So it wasn't a revolutionary year for taxes. Congress didn't chop the capital-gains rate in half or eliminate the Internal Revenue Service "as we know it." Instead, it passed a series of modest bills last summer offering tax breaks to this group and that. But rummaging through the new provisions, you'll find some nice benefits that might figure into your end-of-year planning. Even though most of the changes don't take effect until 1997, now is the time to start gearing up.
For instance, if you're self-employed or work for a company with fewer than 50 employees, you can't afford to pass up the new medical savings account (MSA), which Congress approved on a four-year pilot basis. Starting in January, you can use a tax-deductible savings account earmarked for medical expenses and linked to a catastrophic health insurance policy. Also, you can withdraw MSA money tax-free to pay bills that insurance doesn't cover, and any money your employer contributes is also tax-free. Just as with an individual retirement account, money that isn't spent accumulates on a tax-deferred basis.
ACT QUICKLY. Although the MSA doesn't start until 1997, you can sign up now with a participating insurer. MSAs will be available to the first 750,000 people who apply on a first-come, first-served basis. The MSA was part of the Health Insurance Portability & Accountability Act of 1996, which also allows you to change jobs without losing your health insurance.
Another yearend 1996 tax-planning opportunity is aimed at those who are tapping fat retirement plans, which are becoming increasingly common as people stuff their 401(k)s. Anyone over 59 1/2 who could withdraw more than $155,000 a year from a retirement account will be eligible for a big break--for the next three years, at least. Between 1997 and 1999, you won't be subject to the 15% excise tax on so-called excess distributions of more than $155,000. That means you might want to withdraw at the limit in 1996 but pay yourself more in 1997, when there is no excise tax. If you've got $1 million dollars in your plan, this could save you $150,000 if you pull out the money over the next three years.
Washington was also kind to business owners eyeing new equipment. This year, you can take an immediate deduction on up to $17,500 of new-equipment expenditures, but the Small Business Job Protection Act of 1996 increases the amount to $18,000 in 1997, eventually reaching $25,000 by 2002. So if you have big purchases to make, you might defer them until next year to take advantage of the larger amount. However, the difference isn't so great that you should go out of your way to avoid claiming the deduction in 1996. "In November and December, we find a lot of people loading up on computers or office equipment and furniture so they can get a write-off in the year of purchase, even if it's financed," says James Vonachen, a tax partner with Clifton Gunderson LLC in Denver.
IRA BOOST. Here's a special bone tossed to home-based businesses: Effective in 1996, home-office write-offs can include the room where you store inventory. This provision can help you double your home-office deduction, provided your house is your sole fixed business location and the rooms you claim are not being used for any other purpose.
The new tax law also offers help for married couples with a nonworking spouse and for husband-and-wife businesses. Starting in 1997, spouses can each contribute $2,000 to an IRA, for a total of $4,000 a year, even if one is not employed. That's a big improvement over the combined contribution of $2,250 that was allowed previously. If you open your account now, you can make a 1997 contribution on Jan. 2, which allows you to get a full year of tax-deferred compounding on your savings.
In the same vein, a mom-and-pop business will be able to sock away a maximum of $60,000 next year toward the couple's retirement. Previously, the limit for a husband and wife was $30,000--even though two brothers running a business could each put away $30,000. As a result, since there was no advantage to having both spouses on the payroll, many couples kept one spouse off to avoid Social Security taxes. That won't be necessary now, but be sure to get on the payroll soon. There's a one-year waiting period before small-business owners can start making the extra retirement contributions, says Israel Lustig, a certified financial planner in New York.
CLASS REFUND. It's windfall time if you have received reimbursement from your employer over the past two years for education. You're due a refund from the IRS. Why? Your employer has been withholding federal, state, and Social Security taxes on those benefits. But Congress has kindly reinstated--retroactively, mind you--a tax provision that lapsed in 1994 and allowed up to $5,250 of undergraduate and graduate education costs to go tax-free. You have to file an amended tax return to get your money, though. There's one more hitch: Graduate school tuition on courses begun after June 30, 1996, are not included.
Planning on adopting a child? A tax break may be in your future. Right now, there's no special treatment for adoption expenses such as attorney fees and court costs. But starting in 1997, moderate-income taxpayers will be able to use a tax credit of $5,000 per adopted child--$6,000 if the child has special needs--for qualified expenses. The full credit is available if your adjusted gross income is less than $75,000. But the credit gradually shrinks to zero for people earning $115,000 or more.
Taxpayers in a charitable mood will soon get more options. Donors have long given away stocks or other property that has increased in value over the years. That way they avoid paying capital-gains taxes on the appreciated portion and get a deduction larger than what they paid for the property. Effective on July 1, 1996, this favorable tax treatment was extended to private foundations as well as public charities. So sort through your junk pile and get rid of those old computers, used cars, and anything else you can't sell. Give the stuff to a private foundation set up by a wealthy individual or a public charity such as Goodwill Industries and you will get a tax deduction equal to its book value.
Among the other provisions passed this year that will help minimize 1997's tax bill:
-- Proceeds from long-term-care insurance will be tax-free beginning in January, and a portion of the premiums will be deductible.
-- The normal 10% penalty for early withdrawal from an IRA won't apply if the money is used for medical expenses exceeding 7.5% of your adjusted gross income.
-- Self-employed people will be able to deduct an increasing proportion of their health insurance over the next decade, going from 30% now to 80% by 2006.
-- Starting in 1997, there will no longer be a penalty for failing to withdraw money from a retirement plan at age 70 1/2. Your money will continue to compound on a tax-deferred basis until you choose to take it out.
Those sorts of fixes are mere pocket change, however, compared with what could be the big enchilada of tax breaks. One year ago, investors were asking whether they were going to get a capital-gains tax cut in 1995 or 1996. The answer turned out to be neither of the above. But what about 1997? "I've got clients who haven't sold property for the past five or six years hoping that a capital-gains tax cut will come into existence," says Suzanne McGrath, a managing director with Piper Jaffrey. "Fortunately, they're in a position where they didn't need the cash--and the values have continued to increase." If the Republicans and Democrats keep making cooing noises, you might want to prepare for the best--if you can. By selling your appreciated stock or property in January, you will at least defer paying the tax for another year. And if capital gains relief comes through, and is retroactive to Jan. 1, 1997, then you've locked in lower taxes.
For many people, the 1996 tax season will be pretty much be the same old story. But a little careful planning could bring happier returns for 1997.