THE TAXPAYER RELIEF Act of 1997, signed into law on Aug. 5, contains several provisions that will benefit the self-employed. Here is a roundup of key changes.
Health Insurance Deduction
- The self-employed orthose who are partners can deduct 40 percent of their health insurance costs as an adjustment to gross income in 1997. Last year’s tax act had this escalating to 80 percent by 2006. The new law will allow a 100 percent by the year 2007:
Year Deduction 1998 and 1999 45& 2000 and 2001 50% 2002 60% 2003, 2004, 2005 80% 2006 90% 2007 and on 100%
- Matching contributions. The self-employed who maintain 401(k) plans for themselves and their staff are given relief under the new law with respect to matching contributions. Matching contributions by self-employed individuals are not treated as elective contributions. This means that they can contribute the maximum allowed to any participant — $9,500 and can make matching contributions allowed to any employer. Before this law change it was assumed that the total contribution on behalf of a self-employed individual (from elective and matching contributions) was $9,500.
- The change also applies to SIMPLE IRAs. Thus, the self-employed who maintain SIMPLE IRAs can contribute up to $6,000 (the maximum allowed to any participant) and can make matching contributions required by employers.
- The new rule for SIMPLE IRAs applies for taxable years beginning after Dec. 31, 1996. The new rule for 401(k) plans will take effect in taxable years beginning after Dec. 31, 1997.
- Roth IRAs. The self-employed who are already benefiting from Keoghs or other retirement plans may still be eligible for a new type of nondeductible IRA, called “Roth IRA.” These “backloaded” retirement plans come into effect in 1998 and will offer several advantages over other retirement options:
- Distributions are tax free provided they are taken at least five years after the first year in which a Roth IRA contribution was made and the reason for the distribution is being over age 59-1/2, disabled, a first-time homebuyer up to $10,000 (or on account of death).
- Contributions can continue to be made after age 70-1/2 as long as the individual is still working.
- No required distributions need be taken before death.
- For the self-employed and other high income taxpayers, the key impediment to making contributions is an adjusted gross income limit. Up to $2,000 can be contributed annually to a Roth IRA if adjusted gross income is no more than $95,000 ($150,000 on a joint return). The maximum contribution is phased out for AGI from $95,000 to $110,000 ($150,000 and $160,000 on a joint return).
- Excess distributions. The self-employed who have saved large sums in retirement plans will no longer be penalized when they take out “excess distributions” (or die with “excess accumulations”). The 15 percent penalty tax on excess distributions (and the 15 percent additional estate tax on excess retirement accumulations) was repealed retroactive to Dec. 31, 1996.
Family Tax Savings
- The self-employed with children at home may be able to benefit from several measures. The key to taking advantage of any of them is satisfying an adjusted gross income limit.
- Child tax credit. A credit of $400 per child in 1998 ($500 per child thereafter) can be claimed for those with children under age 17. AGI limit: $75,000 for singles; $110,000 on a joint return.
- HOPE scholarship credit and lifetime learning credit. Two different tax credits are designed to offset the cost of higher education of the taxpayer, spouse and dependents. AGI limit $50,000 for singles; $100,000 on a joint return (partial credit for singles with AGI from $40,000 to $50,000; $80,000 to $100,000 on a joint return).
- Deduction for interest on student loans. Taxpayers who take loans to pay for their, or their children’s education, may be able to deduct interest that would otherwise be treated as nondeductible personal interest. The limit for 1998 is $1,000 (it reaches $2,500 by 2001) and it is treated as an adjustment to gross income. AGI limit $40,000; $60,000 on a joint return (partial deduction for those with AGI from $40,000 to $55,000; $60,000 to $75,000 on a joint return).
- Education IRAs. Those with small children may want to save for their college expenses in a new type of account that comes into effect in 1998. Up to $500 can be contributed annually per child on a nondeductible basis. Earnings can build up on a tax-deferred basis and can even become tax-free, since funds withdrawn to pay qualified higher education expenses are not taxed. AGI limit: $95,000 for singles; $150,000 on a joint return (partial contribution for those with AGI from $95,000 to $110,000; $150,000 and $160,000 on a joint return).