President Clinton signed three major pieces of legislation in August, 1996: the Small Business Job Protection Act of 1996, the Health Insurance Portability and Accountability Act of 1996, and the Welfare Reform Act of 1996. The new laws affect virtually every taxpayer. This article provides an overview of some of the provisions that may be of interest to attorneys and their clients.

PROVISIONS AFFECTING INDIVIDUALS
Employer-Provided Educational Assistance Programs

The exclusion for employer-provided assistance (up to $5,250 per individual), which expired for tax years beginning after December 31, 1994, is retroactively extended. The exclusion now expires for tax years beginning after May 31, 1997. For tax years beginning in 1997, only expenses paid for courses beginning before July 1, 1997, are excludable. If employees were taxed on excludable amounts paid after December 31, 1994, the IRS will establish expedited procedures for the refund of any taxes that were overpaid.

Graduate level courses that were formerly qualifying are no longer eligible for the exclusion as of June 30, 1996. Caution! Employers who are currently reimbursing employees for graduate studies will need to revise the program to withhold income and employment taxes on such reimbursements.

Credit For Adoption Expenses

Taxpayers will be able to claim a non-refundable credit of up to $5,000 for qualified adoption expenses for each eligible child in tax years beginning after 1996. Carryover of unused credits can be up to five years.

Home Office Deduction

Individuals may now deduct expenses related to the portion of his or her home that is used regularly for the storage of inventory or product samples. The individual must be in the business of selling products at wholesale or retail, and the home must be the sole fixed location of the business. Taxpayers are not required to use the space exclusively for the storage of inventory or product samples in order to be eligible for the deduction.

The effective date for this provision applies to tax years beginning after December 31, 1995.

Long-Term Care Insurance

A qualified long-term care insurance contract will generally be treated as an accident and health insurance contract. Thus, amounts received under a long-term care insurance contract are excluded as amounts received for personal injuries and sickness. This exclusion is capped at $175 per day on per diem contracts. Employer-provided long-term care insurance premiums will be received tax-free. Long-term care insurance premiums are not excludable from an employee's income if provided through a cafeteria or other flexible spending arrangement. The deduction for 30% of health insurance expenses of self-employed individuals applies to long-term care insurance premiums. There are certain requirements that need to be met in order to qualify as "long-term care insurance."

Medical Expense Deduction

Unreimbursed amounts paid for qualified long-term care services provided to a taxpayer or taxpayer's spouse or dependents are treated as medical care for purposes of the medical expense deduction.

The premiums paid for eligible long-term care are deductible to the extent that the amounts do not exceed certain annual limitations.

Health Insurance Portability

New rules, together with existing COBRA coverage continuation rules, complete a health insurance portability system that will allow employees to change jobs without the fear of losing coverage and will improve coverage access for individuals with health conditions that until now prevented them from getting coverage.

Dependency Exemption TIN

The personal dependency exemption and the dependent care credit are denied to claimants who fail to provide the dependent's correct taxpayer identification number on the return. Failure to provide the TIN number may bar the taxpayer from using a head-of-household status which provides more favorable tax rates.

RETIREMENT PLAN CHANGES

Individual Retirement Accounts

Effective for tax years beginning after December 31, 1996, non-working spouses will be allowed to contribute up to $2,000 per year to a deductible IRA. Under prior law if one spouse had no compensation, a married couple was allowed a $2,250 maximum annual deductible IRA contribution. Beginning for tax years after December 31,1996, the maximum deductible amount is increased to $4,000 ($2,000 for each) as long as the total compensation of the working taxpayer(s) is at least $4,000. The rules determining whether the IRA contributions are deductible or non-deductible still apply. Therefore, if one spouse is an active participant in a qualified retirement plan, the same restrictions apply to determine whether IRA contributions of either spouse are deductible.

Effective for post-1996 distributions, the 10-percent penalty on early withdrawals will not apply to distributions from an IRA used to pay medical expenses in excess of 7.5 % of adjusted gross income. In addition, the 10% tax will not apply to distributions from an IRA for payment of health insurance premiums to an individual after separation from employment. Other restrictions apply.

Lump-Sum Distributions

For tax years beginning after December 31, 1999, five-year forward averaging for lump-sum distributions is repealed. Prior law rules that applied to individuals who attained the age 50 before January 1, 1986 are still in effect. Keep in mind that most lump-sum retirement distributions qualify for IRA rollover provisions.

Required Distributions

Participants in retirement plans, with the exception of five-percent owners and IRA owners, are no longer required to begin receiving distributions after attaining age seventy and one-half if they are still employed. Distributions must begin by April 1 of the calendar year following the later of either: (1) the calendar year in which the employee reaches the age seventy and one-half, or (2) the calendar year in which the employee retires. For defined benefit plans the employee's accrued benefit must be actuarially increased to reflect the value of the benefits that the employee would have received if he or she had retired at the age of seventy and one-half.

Combined Plan Limit and Excess Distributions Tax

The new law repeals the overall limitations on contributions and benefits that apply if an employee is a participant in both a defined benefit pension plan and a defined contribution plan maintained by the same employer. The repeal of the combined plan limit is effective for limitation years beginning after December 31, 1999. It also suspends the 15% tax on excess distributions received in 1997, 1998, and 1999. Generally, distributions in excess of $155,000 a year or a lump-sum distribution in excess of $750,000 are subject to a 15% excise tax. Taxpayers with substantial retirement accumulations may avoid future excess distribution tax by accelerating their distributions in tax years 1997, 1998, and 1999. The disadvantage of avoiding the excess distribution tax is acceleration of income taxes. The tax levied at death, continues to apply.

