The
new, improved IRS and lots of other tax changes:
The
comment at left, made July 8, 1998, summarizes the feelings of
many taxpayers. The 485-page Internal Revenue Service Restructuring
and Reform Act of 1998 (IRSRRA98) is supposed to lead to an Internal
Revenue Service that is kinder, gentler and more taxpayer friendly,
while still maintaining its ability to interpret and enforce the
tax law. What many people may not realize is that this new law
also includes changes in other areas of tax law. Following is
a brief explanation of some of the key components of the new law.
For your convenience, they are organized by tax topic. However,
not all provisions of the new law are included in this website.
Additionally, this summary is necessarily short and should not
be relied upon to make decisions without consulting a tax professional.
Our professionals are prepared to assist you with these or any
other tax issues. If you have any questions about the Internal
Revenue Service restructuring and Reform Act of 1998, please call
our firm. Also, there may be additional tax legislation this year.
Congress has not resolved next year's budget, and there is much
discussion about additional tax cuts and changes.
Federal Tax Watch® is published for the use of our clients, advisors
and friends. The technical information it contains is necessarily
brief. No final conclusion on these topics should be drawn without
further review and consultation to maximize your tax planning.
For additional information, please contact our firm.
[Capital
Gains] [Both IRAs] [Revenue
Raisers] [Taxpayer Rights] [Electronic
Filing] [Confidentiality Privilege]
[IRS] [401K Focus]
Capital
Gains:
Holding Period
Capital gains held 12 months or longer will
now be treated as long-term. This effectively eliminates the mid-term
(capital gains held between 12 and 18 months), 28 percent category.
The 28 percent rate will now only apply to collectibles. The new
rules are effective retroactively for transactions on or after
Jan. 1, 1998. Congress had inserted the mid-term rate at the last
minute as part of the Taxpayer Relief Act of 1997 (TRA97).
Congress responded to complaints that the mid-term capital gain
calculations caused unduly complicated tax calculations. However,
other complications, such as the special 25 percent rate for depreciation
recapture, remain in place.
Tax Tip
Net capital gains remain an important concept.
It is still important to properly plan capital transactions to
maximize the 20 percent long-term capital gain rate benefit.
Personal Residence
Last year's tax law provided that an individual
could exclude gains of up to $250,000 ($500,000 for a couple filing
jointly) on the sale of a residence if the principal residence
was owned and occupied for a minimum of two years.
However, the law was unclear how the gain from the sale of the
residence should be treated if the holding period was for less
than two years as a result of a business-related move. The new
law clarifies that the exclusion -- rather than the gain -- is
prorated for the qualifying period of time. This is a very taxpayer-friendly
resolution.
Small Business Stock
TRA97 provided a special "rollover provision"
for investments in qualified small business stock. Generally,
the provision allowed individuals who sold their investments to
postpone the gain recognition as long as the individual invested
in another qualified small-business stock within 60 days. The
new law expands this ability to defer gain to investments made
by partnerships and S corporations. The choice to recognize or
defer the gain will be made at the partner/shareholder level.
Investment Tip
This should create new opportunities for
investment in qualified small-business stock by venture capital
partnerships. Look for investment companies to begin offering
partnerships that make investments in qualified small-business
stock.
Both
IRAs
Election To Have All Income Included in
1998
Prior law stated that if a taxpayer converted
a traditional IRA to a Roth IRA in 1998, the taxpayer was required
to recognize the income from the traditional IRA evenly over a
four-year period.
The new law gives taxpayers the right to choose to recognize all
of the income in 1998 or recognize the income evenly over four
years. This election will work well for students and others whose
income is expected to increase substantially after 1998.
Tax Tip
Some of the factors to consider in making
the decision between immediate recognition and recognizing the
income over four years are:
Current and future marginal tax rates availability of funds to
pay taxes from outside the IRA or whether early withdrawal penalties
could be incurred Possible loss of itemized deductions or exemptions
as a result of the increase in income
Early Distribution when Four-Year Spread
Is Used
Some tax and investment advisors have suggested
that taxpayers could convert their traditional IRAs to Roth IRAs,
pay the tax over four years and -- assuming you meet the Roth
IRA distribution requirements -- take withdrawals from the IRA
without penalty. As expected, the new law has retroactively closed
this loophole.
