Business News & TipsALAN MOORE / L’Observateur / September 16, 1998The Internal Revenue Service Restructuring and Reform Act of 1998 (the “’98 Act”) was signed by the President on July 22, 1998. This act, as itsfull name implies, provides for the restructuring of the way the IRS is organized, requires the IRS to revise its mission statement, establishes an Oversight Board, and creates and expands taxpayer rights. It alsoincludes important tax law changes that affect how investor taxes are calculated…1. If you’re an investor, the most significant change for you is thereduction of the long-term capital gains holding period from “more than 18 months” to “more than 12 months”. Capital gains realized on or afterJanuary 1, 1998 qualify for the 20% tax rate if the assets have been held for more than 12 months. The 18 month holding period has been eliminatedexcept for distributions by mutual funds which represent pre-1998 gains on assets held for more than one year but not more than 18 months. Youmay have to pay tax on these gains at a tax rate of 28% instead of 20% unless an anticipated Technical Correction is passed.
2. The Taxpayer Relief Act of 1997 (the “’97 Act”) changed the taxationof a gain on the sale of a principal residence to exclude $250,000 of the gain ($500,000 if you’re married and file a joint tax return) if you owned and used the residence for at least two years. If you fail the two year’ownership and use’ test because of a change in place of employment, health, or unforeseen circumstances, a fraction of the excludable amount can be excluded. The ’98 Act makes it clear that the fraction of the twoyear period that the property was owned and used, times the maximum excludable amount is used to reduce the gain.
3. The ’98 Act has also clarified many of the Roth IRA provisions of the’97 Act. Most importantly, it allows a 1998 conversion from a Traditional(deductible or non-deductible) IRA to a Roth IRA to be rescinded and transferred back to a Traditional IRA up until the IRA holder’s tax return due date (including filed-for extensions). The transfer must include theamount converted and all earnings on that amount. Therefore, if youbecome ineligible for a Roth IRA conversion because your modified adjusted gross income (MAGI) exceeds $100,000, you may reverse the conversion. This is referred to as the “Look-Back Privilege.” Also, a RothIRA contribution may be recharacterized as a contribution made to a Traditional IRA. The recharacterization must be completed prior to theRoth IRA holder’s tax filing deadline (including filed for extensions). Anyearnings attributable to the contribution must also be transferred.
4. The ’98 Act includes a provision which will allow more taxpayers age70 1/2 or older to convert Traditional (deductible or non-deductible) IRAs into Roth IRAs. Traditional IRAs require a minimum distribution when anIRA beneficiary reaches 70 1/2. Under current law, individuals andmarried couples with MAGI in excess of $100,000 cannot roll their Traditional IRA into a Roth IRA. The ’98 Act changes existing provisions byexcluding required minimum distributions from Traditional IRAs from the $100,000 income test. This means more opportunity to pass on the RothIRA benefits of tax-free earnings and qualified withdrawals to heirs. Theprovision is effective for tax years beginning after December 31, 2004.
5. In addition, the ’98 Act allows taxpayers who convert to Roth IRAs in1998 to elect to have the entire conversion amount taxed in 1998 rather than reporting the income evenly over a four-tax-year period beginning in 1998. However, if you withdraw money during the four-tax-year period theincome tax will be accelerated.
6. Distributions of earnings from all Roth IRAs will be tax-free only if thedistribution is made five years or more after the first Roth IRA contribution is made. The ’98 Act eliminates the rule that created aseparate five-year holding period for Roth IRA conversions for purposes of taxation.
7. Finally, an unintentional loophole from the 10% early withdrawalpenalty for amounts withdrawn from converted Roth IRAs has been retroactively closed by the ’98 Act. Now, only if a withdrawal from aconverted Roth IRA is made after five years from the date of conversion will it be exempt from the 10% early withdrawal penalty. This exemptionwill apply even if you are under age 59 1/2 and no other exemption applies.
If you’re confused about any of the important tax changes set forth in the IRS Restructuring and Reform Act of 1998 or how they will affect your specific situation, you should contact your tax or financial advisor.
(Alan S. Moore is a financial advisor in the New Orleans office of LeggMason Wood Walker, a diversified securities brokerage and financial services firm that is a member of the New York Stock Exchange, Inc.)
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