This past summer, President Clinton signed the Taxpayer Relief Act of 1997, which contains substantial changes in income, excise, estate and gift taxation. The name of the Act is more than appropriate, and a few of my partners are lobbying for an annual tax relief act!
Some of the more important changes in the Act include:
- Reduction of the individual long term capital gain rate to 20% (10% for those in the 15% bracket) for property held 18 months or more and sold after July 28, 1997 (12 months if sold prior to July 29, 1997). For property held over 12 months but not 18 months, and sold after July 28th, the maximum rate is 28%. There are a number of other special circumstance capital gain changes and an eventual reduction to an 18% maximum rate for property acquired after 2001 and held for more than 5 years;
- Increase in the exclusion for profits realized on the sale of a personal residence from $125,000 to $500,000 for joint filers ($250,000 for a single taxpayer);
- Increase in the unified estate and gift tax credit from $600,000 by $25,000 per year through the year 2003 and $50,000 per year through the year 2006, resulting in a $1,000,000 unified credit when fully phased in beginning January 1, 2006; and
- A unified estate and gift tax credit of up to $1.3 million with respect to the transfer of a family business.
We will be commenting upon various changes brought about by the Act in the coming issues. Our comments will be directed more towards the unusual, the worrisome, and the “opportunity” type changes. For example, cost of living adjustments are now found to be more frequent. The $10,000 annual exclusion for gifts, the $750,000 ceiling on special use valuations, the $1,000,000 generation-skipping transfer tax exemption, and the $1,000,000 ceiling on the value of a closely-held business eligible for special low rate interest for deferred tax payments, each will adjust annually. The adjustment will be the percentage by which the consumer price index in the calendar year preceding the applicable tax year exceeds the CPI for calendar year 1997. The IRS will announce the adjustment annually.
A new exemption equivalent credit is available in computing the federal estate tax on the transfer of a family-owned business interest, up to a maximum of $1.3 million. To qualify for this special treatment, the interest of a decedent in a family-owned business must exceed 50% of the decedent’s adjusted gross estate and the decedent or a member of the decedent’s family must have owned and materially participated in the business for at least five of the eight years preceding the decedent’s death. Gifts can be made only to qualified heirs, who are required to participate in the business for at least five years of any eight year period within ten years following the decedent’s death. The $1.3 million exemption amount is effective for persons dying after January 1, 1997. However, the $1.3 million amount decreases each year as the $600,000 exemption increases and each equal the $1,000,000 unified credit in 2006. The new changes create an anomaly whereby the effective small business exemption decreases each year as the regular exemption amount increases. Expect future legislation to address this issue.
In 1996, the 15% excise tax on excess distributions from retirement plans, tax shelter annuities, and IRAs was suspended for four years. The Act repeals the 15% excise tax, eliminating the need to determine whether and in what year a pension plan withdrawal should have been made to take advantage of the suspension.
Watch out for the new $500,000 ($250,000 for single taxpayers and certain married taxpayers filing separately or owning property separately) exclusion on the sale of a personal residence. This change replaced not only the $125,000 “over 55” exclusion, but also replaced the longstanding rule that permitted indefinite deferral when you spent the proceeds on a new home within two years before or after the sale. This exclusion can be used as often as you qualify for it, but not more than once every two years. The exclusion is mandatory.
In view of the many estate and gift tax changes in the Act, our priority recommendation is that persons owning a family business and persons having adjusted gross estates in excess of $600,000 review their estate transfer documents immediately. We will be presenting other more specific recommendations in future issues and will be addressing inquiries we receive from you in the interim.
A new exemption equivalent credit is available in computing the federal estate tax on the transfer of a family-owned business interest, up to a maximum of $1.3 million. To qualify for this special treatment, the interest of a decedent in a family-owned business must exceed 50% of the decedent’s adjusted gross estate and the decedent or a member of the decedent’s family must have owned and materially participated in the business for at least five of the eight years preceding the decedent’s death. Gifts can be made only to qualified heirs, who are required to participate in the business for at least five years of any eight year period within ten years following the decedent’s death. The $1.3 million exemption amount is effective for persons dying after January 1, 1997. However, the $1.3 million amount decreases each year as the $600,000 exemption increases and each equal the $1,000,000 unified credit in 2006. The new changes create an anomaly whereby the effective small business exemption decreases each year as the regular exemption amount increases. Expect future legislation to address this issue.
In 1996, the 15% excise tax on excess distributions from retirement plans, tax shelter annuities, and IRAs was suspended for four years. The Act repeals the 15% excise tax, eliminating the need to determine whether and in what year a pension plan withdrawal should have been made to take advantage of the suspension.
Watch out for the new $500,000 ($250,000 for single taxpayers and certain married taxpayers filing separately or owning property separately) exclusion on the sale of a personal residence. This change replaced not only the $125,000 “over 55” exclusion, but also replaced the longstanding rule that permitted indefinite deferral when you spent the proceeds on a new home within two years before or after the sale. This exclusion can be used as often as you qualify for it, but not more than once every two years. The exclusion is mandatory.
In view of the many estate and gift tax changes in the Act, our priority recommendation is that persons owning a family business and persons having adjusted gross estates in excess of $600,000 review their estate transfer documents immediately. We will be presenting other more specific recommendations in future issues and will be addressing inquiries we receive from you in the interim.
– Mike Beausang