's
total tax liability for the
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year, less tax withheld and estimated payments, will have to be $1,000 or less in order
to avoid a penalty. The pre-1998 threshold is $500.
- Rate You Can Claim for "Charitable" Mileage Goes Up. Beginning in 1998,
the standard mileage rate for purposes of computing the charitable contribution deduction
will go up to 14 cents per mile. It is now 12 cents per mile. See the mileage table for complete 1997 mileage rates.
Tax Breaks for Parents
- The New Child Tax Credit Goes into Effect. Beginning in 1998, a $400 tax credit
is available for each dependent child (including stepchildren and eligible foster
children) who is under the age of 17 at the end of the taxable year. For calendar year
1999, the ceiling on the credit goes up to $500. The child credit generally is available
only to the extent of a taxpayer's regular income tax liability. However, for a taxpayer
with three or more children, this limitation is increased by the excess of Social Security
taxes paid over the sum of other nonrefundable credits and any earned income tax credit
allowed to the taxpayer.
The child credit is reduced, and eventually is eliminated, as family income increases from
$110,000 to $120,000. Taxpayers filing joint returns will lose $50 of the credit for every
$1,000 (or part thereof) of adjusted gross income (AGI) in excess of $110,000. For other
taxpayers, the credit begins to phase out at an AGI of $75,000. The child credit and the
income threshold amounts are not indexed for inflation.
- Standard Deduction of Certain Dependents Goes Up. If a child (or other
individual) is claimed as a dependent on another taxpayer's return, that child's otherwise
available standard deduction may be limited to an amount equal to the child's earned
income. Beginning in 1998, if the limit applies, it is increased by $250 (indexed for
inflation after 1998). This allows the child to have a small amount of investment income
without having to compute and pay tax.
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Incentives for Higher Education
- Many Will Qualify for the new HOPE Scholarship Tax Credit. Beginning in 1998, a
$1,500 nonrefundable HOPE scholarship tax credit is available for college tuition and
certain fees incurred by the taxpayer, the taxpayer's spouse, or a qualified dependent of
the taxpayer. The credit is reduced by scholarship or fellowship grants already excluded
from income. For each student, the HOPE credit covers the first $1,000 and 50% of the next
$1,000 in education expenses incurred in the first and second years of college. 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.
- New Lifetime Learning Credit for Higher Education Tuition Expenses Is Available.
For those not qualifying for the HOPE scholarship credit, a lifetime learning credit will
be available for education expenses paid after June 30, 1998. 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 available in the year
the expenses are paid and the corresponding education must begin during that year or the
first three months of the next year. The credit will be phased out for taxpayers with
modified AGI between $40,000 and $50,000 ($80,000 to $100,000 for joint filers).
- Deduction for Student Loan Interest Will Be Available. Starting in 1998, a $1,000
above-the-line deduction is available for interest paid on qualified education loans. 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 taxpayers with modified AGIs between $40,000 and $55,000 ($60,000 to
$75,000 for joint filers).
The deduction will apply to interest on loans incurred to pay expenses for undergraduate-
and graduate-level tuition, room and board, and related expenses (reduced by scholarships
or fellowship grants). The student must be enrolled on at least a half-time basis and be
attending an accredited college, university, or vocational school, or an institution
conducting internship or residency programs leading to a degree or certificate from an
institution of higher education, hospital, or health care facility conducting postgraduate
training. If such a loan already exists, interest payments would qualify provided the
60-month period has not expired.
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Existing Ways to Save for
Retirement Just Get Better
- Making Deductible IRA Contributions Will Get Easier. Currently, deductions for
contributions to a regular IRA are gradually phased out as income increases. For taxpayers
who are active participants in an employer-sponsored retirement plan, the phaseouts begin
at $40,000 for married taxpayers filing jointly and $25,000 for single taxpayers. Starting
in 1998, those phaseout thresholds will gradually go up. For married taxpayers filing
jointly, the threshold will reach $80,000 in 2007, and for single taxpayers it will reach
$50,000 in 2005.
Also beginning in 1998, an important restriction on IRA contributions is removed.