One of the questions many people asked was, "What if I convert
my traditional IRA to a Roth IRA and then, when I prepare my tax
return, determine that my adjusted gross income (AGI) is too high?"
Previously, the answer to this question was unclear at best. Now
the new law has provided a very taxpayer-friendly answer. Taxpayers
will have until the due date of their returns, including extensions,
to change their minds about conversion. Many people were waiting
to convert their IRAs until the end of the year so they would
be better able to estimate their income. This new provision will
allow taxpayers to convert without concern that their AGI may
be too high.
Revenue
Raisers
Mark-To-Market Treatment of Certain Accounts
Receivable
This is a good news/bad news situation.
The good news is that, by recognizing the issue, the law has effectively
validated that, properly implemented; the mark-to-market method
could be used for certain trade accounts receivable. The bad news
is that the method is no longer available, and amounts deducted
must be taken back into income evenly over a four-year period.
This provision is effective for tax years ending after July 22,
1998, the date of enactment.
Tax Tip
This means that any business with a tax
year-end before July 22, 1998 can make a mark-to-market election,
take the entire deduction in the current year and recapture the
income over four years. In many cases, this is the equivalent
of an interest-free loan.
Deduction of Vacation and Severance Pay
The new law legislatively eliminates the
ability of a business to accelerate the deduction for vacation
or severance pay, unless payment is actually made to employees
within 2 ½ months after year-end.
Taxpayer
Rights
Burden of Proof
This is one of the most controversial areas
of the new law. Under the act, the burden of proof with respect
to factual issues will shift from the taxpayer to the IRS for
any court proceeding regarding income, gift and estate tax liability
if the taxpayer introduces credible evidence on factual issues
Maintains records and substantiates items as required Cooperates
with reasonable IRS requests for meetings, interviews, witnesses,
information and documents.
However, the new rules also will apply to individuals if the IRS
uses statistics to reconstruct an individual's income.
The change in the burden-of-proof rules does not apply to corporations,
trusts or partnerships that have a net worth in excess of $7 million.
Many tax professionals believe this change will result in increased
requests and more in-depth scrutiny of taxpayers under IRS audit
because the IRS will have to be prepared with more evidence in
case the situation reaches litigation.
Proceedings by Taxpayers
The act has a variety of new provisions
to help taxpayers in tax litigation. Some of the provisions include:
The ability to claim higher attorney's fees, especially for "difficult"
cases The ability to collect up to $100,000 if an IRS officer
or employee negligently disregards the IRS Code or regulations
An increase in the threshold for small tax cases from $10,000
to $50,000.
Innocent Spouse
Innocent spouse relief will be easier to obtain, especially for
spouses who are divorced or legally separated.
Audit and Collection Protections
Many of the reported IRS abuses at the recent
congressional hearings pertained to the audit and collection process.
The new law provides more than 20 new provisions to address this
issue. Some of the areas covered include:
Eliminating "financial audit techniques" unless the IRS has a
reasonable indication that there is a likelihood of unreported
income Making offers-in-compromise easier for taxpayers Making
installment payments more available Implementation of fair debt
collection practices Supervisor reviews on any lien, levy or seizure
action Waiver of early withdrawal penalties for IRS levies on
retirement plans.
Interest and Penalty Relief
In response to complaints that the interest and penalty structure
is unfair, the act mandates studies to determine how penalty administration
can be simplified and the burden on taxpayers reduced.
Among the changes in this area: The interest rate on refunds for
individuals will now match the underpayment rate, and certain
businesses can designate how payroll tax deposits should be allocated
to minimize potential penalties.
Electronic
Filing
Congress recognized that increasingly taxpayers
are preparing or having their returns prepared electronically.
The act states that by 2002, any return prepared electronically
will be required to be filed electronically. The goal of Congress
is to have 80 percent of all returns filed electronically by 2007.
Confidentiality
Privilege
Under the new law, the existing attorney-client
confidentiality privilege is generally extended to CPAs and others
authorized to practice before the IRS in any non-criminal proceeding
with the IRS or any federal court. This generally means that CPAs
and lawyers will have the same confidentiality privilege for tax
planning.
