New Tax Legislation 1977

Taxpayer Relief Act of 1997 contain significant tax traps for the initiated

Although the Taxpayer Relief Act of 1997 contains the most dramatic tax reductions in 16 years, there are significant tax traps for the uninitiated. The following summarizes the benefits and exposes some of the traps which retail managers and their employees may experience.

The capital gains tax changes represent significant benefits for individual (and other non-corporate) investors. The maximum capital gains rate is reduced to 20 percent from 28 percent for assets held for more than 18 months. For those in the 15 percent income tax bracket, the rate is reduced to 10 percent.

The 28 and 15 percent rates will continue to apply for assets held more than one year but less than 18 months, except that the new rates apply to sales of capital assets after May 6, 1997 and before July 29, 1997. Otherwise, the new rules apply to sales and exchanges after May 6, 1997 and installment payments received after that date.

Example: Mary has taxable income of $70,000 in 1997 which includes post May 6, pre-July 29, 1997 capital gain of $50,000 on property held for more than one year, but less than 18 months. For 1997, the first $26,640 is taxed at 15% Mary's $20,000 of ordinary income is taxed at the 15% rate; $4,640 of the capital gain is taxed at the new 10 percent rate; the balance of the capital gain is taxed at the new 20 percent rate. If Mary's ordinary income for 1997 is in excess of $24,640, the entire capital gain is taxed at 20 percent.

Starting in 2001, an additional capital gain bracket is added for assets acquired after December 31, 2000 and held for more than 5 years. The rates are 8 percent (rather than 10 percent) and 18 percent (rather than 20 percent).

Taxpayers holding property on January 1, 2001 may elect to recognize gain (difference between basis and fair market value) so that the property may then qualify for the special five year rate. Loss is not recognized. Careful calculation is required before this election is made. The election probably should not be made if there is a gain not offset by losses, or the individual has a short life expectancy.

The long term capital gain rates on the sale or exchange of collectibles (e.g. artwork, gems, stamps, coins) is taxed at a maximum of 28 percent. The maximum tax on the sale of Section 1250 property (i.e., depreciable real property), to the extent the gain would be treated as ordinary income under Sec. 1245 is 25 percent.

The sale of a principal residence represents a change and big break for homeowners while at the same time eliminating the existing rollover deferral rules and the one time $125,000 exclusions for the over age 55. Homeowners may exclude up to $250,000 ($500,000 for a married couple filing a joint return) from the sale of a principal residence. The exclusions may only be used once every two years, provided the house was used as the principal residence for at least two of the last five years.