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Here are 11 of the most important new-for-’97 changes.

  1. Expensing deduction. Small businesses can elect to currently deduct– “expense”–newly purchased equipment and machinery rather than writing it off over a period of years. But there is a limit on how much can be expensed each year. Before 1997, the limit was $17,500. Starting in 1997, the limit is gradually raised–from $18,000 in 1997 to $25,000 in 2003 and beyond.

  2. Medical Savings Accounts. Starting in 1997, small businesses can set up a new kind of plan that allows employees to save and pay for out-of-pocket medical expenses on a tax-favored plan. If the company covers employees under a high-deductible, catastrophic-type health insurance plan, tax-deductible contributions can be made to a “medical savings account” (MSA), either by your company or the employees. These contributions can later be withdrawn tax-free to pay out-of-pocket medical expenses. MSA balances that remain at year end can be carried over and used in future years. If MSA funds are not needed for medical expenses, they can be withdrawn at retirement, much like an IRA. (Withdrawals not used for medical expenses are subject to income tax and, if made before age 65, a 15% penalty tax.)

  3. Savings Incentive Match Plan for Employees. Beginning in 1997, small businesses can offer their employees a new type of retirement plan — a Savings Incentive Match Plan for Employees, or SIMPLE. A SIMPLE plan can be set up either as an IRA for each employee or as part of a 401(k) plan to which employees may make pre-tax contributions of up to $6,000 per year. In either case, your company will not be subject to complex nondiscrimination testing as long as (1) it matches employee contributions up to 3% of the employee’s compensation or (2) it makes nonmatching contributions equal to 2% of the employee’s compensation.

  4. Adoption credit. Taxpayers will be allowed a tax credit of up to $5,000 per child for adoption expenses, starting in 1997. Eligible expenses include adoption fees, court costs, and attorneys’ fees. The credit is increased to $6,000 for special needs adoptions (other than foreign adoptions). Unused credits may be carried forward up to five years. Another change allows taxpayers to receive up to $5,000 ($6,000 for nonforeign special needs adoptions) of tax-free, company-provided adoption assistance. The tax breaks for adoptions are phased out for taxpayers with adjusted gross incomes above $75,000.

  5. IRA withdrawals. Beginning in 1997, taxpayers can make penalty-free withdrawals from an individual retirement account (IRA) to pay for medical expenses in excess of 7.5% of adjusted gross income (AGI). In addition, penalty-free withdrawals may also be made for medical insurance (without regard to the 7.5% of AGI floor) if a taxpayer has received unemployment compensation for at least 12 weeks.

  6. Required retirement plan payouts. In the past, members of company retirement plans had to begin receiving distributions by age 70 1/2–even if they still worked for the company. But starting in 1997, distributions can generally be postponed until an employee retires. However, the old rule will continue to apply to plan members who also own 5% or more of the company.

  7. S corporations. Several changes that are designed to make it easier to qualify and operate as an S corporation take effect in 1997. For example, an S corporation can have as many as 75 shareholders, up from the old 35-shareholder limit. And for the first time, an S corporation can have subsidiaries, which may be either other S corporations or regular C corporations.

  8. Long-term care. Beginning in 1997, taxpayers can claim a medical expense deduction for the cost of long-term care insurance. The medical expense deduction is subject to dollar caps that vary according to age. In addition, a tax exemption is also allowed for benefits received under a long-term care policy and for coverage under company-provided long-term care insurance. The medical expense deduction is subject to dollar caps that vary according to the age of the taxpayer.

  9. Spousal IRA. Before 1997, married taxpayers could claim a deduction of up to $2,250 for IRA contributions when one spouse did not work outside the home. A recent change permits deductible IRA contributions of up to $2,000 to be made for each spouse if the combined earnings of both spouses is at least equal to the contributed amount.

  10. Expatriates. Starting in 1997, there is a new crackdown for U.S. citizens who expatriate to avoid tax. The new changes build on existing rules that subject citizens who expatriate to special U.S. taxes for 10 years following the expatriation. Specifically, the new law presumes that certain high-income taxpayers have a tax avoidance purpose for expatriating, and it expands the type of income subject to tax during the 10-year period following expatriation. Finally, the law applies the expatriation rules to certain long-term resident aliens who relinquish their U.S. residency.

  11. Health insurance. Self-employed taxpayers can deduct a portion of their health insurance premiums, whether or not they itemize their deductions. Starting in 1997, self-employeds can deduct 40% of their premium payments, up from 30% in 1996. The deductible portion will gradually increase until it reaches 80% in 2006.
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