Just when you thought you finally had your tax situation figured out, it's on the brink of changing again. But will the proposals being considered by Congress help you or hurt you? That depends on your circumstances--and on who prevails on Capitol Hill. A good many of the tax measures before Congress are part of President Clinton's 1999 budget package, but Republican lawmakers have a tax agenda as well, with a major focus on broad income tax cuts. Small-business owners stand to benefit from several of the proposals, but the Clinton administration's efforts to crack down on estate-planning strategies could mean higher taxes for family firms.
The administration wants to use the tax code to accomplish some specific policy objectives. For example, it would provide small-business owners with tax incentives for setting up and expanding employees' pension and retirement plans, and businesses would receive tax benefits for improving energy conservation.
The budget package also includes measures to extend several business tax credits and deductions that are due to expire. These include an employer education assistance deduction, a work opportunity credit, a welfare to work credit, and a research and experimentation credit. These "extenders" help focus attention on other tax proposals, says Thomas P. Ochsenschlager, a tax partner in the Washington, DC, office of accounting firm Grant Thornton. "Congress ends up extending these credits, and that generates congressional interest in a tax bill," he explains.
Graduate education would be given a boost under Clinton's extension of the employer educational assistance deduction. He proposes allowing educational grants of up to $5,250 per year for undergraduate courses to be considered a deductible expense for employers but not counted as income for workers through May 31, 2001. Clinton also wants to allow employees taking graduate-level courses to receive the same tax benefit from July 1, 1998, through May 31, 2001.
Show Me The Money
To encourage more entrepreneurs to offer pension plans to employees, the administration has proposed a credit for business owners of 50 percent of the first $2,000 spent for first-year administrative and educational costs associated with setting up a new qualified defined benefit or defined contribution retirement plan. The credit would be reduced to 50 percent of the first $1,000 for the same costs associated with the second and third years of the pension plan.
Retirement plans that would qualify for the credit include 401(k)s, Savings Incentive Match Plans for Employees (SIMPLEs) and Simplified Employee Pensions (SEPs). Employers could also offer their employees the opportunity to make pre-tax IRA contributions through payroll deductions. (For details on the tax advantages businesses now receive for offering these plans, see "Tax Talk," March 1998.)
On the energy conservation front, the administration wants to provide tax credits to businesses that invest in energy-efficient equipment and rooftop solar collectors. To encourage ride-sharing, business owners would be able to offer employees nontaxable transit and vanpool benefits of up to $175 per month starting next year, a sizable increase from the current monthly rate of $65.
The administration also hopes more employers will provide child-care services for their employees. Its proposal: In 1999, employers would be entitled to a credit of up to 25 percent of expenses (not to exceed $150,000) to build or acquire an employee child-care facility.
In an effort to provide minority-owned firms greater access to capital, Clinton has proposed some changes in the tax benefits for Specialized Small Business Investment Companies (SSBICs). These are investment firms licensed by the SBA under section 301(d) of the Small Business Investment Act of 1958, and they help fund many minority-owned businesses.
Under the proposal, the administration would let investors defer capital gains from the sale of publicly traded securities if the proceeds are reinvested in SSBICs within 180 days of the sale. Current law requires that proceeds be reinvested within 60 days.
Another proposed change would allow individual investors who buy shares of stock in these investment companies to roll over as much as $750,000 in capital gains during their lifetime. The current lifetime rollover limit for an individual investor is $500,000, which supporters of the change say is too small to create a significant capital market for minority entrepreneurs. Investors would be able to defer taxes on these assets as long as they hold shares in the investment companies. The lifetime limit for corporations would be $2 million.
The Fine Print
While the administration's tax-cut proposals are attractive to small-business owners, the package unfortunately includes a host of new business taxes. The administration also wants to eliminate the tax benefits of a number of popular estate-planning techniques. These include strategies such as establishing a family limited partnership or a Crummey Trust, named after an important tax case of the late 1960s. The Crummey Trust is a popular technique that allows taxpayers to transfer property out of their estates, typically to their children, while at the same time delaying the date when the children would have control of the gift. (For more details on family limited partnerships, see "Tax Talk," July 1997.)
Clinton also wants to raise additional revenue by boosting taxes on insurance companies that maintain higher than necessary reserves against their annuity contracts. The Department of the Treasury claims high reserves cause a "material understatement" in the income of life insurance companies, which allows them to pay less federal tax. In addition, Clinton is proposing to tax any exchanges between annuity contracts. Currently, individuals with variable-rate annuity contracts can generally transfer their investments among different types of funds without paying taxes on any of the gains.
The 1999 budget package also includes a provision that would make converting from a C corporation valued at more than $5 million to an S corporation a taxable event. The change would mean that both the corporation and its shareholders would immediately realize capital gains when making the conversion. The administration has tried unsuccessfully to win support for this proposal in the past.
Across The Aisle
Congressional Republicans strongly oppose tax increases and instead want broad tax cuts. They favor not only cutting income taxes but also a further reduction of estate taxes and a less-onerous marriage penalty.
Rep. Bill Archer (R-TX), chairman of the House Ways and Means Committee, wants to change a major provision in last year's tax law concerning capital gains taxes. Specifically, he wants to reduce the holding period necessary for investments to qualify for long-term capital gains treatment from 18 months to one year.
Under the 1997 law, gains on investments held for 12 months or less are taxed as ordinary income; gains on investments held for more than 12 months and up to 18 months are generally taxed at a 28 percent capital gains rate; and gains on investments held longer than 18 months are taxed at a maximum long-term capital gains rate of 20 percent. For individuals in the 15 percent income tax bracket, the rate is only 10 percent. Archer says the change would help simplify last year's tax law.
While the Republicans are talking about doing away with the existing tax code by 2001, little action is expected on such an agenda this year. For now, the GOP strategy is to pursue broad tax cuts and to continue discussing a major tax simplification plan for the future. It's not clear what new system would take the place of the existing tax code, since some Republicans want to establish a national sales tax on goods and services at the time of purchase, while others support a flat tax.
Down The Road
While the administration's proposals are far from a slam-dunk, they do carry a good deal of weight among lawmakers, say congressional experts. "You have to give pretty high regard to President Clinton's proposals, because they have a head of steam behind them that a typical legislative proposal doesn't have," says Ochsenschlager.
The Department of the Treasury recently pointed out that nearly half the tax measures previously proposed by the administration have passed. But experts say passing another tax bill this year won't be easy, since Democrats and Republicans strongly disagree on the direction of tax changes. Only time will tell whether a compromise will eventually be reached.
Grant Thornton LLP, 1707 L. St. N.W., Washington, DC 20036, (202) 861-4115
Joan Szabo is a writer in McLean, Virginia, who has reported on tax issues for more than 12 years.