IRS
The act reorganizes the IRS "from the ground up." The most obvious
change is that the IRS will be restructured into groups to serve
similar types of taxpayers, i.e., individuals, small businesses,
large businesses and tax-exempts, instead of the current geographical
hierarchy. The taxpayer advocate will be more autonomous and will
have more of a local presence. Lastly, an independent oversight
board will be responsible for monitoring the strategic plans,
modernization, training and collection procedure.
401K
Focus
Reasons to sign up for a 401(k) Here, are
reasons why you should sign up for a 401K Plan! "What the 401(k)
does is … make savings a priority. The money comes off the top,"
All you do is figure out how much you want to contribute to your
plan -- up to $10,000 annually --($10,500 for the year 2000) and
the money is taken out of your paycheck each pay period.
401(k) plans let you take advantage of an investment technique
called dollar cost averaging. Over time, as you invest systematically,
you will be buying shares at whatever the current market price
is. Sometimes, you will buy fewer shares at higher prices. Sometimes
you'll buy more shares at lower prices. When you buy more lower-priced
shares, that will help bring down the average cost of all your
shares. So when share prices rise, you will see profits off that
lower base and on a greater number of shares. Since a 401(k) plan
takes the same percentage out of every paycheck, it does the systematic
investing for you. The employee benefit that works for you through
the power of long term investment. 401(k) plans offer ordinary
people the opportunity to invest in funds that might otherwise
be open only to big-money investors.
Contributing to a 401(k) plan reduces your taxable income & thus
the reduction of current income taxes. you put a maximum of $10,000
every year into a 401(k) plan before IRS starts calculating taxes
on your gross income. You can also use 401(k) contributions to
push yourself into a lower tax bracket, where you pay a lower
tax rate. It's possible to make 401(k) contributions to drop a
tax bracket This can be illustrated by a hypothetical example
| |
With
401(k)
|
Without
401(k)
|
| Gross
Pay |
$25,000 |
$25,000 |
| 401(k)
Deduction |
$1,250 |
---
|
| Taxable
Pay |
$23,750 |
$25,000 |
| Fed
Income Tax (28%) |
$6,650 |
$7,000 |
| Fica
(7.65 %) |
$1,913 |
$1,913 |
| Tax
Savings |
$350 |
---
|
Taxes
are deferred on all the profits you make on the money while it's
in the 401(k) plan. You pay taxes, when you pull the money out
at retirement. By the time you quit work, your annual income could
be a lot lower, in which case you'll be paying taxes at a lower
rate.
If you take money out of the plan before you reach age 59½, you
have to pay a 10 percent penalty tax in addition to income tax
on the money and profits. However, if you stop working at age
55 or later you will not have to pay the penalty, though you will
still owe taxes.
Over the three decades until the you reach retirement age, $10,000
could grow tenfold, to $100,000, through compounding assuming
you earn a interest rate of 8%. In effect, you earn interest on
your interest -- and taxes are deferred on all of it.
IRAs have limitations. One is that the government allows you to
only save $2,000 a year, tax-deferred. (And depending on your
income level, you may not be able to deduct all or even part of
your contributions from your gross income.) On the other hand,
you can save up to $10,000, tax-deferred, in a 401(k), and your
contributions are always tax deductible.
On October 19,1999, the Internal Revenue Service raised the year
2000 annual contribution limit from 10000 to 10500.
A real bonus of a 401(k) plan is your company's matching contribution.
In short, it's free money. The employer match is also tax deferred.
"(No other investment) can match a 401(k) plan, you can get similar
things with an IRA. But no other plans have the employer match."
Even if your employer match hasn't vested, you still own your
contributions. Unlike traditional pension plans, you can take
the money in a 401(k) with you if you switch jobs. There is a
caveat: The government gives you 60 days to find a new tax-sheltered
plan to put the money in. You can put it into your new employer's
401(k) plans, if the plan allows rollovers, or roll the money
into what's known as a rollover IRA.
If you miss that 60-day deadline, however, you have to pay taxes
on the money in the plan, plus a 10 percent penalty if you are
fewer than 59½. Your best bet is to do a direct rollover from
one plan to the next, and never have the check made out to you.