Currently, an individual who is not an active participant in an employer-sponsored
retirement plan cannot make a deductible IRA contribution if his or her spouse is an
active participant. That restriction will no longer apply, provided that the spouses'
joint income is less than $150,000.
- Penalty-Free Withdrawals from IRAs for Higher Education Expenses
and First-Time Homebuyers Become Available. Beginning in 1998, the 10% additional
tax on early withdrawals from IRAs is waived for withdrawals used to pay qualified
higher-education expenses and for qualified first-time home buyers. These withdrawals do
continue to be subject to regular income tax.
Qualified higher-education expenses include tuition, fees, books, supplies, room and
board, and equipment expenses.
A qualified first-time homebuyer distribution is a withdrawal of up to $10,000 during the
individual's lifetime that is used within 120 days to pay costs (including reasonable
settlement, financing, or other closing costs) of acquiring, constructing, or
reconstructing the principal residence of a first-time homebuyer. This exception is
available for the first-time homebuyer expenses of the individual or the spouse, child,
grandchild, or ancestor of such individual or spouse.
- Elective Deferrals of Partners and Self-Employed Individuals. In 1998, partners
who participate in section 401(k) plans will be able to receive matching contributions on
their own contributions on the same basis as employees of the partnership. Under prior
law, matching contributions made for partners counted against the maximum annual dollar
limit on the partner's 401(k) contributions ($9,500 in 1997). Matching contributions of
employees who are not partners have not been counted against this limit.
The new rules may make it more attractive for a partnership to sponsor a 401(k) plan.
However, the new rules don't change the maximum amount that can be allocated to any
employee (including a partner) under other qualified plan limits or the maximum
contribution that may be deducted.
A similar provision applies to SIMPLE plans. For SIMPLE plans, the changes are effective
for 1997 and later years.
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New Kinds of IRAs Will Be Available
- Nondeductible Roth IRAs. The Roth IRA is funded solely with after-tax
(nondeductible) contributions, but unlike current nondeductible IRAs, it exists as a
separate account and offers the possibility of tax-free earnings. It is first available in
1998.
The principal features of the Roth IRA are as follows:
- No tax deduction is allowed for contributions to the account.
- Income accumulates tax-free in the account.
- Qualified distributions from the account are not included in income.
- Income limitations for contributions begin at $150,000 for married taxpayers filing
jointly and $95,000 for single taxpayers.
- The maximum contribution is coordinated with the deductible IRA and is limited annually
to the maximum IRA contribution allowed for that individual.
- Contributions can be made even if the individual is beyond age 70½.
- No distributions are required when the individual attains age 70½.
- Distributions are required only upon death.
- Rollovers are permitted from one Roth IRA to another Roth IRA.
Nontaxable qualified distributions from a Roth IRA include distributions made at least
five years after the first taxable year in which the individual made a contribution to the
Roth IRA, if they are made (1) after the individual reaches age 59½; (2) after death; (3)
on account of disability; or (4) for qualified first-home purchases. Nonqualified
distributions are includible in income to the extent of earnings after recovery of
contributions and are subject to the additional 10% early withdrawal tax.
- Nondeductible Education IRAs. Starting in 1998, individuals can open an Education
IRA (trust or custodial account) that exists as a separate IRA account and has the
intended purpose of providing funds for the attendance of a program of higher education.
This account may be established for paying the qualified higher-education expenses of a
designated beneficiary. As with the Roth IRA, this account is created without providing an
income tax deduction for the contribution. However, the earnings of this account are
subject to inclusion in gross income, along with the additional 10% tax upon distribution
to the extent the distribution exceeds qualified higher-education expenses.
The Education IRA has the following principal features:
- Contributions of up to $500 annually are allowed (in addition to the $2,000 limit).
- Contributions may be made regardless of whether the beneficiary has gross income.
- Contributions may not be made after the beneficiary turns 18.
- Distributions of income from the account are included in income and subject to the
additional 10% tax to the extent that they exceed qualified higher-education expenses.
- Income limitations for contributions begin at $150,000 for married taxpayers filing
jointly and $95,000 for single taxpayers.
