Hugh's Easy to Understand Synopsis of the 1997 Tax Bill
Several people have asked me, just a plain old computer geek, about what
the 1997 Tax Bill means to common everyday folk. Well, since I don't sell
real estate, IRA products or mutual funds, I think I have a pretty unbiased
opinion on the great and not so great things in this bill.
The Best Deal of all -- the Roth IRA
What a deal! We can roll over our present IRA's, pay the tax on it
(in 1998 you could) over four whole years, and after that never pay a dime of tax on
the earnings! It is hard to believe Congress passed such a great boon for
investors. Anyone making less than $95,000 ($150,000 for couples) is eligible
and may also contribute up to $2000 a year to the plans.
For rollovers married couples must make less (AGI) than $100,000/year.
There is NO
minimum withdrawal at 70 1/2 and no penalty after 59 1/2.
For younger folks this is a great way to save for your first home since if
the funds are held for more than 5 years $10,000 can be withdrawn (tax-free!)
to purchase a first home.
So why did Congress do such a nice thing? Well, just think how much tax will
be shelled out in 1998-2002 on these things from these massive IRA rollovers.
Sure in the long run the feds will lose out big time, but we all know our
friends in Washington care as much about the long term as your average CEO
(i.e. zippo). The federal budget gets tons of new money soon which makes them
look so great. "We're balancing the budget! We have more money for our
local pork barrel projects! Re-elect me! Whooppeee!"
No more penalty for being smart!
They got rid of the stupid 15% penalty for people who were frugal and smart
enough to sock away big bucks in their IRA's and 401(k) plans. Maybe now
the tax laws are set to help people who save! (Okay, at least they are
closer to that goal!) If Great Aunt Betty skimped and saved all her life
to max out her IRA to leave to her heirs, it would be a shame if she found out
due to the bull market of the 80's and 90's that she has to pay a tax
PENALTY while those who saved less didn't.
Capital Gains -- Hold those Assets, except that House!
Note: Modified for 1998 - Congress phased out the nasty 12 to 18 month "28%"
capital gain rule. That sure made 1997 returns a pain!
The Republicans are pleased -- finally some real capital gains cuts!
if you hold your assets more than 12 months, the capital gains tax is 20%
(10% at the 15% bracket). And if you hold your assets for more than 5 years the
rate is 18% (8% at the 15% bracket). That sure is a lot fairer than making
the rate the same on an asset held for 13 months as one held for 20 years
as it was in the past. You have to factor just plain inflation into
capital gains somehow. It never seemed right that Mr. Wall Street would pay the
same capital gains tax on equities he bought two years ago for $20,000 and
sold for $100,000 as Great Aunt Betty when she sold her second house (the
first one used up her over-55 exclusion -- she's really old!) for $100,000
that she bought for $20,000 say 30 years ago.
And now home owners can forget about any capital gains on selling their house
if their gain is less than $250,000 ($500,000 for couples). You can buy and sell
houses with gains less than this amount at any time now. There is just a two
year residency limit. Now people from expensive areas can actually move without
having to buy a gargantuan house in a cheaper location! You don't have to
worry about moving to a less expensive home anymore! And Great Aunt Betty won't have to worry about her $80,000 gain after all!
Some kindness to families
Starting in 1998 children under 18 are worth $400 each
($500 starting 1999) off your taxes. Note that this is
not a deduction off your income but an actual tax credit, which is worth
a lot more. Granted, $400 or even $500 barely even pays for a year of
diapers, but it's better than nothing. Having kids is never a money
making endeavor; you pay a lot of money, sweat and tears, but for some
reason it seems worth it!
Wow, $500 per year for college? That's Something Alright!
This is a great idea with a lousy limit. Make annual payments after-tax to a
investment plan where you can withdraw money tax-free for college.
So who decided the wimpy $500 a year limit? What's the point of such a nice
plan when after even 18 years, you might have $30,000 tops. You'll be lucky to
afford anything with $30,000 in 18 years. See my
tuition savings calculator for more details. I hope nobody thinks this is
all the college savings they need.
College Credits That Count!
Two other college tuition related credits were created with the tax bill.
The Hope Scholarship Credit provides a tuition credit of up to $1,500 per year
per student, 100% of the first $1,000 and 50% of the second $1,000 of tuition
for the first two years of college. After the first two years the
Lifetime Learning Credit kicks in, giving a 20% credit from the first
$5000 of tuition expenses ($10,000 after 2002). Note that you can use
either an Education IRA or the college tuition credits. Typically
the IRA is more worthwhile for younger children (10+ years from college),
especially if they increase that wimpy minimum. These college credits though,
are great for families with teenagers who do not have the time to make the
tax free earnings from the Education IRA worthwhile.
Another nice deal is that student loan interest is now deductible much like
mortgage interest. The limits are $1000 in 1998, $1500 in 1999, $2000 in 2000,
and $2500 in 2001. More lost revenue for Washington!
Unified Credit -- you call that an increase?
It is good they are increasing the $600,000 unified credit exemption to
$1,000,000, but do people realize how slowly they are doing so? In 1998
it goes up a whopping $25,000 to $625,000. Wow. That's 4.17%. In 1999 add
on another $25,000. That's a whopping 4.0%. I think most people who have
$600,000 in assets now will see more than a 4% return on the bulk of their
estates. This is really just a long overdue inflation indexing, and it stops
in 2006. Why not keep it indexing forever? It just doesn't make sense. If
you've seen the numbers they are really bizarre: (I've included a column starting with $600,000 compounding at a rather mundane 6%)
| Year | Unified
Credit | Compounded
600K
|
|---|
| 1997 | 600,000 | 600,000
|
| 1998 | 625,000 | 636,000
|
| 1999 | 650,000 | 674,160
|
| 2000 | 675,000 | 714,609
|
| 2001 | 675,000 | 757,486
|
| 2002 | 700,000 | 802,935
|
| 2003 | 700,000 | 851,111
|
| 2004 | 850,000 | 902,178
|
| 2005 | 950,000 | 956,308
|
| 2006 | 1,000,000 | 1,013,687
|
The increase is reaallyy sloowww up to 2003 at $700,000.
At this point the increase
is only 16% over 7 years. That's really pretty piddly. What's the point of
such a gradual increase up to 2003, and then a big jump in 2004? Many of you
may think these numbers are beyond you anyway, but think again! Have you
checked your 401(k) balances? The face value of your life incurance policies?
*All these* are included in your taxable estate and are liable for estate tax
unless you protect them with trusts (See Estate
Calculator). So if rich
Great Aunt Betty is on her death bed in 2003, put her on life support until
2004! The estate will save over $50,000! Who can figure out how they came up
with these numbers?
Disclaimer: I mean no disrespect to any Great Aunts who may be named
Betty.
Hugh