Multiple Salary Reduction Agreements Permitted under 403(b)

The Act repeals the prior law that barred 403(b) Tax Sheltered Annuity (TSA) participants from entering into more than one salary reduction agreement in any tax year. As a result, TSA participants may now enter into salary reduction agreements with the same frequency as 401(k) plan participants. Under prior law, a professor, for example, who entered into another salary reduction agreement could not exclude from income the amounts contributed to the second TSA salary reduction agreement. These provisions apply to tax years beginning after December 31, 1995.

PROVISIONS AFFECTING BUSINESSES
Miscellaneous

New guidelines effective in 1997 are established which will provide clearer uniform standards for proper treatment of a worker as an employee or as an independent subcontractor. These clarifications are intended to favor the taxpayer by easing restrictive interpretations of Section 530 relief. Under the new interpretation of burden of proof, an employer who cooperates with an IRS investigation, will shift to the IRS, the burden of proving the employer wrong.

During 1996, the IRS notified certain Employers that beginning January, 1997, they had to make their payroll tax deposits via Electronic Funds Transfer or be subject to IRS-imposed penalties for non compliance. This requirement has been postponed to July 1, 1997.

Self-Employed Health Insurance Deduction

The deduction for health insurance expenses of self-employed individuals and their spouses and dependents is increased from 30% to 80% by the year 2006. For 1997, the percentage will increase to 40%. These changes also apply to qualifying individuals in Partnerships and S Corporations.

Increased Limitations on Section 179 Election

Eligible taxpayers may elect to deduct, rather than depreciate the cost of qualified business property in the year the property is placed in service. The allowable expensing deduction increases as follows:

Tax Credits

The credit for increasing research activities which expired on June 30, 1995, is extended for the period July 1, 1996 through May 31, 1997. The credit was not retroactively extended, and expenditures paid or incurred from July 1, 1995 through June 30, 1996, are not eligible for the research tax credit. Under a new alternative computation, a taxpayer's research credit may be larger than using the standard computation.

Pension Reform

Starting in 1997, employers with 100 or fewer employees who received $5,000 in compensation from the employer in the preceding year may adopt a new simplified retirement plan (SIMPLE), if they do not currently maintain another qualified plan. The "Savings Incentive Match Plan for Employees" allows employees to make elective contributions up to $6,000 per year and requires employers to satisfy one of two contribution formulas for contributing amounts to the employees' accounts. Self-employed individuals can participate in a SIMPLE plan.

SIMPLE plans are not subject to the non-discrimination rules generally applicable to qualified plans. A SIMPLE plan can be either an IRA account for each employee or part of a qualified cash or deferred arrangement (a 401(k) plan).

Distributions from a SIMPLE account are generally taxed like IRAs. There is a 25% early withdrawal penalty if the employee withdraws amounts during the first two-year period beginning on the date that they first began participating in the SIMPLE plan.

Caution--Small businesses that have fluctuating profits should be aware that they must continue to make contributions to a SIMPLE plan even if the business is not performing well in that year. In a lean year, an employer will be required to match at least one percent of his employees' compensation. The owner of a small business whose income is much higher than that of his employees and who wants to compile retirement assets as quickly as possible, may prefer the traditional qualified plan that allows higher annual contributions.

S Corporation Simplification

The maximum number of eligible shareholders for S corporations has been increased from 35 to 75 for tax years beginning after 1996.

An electing small business trust may be a shareholder in an S corporation. This provision allows estate planning opportunities for S corporation shareholders by allowing trusts to be funded with S corporation stock.

The post-death holding period of S corporation stock for a grantor trust is expanded to two years (from 60 days). Also, a trust that becomes an S corporation shareholder by virtue of a transfer as set forth in the terms of a will is also permitted to be an S corporation shareholder for two years.

An S corporation may now own 80% or more of the stock of a C corporation. An S corporation, however, cannot elect to file a consolidated return with its affiliated C corporations.

An S corporation is also permitted to own a qualified subchapter S subsidiary. This includes any domestic corporation that qualifies as an S corporation and is 100% owned by an S corporation parent.

The IRS has been given expanded authority to waive inadvertent terminations and validate certain invalid elections. Any termination of the subchapter S election in a tax year beginning before January 1, 1997, and within a five-year period, can re-elect subchapter S status without the IRS's consent.

For tax years beginning after December 31, 1996, distributions made during the year are taken into account before applying loss limitations for the year. The loss for the year does not reduce the adjusted basis for purposes of determining the taxable effect of the distributions. The distribution provision allows for expanded tax-free distributions during loss years.

James Lange, CPA, JD provides specialized retirement and estate planning services to married university faculty members with significant retirement plan accumulations.  He has prepared over 450 simple and complex retirement and estate plans.  These plans include tax-savvy advice, will and trust preparation, and sophisticated beneficiary designations for TIAA-CREF accounts, IRAs and other retirement plans.

You can contact Jim by phone at (800) 387-1129, or (412) 521-2732, or by e-mail at admin@faculty-advisor.com.