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Changes in Estate, Gift, and
Generation-Skipping Taxes Can Save You Money
- Increase in Estate and Gift Tax Unified Credit Goes into Effect. A unified credit
of $192,800 against the estate and gift tax now effectively exempts the first $600,000 of
property transfers during life or at death. Beginning in 1998, the effective exemption
increases until it reaches $1 million in 2006. The increase is phased in as shown in Table 1-3 below.
Under current law, the benefits of the graduated rate schedule and the cur-rent unified
credit are recaptured by a 5% surcharge on estates between $10,000,000 and $21,040,000.
This recapture range has been broadened to provide a recapture of the new increased
unified credit amount. Thus, very large estates (over $24,100,000) will not enjoy any tax
reduction as a result of the exemption increase.
TABLE
1-3
Estate and Gift Tax Unified Credit |
Date |
Exempt Transfer
Amount |
Unified Credit
Amount |
| 1997 |
$600,000 |
$192,800 |
| 1998 |
$625,000 |
$202,050 |
| 1999 |
$650,000 |
$211,300 |
| 2000 |
$675,000 |
$220,550 |
| 2001 |
$675,000 |
$220,550 |
| 2002 |
$700,000 |
$229,800 |
| 2003 |
$700,000 |
$229,800 |
| 2004 |
$850,000 |
$287,300 |
| 2005 |
$950,000 |
$326,300 |
| 2006 |
$1,000,000 |
$345,800 |
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- Estate Tax Exclusion for Qualified Family-Owned Businesses Is to Begin. Beginning
in 1998, an exclusion of value attributable to a qualified family-owned business interest
becomes available, if the interest is left to qualified heirs. The excludable amount is
the difference between $1.3 million and the amount exempted under the unified credit for
the year. The decedent must be a U.S. cit-izen or resident at the time of death. To
qualify, a "family-owned business interest" must comprise more than half of the
estate and must have its principal place of business in the United States. A business is
family-owned if one family owns at least half of the business, two families own at least
70%, or three families own at least 90%. An individual's family includes the individual's
(1) spouse, (2) parents and grandparents, and (3) children, stepchildren, brothers,
sisters, nieces, nephews, and their spouses, and ancestors.
Qualified heirs include members of the decedent's family and any individual who has been
actively employed by the trade or business for at least 10 years before the date of the
decedent's death. If a qualified heir is not a citizen of the United States, different
rules apply. To the extent that a decedent held qualified family-owned business interests
in more than one trade or business, the executor must aggregate all those interests. If
certain triggering events occur, taxpayers may lose the benefit of this relief provision,
and additional tax is imposed on the date of the event.
- Reduction in Estate Tax for Certain Land Subject to Permanent Conservation Easement
Becomes Available. Estates of decedents dying after 1997 may qualify for an exclusion
from estate tax for 40% of the value of land subject to a qualified conservation easement
granted to a qualified charity. The easement must restrict development rights to preserve
habitat, open space, or recreational uses. The 40% exclusion is based on the value of the
property after the grant of the easement. The maximum exclusion will be $100,000 in 1998
and will increase $100,000 each year until 2002, when it reaches $500,000.
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Foreign Taxes and Income
- Simplified Foreign Tax Credit Limitation for Individuals Will Go into Effect.
Beginning in 1998, individuals with no more than $300 ($600 if married filing jointly) of
creditable foreign taxes and no foreign source income other than passive income, will be
able to claim a credit for those taxes without regard to the foreign tax credit limitation
rules. An electing individual meeting certain documentation requirements would report the
foreign tax credit directly on Form 1040 and would no longer be required to file a Form
1116 with his or her individual income tax return.
- The Foreign Earned Income Exclusion Is Set to Increase. The ceiling on the
exemption from U.S. tax for foreign earned income derived by certain U.S. citizens or
resident aliens working in a foreign country will increase beginning in 1998. The present
ceiling is $70,000; it will rise to $80,000 in increments of $2,000 per year. For 2008 and
later years, the $80,000 amount will be indexed for inflation.
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Tax
Guide
