Points for paring your tax bill

Nation's Business, Dec, 1997 by Joan Pryde

It's pencil-sharpening time for those who want to make the most of tax-law changes affecting 1997 returns.

Federal tax laws enacted over the past two years have created several year-end tax-saving opportunities for small-business owners.

Although two key tax-related laws enacted in 1996--the Small Business Job Protection Act and the Health Insurance Portability and Accountability Act--may pale in comparison with the Taxpayer Relief Act of 1997, enacted Aug. 5, those 1996 laws contain several important changes that are new for the 1997 tax year.

This is the first year, for example that the self-employed may deduct a portion of their premiums for long-term-care insurance. The deduction, however, is limited to 40 percent of the total cost, the same limit that applies to health-insurance premiums paid by the self-employed.

"You might think about going out and getting long-term-care insurance now so you can deduct it on your 1997 return," says Susan Jacksack, a small-business analyst with CCH Business Owners Toolkit of Riverwoods, Ill., an online information source for small-business owners.

In 1996 Congress increased the health-insurance deduction available to the self-employed from 30 percent to 40 percent effective in 1997. Under a provision in the 1997 tax law, the deduction will rise to 45 percent in 1998 and will continue climbing in stages until it reaches 100 percent in 2007.

Although the health-insurance and long-term-care deductions for 1997 are limited to 40 percent, Jacksack says it's important to remember that the other 60 percent of premiums can be included in itemized medical expenses, which can be deducted to the extent that the total exceeds 7.5 percent of adjusted gross income.

In another health-related change enacted in 1996 to take effect in 1997, the law now permits penalty-free withdrawals from individual retirement accounts (IRAs) for medical expenses that exceed 7.5 percent of a taxpayer's adjusted gross income. In addition, self-employed individuals may make penalty-free IRA withdrawals to pay their health-insurance premiums.

These changes offer "a way of converting your IRA account into a sort of emergency medical account," says Jacksack.

Capital Gains

The recently enacted Taxpayer Relief Act creates immediate savings opportunities on individual long-term capital gains, though there were no changes in corporate capital-gains rates, which go as high as 35 percent. Most of the law's other major changes, including a significant reduction in the estate tax for small-business owners, don't take effect until 1998.

Even so, now is the time to begin thinking about ways to use the provisions in the 1997 law to minimize taxes in 1998 and beyond, according to tax experts.

This past summer's tax law cut the long-term capital-gains-tax rate to 20 percent from 28 percent, effective July 29. Under previous law, long-term was defined as one year. Under the new law, assets must be held for 18 months to qualify for treatment as a long-term gain.

Assets held longer than a year but less than 18 months are considered medium-term and will continue to be taxed at 28 percent.

The law created a number of other capital-gains-tax rates depending upon the type of asset sold, the date the sale took effect, the length of time the asset was held, and the seller's tax bracket. (See the chart.)

The Capital-Gains Maze

This chart shows capital-gains-tax rates resulting from changes enacted Aug. 5. (Short-term capital gains, defined as gains on assets held 12 months or less, are still taxed at the seller's regular income-tax rate, which can be as high as 39.6 percent.)

The new, lower capital-gains rates depend on the type of property that was sold, the date the sale took effect, the length of time that the property was held, and the seller's tax bracket.

[TABULAR DATA NOT REPRODUCIBLE IN ASCII]

Now that capital-gains rates are at their lowest since 1986, a key question for many small-business owners, particularly those close to retirement, is whether it's time to sell the business, says Peter DeMarco, director of the tax-services group at the accounting firm of Meaden & Moore in Akron, Ohio.

For business owners who hold stock or other securities, now may be the time to re-examine portfolios.

Reviewing Estate Plans

The new tax law also creates opportunities to save on estate taxes, so small-business owners should start planning now to take full advantage of those changes when they go into effect next year.

Owners may need to restructure their wills to make sure they take advantage of the increase to $625,000 in 1998 in the so-called unified credit.

This is the amount that escapes federal gift and estate taxes. The credit had been $600,000 since 1986. Under provisions of the new law, the credit will continue to increase each year until it reaches $1 million in 2006.

For qualified family-owned businesses, an additional exclusion of $675,000 for 1998 brings the full amount exempt from estate taxes to $1.3 million. The exclusion will decline each year by the same amount that the unified credit increases, with the result that the total exemption available to closely held businesses will remain at $1.3 million.