President Clinton recently signed three bills into law that may provide you with some significant tax planning opportunities. What follows is a summary of some of the provisions of The Small Business Job Protection Act, The Health Insurance Portability and Accountability Act, and The Personal Responsibility and Work Opportunity Reconciliation Act. We have highlighted some of the most important changes. All the changes below are effective for tax years beginning after 1996, unless otherwise noted.
IRAs
- A spouse who files a joint return but who has no compensation can now make a yearly $2,000 contribution to an IRA (up from $250 under prior law).
- IRA payouts for medical expenses and IRA withdrawals by unemployed individuals to pay for medical insurance will be exempt from the 10% early withdrawal penalty.
Qualified Retirement Plans
- Employees who work beyond age 701/2 will be able to defer the start of distributions until April 1 of the year following retirement.
- Savings Incentive Match Plan for Employees, or SIMPLE plans, are retirement plans which may be set up by employers with less than 100 employees as well as by self-employed individuals. If established in IRA form, a SIMPLE plan is not subject to the nondiscrimination rules generally applicable to qualified plans (including the top-heavy rules) and simplified reporting requirements apply. A SIMPLE plan established as part of a 401(k) plan does not have to satisfy the special 401(k) tests applicable to 401(k) plans and is not subject to the top-heavy rules. Simplified reporting requirements also apply.
- The excise tax on excess distributions from qualified plans, tax-sheltered annuities, and IRAs that generally applies to combined distributions in excess of $155,000 (indexed for 1996; $775,000 for lump-sum distributions) does not apply to excess distributions received in 1997, 1998 or 1999.
- Five-year averaging for lump sum distributions has been eliminated for tax years beginning after 1999.
- The definition of highly compensated employee has been simplified.
- The family aggregation rules have been repealed which will allow family members working in the same company to receive greater benefits.
- The 401(k) deferral and matching contribution nondiscrimination rules have been simplified.
- For plan years beginning after December 31, 1997, the definition of compensation for purposes of the qualified plan limits on contributions and benefits has been amended to include elective deferrals to 401(k) plans and similar arrangements, elective contributions to nonqualified deferred compensation plans of tax-exempt employers and state and local governments, and salary reduction contributions to cafeteria plans.
- SEPs with salary reduction features will no longer be allowed.
- Amendments required by the new law need not be made before the first day of the first plan year beginning on or after January 1, 1998 if (i) during the period between the effective date of the amendment and the date above, the plan is operated in accordance with such amendment; and (ii) the amendment applies retroactively to such period.
Business Tax Changes
- The deduction for a self-employed individual's health insurance costs will be increased from 30% to 40% of eligible costs. The percentage is scheduled to increase yearly until it reaches 80% for tax years beginning after 2005.
- The cost of certain types of property such as tangible personal property or other tangible property used as an integral part of manufacturing or production can be deducted currently (as opposed to depreciated). The annual limit for this deduction has been increased to $18,000 for tax years beginning in 1997 and will increase yearly until it reaches $25,000.
- A lessor who makes leasehold improvements for a lessee and disposes of or abandons it when the lease is terminated may have a capital loss.
S Corporations
- The number of allowable shareholders has been increased from 35 to 75.
- There are now several new types of shareholders allowed including an "electing small business trust," qualified retirement plain trusts and certain other tax-exempt organizations.
- An S Corporation can now have subsidiaries, either a C Corporation or a "qualified subchapter S subsidiary."
Individual Tax Changes
- The personal injury damages exclusion from federal income tax has been narrowed.
- Tax-favored treatment will be provided to qualified state tuition programs that allow parents to save for their children's college costs on a prepaid basis.
- Earned income credit rules have been modified.
Payroll Taxes
- There has been a major overhaul for Section 530 relief from reclassification of independent contractors as employees.
- There will be a delay in the implementation of the electronic funds transfer system by an additional 6 months to July 1, 1997.