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The introduction of lengthy tax packages is becoming an annual event in Washington, DC, and 1998 is no exception. This year, lawmakers passed the IRS Restructuring and Reform Act of 1998, which makes some long-overdue improvements in IRS policies and procedures and adds a host of other changes to an already bulging tax code.
The IRS-overhaul portion of the act stems from the work of a special congressional commission that studied the agency's need to restructure and from Senate Committee on Finance hearings held last fall that publicized numerous abuses taxpayers suffered under the strong arm of the IRS.
But there's more to the new law than IRS reforms. CCH Inc., a provider of legal, tax and business information in Riverwoods, Illinois, points out that the new statute contains 144 main act sections, more than 40 taxpayer-rights provisions, and more than 70 provisions that make what lawmakers call "technical corrections" to the existing tax code.
One change that's potentially lucrative for investors concerns the shortening of the capital gains holding period. Small businesses also benefit from a change dealing with the rollover treatment for gains on small-business stock. The new law also makes changes in the existing estate and gift tax law and alters some of the rules on Roth IRAs.
Joan Szabo is a writer in Great Falls, Virginia, who has reported on tax issues for more than 12 years.
Shaking Up The Service
One of the most controversial provisions in the new law has to do with the burden of proof. Previously, taxpayers bore the burden of proof when challenged by the IRS. Under the new law, the burden of proof is shifted away from individuals and corporations (with net worths of less than $7 million) under certain circumstances.
"In [standard] audit situations, there isn't a change," says enrolled agent Jan Zobel, owner of a tax preparation and consulting business in Oakland, California. Instead, the shift in the burden of proof relates only to tax court cases. Such a small proportion of taxpayers go to the tax court level that the change won't make much of an impact, Zobel says.
Nevertheless, the new law provides business owners and other taxpayers with some significant new rights. For example, the IRS now has 18 months to notify taxpayers that they owe money. If it doesn't notify the taxpayer in that time, penalties and interest are suspended until notification occurs.
The statute also contains a provision that extends the existing attorney-client privilege of confidentiality to CPAs and enrolled agents. As a result, taxpayers concerned about maintaining confidentiality now have a greater choice about who represents them on tax matters, says Marvin Michelman, a director of IRS practice and procedure with Deloitte & Touche LLP.
Congress also reined in the tax agency on the issue of property seizure. Under the new law, the IRS must exhaust all other payment options before seizing a taxpayer's business assets or principal residence. The agency also can no longer seize nonrental real estate that is used as a residence for satisfying an unpaid liability of $5,000 or less.
One of the most important changes affecting the tax agency itself is the creation of a nine-member oversight board that will have a strong say in strategic IRS planning, modernization, training and collections procedures. It will be made up of six private-sector experts (appointed by the president with Senate approval), the Secretary of the Treasury, the IRS commissioner and an IRS employees' representative.
Another significant provision is the creation of a new organizational structure that calls for operating units within the IRS to serve specific groups of taxpayers, such as individuals, small businesses, large businesses and tax-exempt organizations.
The new law also establishes a system of local taxpayer advocates who report to a national taxpayer advocate and are independent from the IRS examination, collection and appeals divisions.
To increase electronic filing by taxpayers, the new tax law first requires the Secretary of the Treasury to develop a plan to make it easier for taxpayers currently preparing their returns using tax preparation software to file electronically. Even though these taxpayers use software to prepare their returns, many print and mail them to the IRS. If taxpayers already have their filing information on their computers, sending the return electronically makes it easier for everyone, says Michelman. The aim is to have those returns filed electronically by 2002.
Knowing When To Fold 'Em
The new law also gives investors a break by allowing them to get a faster payback on their investments. Last year, Congress lowered the rate on capital gains from 28 to 20 percent, as long as investors held assets 18 months (vs. the previous 12-month holding period). In addition, the 1997 law created a new category of gains called "midterm gains," which applied to assets held more than 12 months but fewer than 18. These were subject to the old capital gains rate of 28 percent.
This year, Congress eliminated the midterm gains category and the 18-month holding period. As a result, investors are only required to hold investments for 12 months and a day to receive the lower 20 percent capital gains rate. This is effective for gains realized after December 31, 1997.
Lawmakers also took steps to further enhance an existing capital gains provision designed to benefit small emerging companies in need of capital. By law, people who invest in certain small-business stocks receive a 50 percent exclusion on gains from that stock if it's held for at least five years. The company issuing the stock must be a "qualified small business" with assets of less than $50 million.
Under last year's law, individuals who invested in qualifying small businesses could avoid paying taxes on their capital gains as long as they rolled over the proceeds from the sale of a company's stock into the stock of another qualified small business. In addition, under that change, it was still possible to qualify for the 50 percent exclusion that was allowed after the first five years of holding the stock.
In 1998, Congress extended the tax-free rollover treatment for gains on small-business stock to stock held by partnerships and S corporations. This change essentially allows investment pools to be set up to make it easier for people to invest in emerging businesses, says Thomas P. Ochsenschlager, a tax partner in the Washington, DC, office of accounting firm Grant Thornton LLP. The stock doesn't have to be publicly traded, but it must be in a company organized as a standard corporation.
In the estate tax area, Congress made some changes affecting family businesses. Under the 1997 law, executors for family-business owners who died after December 31, 1997, were able to elect special estate tax treatment for family-owned business interests if those interests made up more than 50 percent of the estate; other requirements also had to be met.
The 1997 act created an exclusion from the family-business owner's taxable estate for the first $675,000 of value in qualified family-owned business interests. This year's law converts that exclusion to a deduction and stipulates that the deduction can apply only for estate tax purposes.
For Roth IRAs, the new act gives high-income elderly taxpayers who were previously ineligible to make a rollover from a traditional IRA to a Roth IRA more leeway in converting to a Roth IRA starting in 2005. Under the new law, for example, if required annual withdrawals from a couple's IRA push their yearly income to more than $100,000, the couple can still convert a traditional IRA into a Roth IRA. Roth IRAs allow tax-free withdrawals, but contributions to these accounts are not tax-deductible.
Because lawmakers anticipate the change will encourage Roth conversions, they expect $8 billion in revenue to be raised over the next 10 years as a result. Another revenue raiser picks up $4.1 billion over the next 10 years by generally prohibiting employers from claiming deductions for vacation or severance pay that would be granted to employees in a tax year other than the one in which the vacation or pay was earned.
While far from straightforward and simple, the new law rights some IRS wrongs and provides new tax benefits to taxpayers, investors and business owners. With election-year fever already mounting, Capitol Hill observers wonder what the next round of tax changes will bring. Stay tuned.
For more information on the new tax law, you can order 1998 Tax Legislation Highlights, an easy-to-read 32-page booklet, for $7 plus shipping and handling. To order, call CCH Inc. at (800) 248-3248.
Jan Zobel, E.A., (510) 482-1015, JanZtax@aol.com