The 104th Congress opened its legislative agenda proposing $240 billion in tax cuts for individuals over a seven-year period. Although he disagreed with the size of their proposed cuts, President Clinton shared their commitment to substantial cuts for individuals, starting with a tax credit for families with children and significant liberalizations of individual retirement account (IRA) rules. Nearly two years later, neither of these proposals has been enacted. Instead, they have been collapsed into a handful of modest changes. The most important of these relate to health care.
Long-Term Care Provisions
Under the Act, a qualified long-term care insurance contract generally is treated as an accident and health plan. This allows long-term care insurance contracts to receive the same tax benefits as other health insurance plans.
Amounts received under such a contract generally are excludable as amounts received for personal injuries or sickness, subject to a $175-per-day limitation on per diem contracts.
Premiums for long-term care insurance and long-term care services are treated as medical expenses for purposes of the itemized deduction for medical expenses and the exclusion for employer-provided health benefits.
Long-term care insurance will not be permitted to be offered under a cafeteria plan or to be covered under flexible spending arrangements.
Effective date: The provisions are effective for taxable years beginning after Dec. 31, 1996.
IRA Withdrawals For Certain Medical Expenses
The Act creates an exception to the 10% penalty tax on early withdrawals from an Individual Retirement Account (IRA) for medical expenses in excess of 7.5% of adjusted gross income. In addition, the 10% tax does not apply to distributions for medical insurance (without regard to the 7.5% floor) if the individual has received unemployment compensation under federal or state law for at least 12 weeks.
Effective date: The provision is effective for taxable years beginning after Dec. 31, 1996.
The Act provides a $5,000-per-child credit for qualified adoption expenses incurred by individuals. The credit is phased out as modified adjusted gross income (AGI) increases from $75,000 to $115,000. The credit is increased to $6,000 in the case of special needs children (except for special needs foreign adoptions that are limited to the $5,000 credit). Unused credits may be carried forward for up to five years.
In addition, the Act provides an exclusion from income for up to $5,000 per child of employer-provided adoption assistance. The credit is increased to $6,000 in the case of a special needs child (except for special needs foreign adoptions that are limited to the $5,000 credit). This exclusion phases out as modified AGI increases from $75,000 to $115,000. No credit is allowed for any adoption expenses paid or reimbursed under an employer adoption assistance program.
Effective date: The credit and exclusion apply to taxable years beginning after 1996. The credit for non-special-needs adoptions terminates for expenses paid or incurred after Dec. 31, 2001. The exclusion for employer-provided assistance terminates for payments paid or incurred after Dec. 31, 2001.
Inclusion of Punitive Damages
Under the Act, punitive damages received on account of personal injury or physical sickness are now included in gross income, and so are taxable. The Act also includes in income other damage recoveries for nonphysical injuries, such as emotional distress and employment discrimination.
Effective date: The provision generally is effective for amounts received after the date of enactment.
Treatment of State Prepaid Tuition Plans as Tax-Exempt Entities
The Act provides that gross income generally does not include amounts received by a contributor or beneficiary from a qualified state tuition program to the extent that the amounts received or the educational benefits provided do not exceed the contributions made. Additionally, the Act provides tax-exempt status to such programs. Qualified state tuition programs are defined as programs established and maintained by a state under which persons may purchase tuition credits on behalf of a beneficiary or contribute to an account established solely for higher education expenses of a beneficiary.
Effective date: The provision is effective for taxable years ending after the date of enactment.
Personal Exemptions and Dependent Care Credit Disallowance
The Act authorizes the IRS to deny the personal exemption and the dependent care credit for taxpayers who file tax returns without a taxpayer identification number (TIN) for the filer’s dependent. Failure to provide a required TIN will be treated as a mathematical or clerical error, so the IRS may immediately assess tax without conducting an audit.
Effective date: The provision is effective for returns due 30 days after the date of enactment with a transition rule for certain pre-existing programs.
The remaining provisions in the small business bill that affect individuals are a collection of essentially miscellaneous excise tax changes.
The Act reinstates the Airport and Airway Trust Fund excise taxes, which expired Dec. 31, 1995, for the period beginning seven days after enactment and ending Dec. 31, 1996.
The Act exempts from the diesel fuel tax fuel used in recreational motorboats for the period beginning seven days after enactment through Dec. 31, 1997.
The Act extends and phases out the excise tax on luxury automobiles (currently vehicles priced at over $34,000) so that the tax expires after 2002. Under the phase-out the tax rates will be as follows:
|For Sales in
|Excise Tax Rate
Effective date: The provision is effective for sales on or after the seventh day after the date of enactment.
The Act also repeals the tax credit previously available for purchasers of diesel-powered automobiles, vans, and light trucks, effective for vehicles purchased after the date of enactment.