1997 Tax Law Update

Table Of Contents

Introduction

What We Will Cover Today

HR2014 "Taxpayer Relief Act of 1997". We are not going to discuss how to prepare a tax return or how to compute tax liabilities. I am making an attempt to discuss and cover the subject without discussing numbers, percentages or tax brackets. The coverage is going to be from the manager’s view as much as is possible. The coverage is going to be discussing the details without discussing the number crunching.

The Tax Planning Pyramid

Do not get your priority triange upside down.  You might "find your self behind the 8 Ball"!

Keep your priority triangle "right side up" with placing the most important objectives on the foundation (bottom) of the pyramid (triangle)!

This pyramid places the tax-planning portion in perspective. Tax planning has two foci. One is the compliance issue and one is the controlling of the costs of the tax liability.  When the tax costs and tax liabilities are so small that incurring expenses with the only objective for tax write-offs, being only objecive - the decision maker must consider the prudence of the decision to incur unnecessary expenditures.  When the tax cost is significant, then the decision maker must make prudent business decisions to reduce the costs to an acceptable level.

I make this presentation for the person or persons whose sole intention is to reduce or eliminate the income tax, at the expense of lost opportunities to increase net worth through a broad based operations management.

A broad based operations management will focus on the increasing of liquidity, operations profit and equity.  The broad based manager will use (among other things) planning, monitoring results, adjusting (actions, decisions, policies and procedures), planning for product and service development and quality control, marketing to both new and existing clients and markets, staffing and training, and tax planning.

* Any anticipated business decision must have one or more tests applied in order to determine the feasibility of the proposal. Structuring decisions around Income Tax Legislation is no different. When making a business decision, the decision must be based upon tests other than tax cost. If the tax cost can be reduced with prudent actions, then do so. Do not make rash decisions be structuring a decision based only the tax cost. Whenever making a decision based heavily upon the tax implications, then test cash or checking account balances with and without the decision based upon tax effect.

* Neither tax nor current cash balances are conclusive or sole criteria for making decisions. Please, do not use the income tax savings as the only criteria.

Chapter 1 - 1997 Tax Briefing – New Threats to Wealth? -or- new ARMISTICE agreements?

Income Tax Provisions

Characteristics of Taxpayers Effected

Individuals

Dependent Children < 14

Buying a home – or selling a home

Own stocks, bonds, or other securities

Have or will have an IRA

Will be incurring educational expenses

Child Tax Credit

The Act provides taxpayers with a child tax credit for each qualifying child under 17 years of age. The credit is first available for the 1998 taxable year, and so may be claimed on tax returns to be filed in 1999. For that first year, taxpayers may claim a maximum credit of $400 per qualifying child. The maximum credit increases to $500 for subsequent years. This credit is phased out by $50 for each $1,000 of the taxpayer's modified adjusted gross income ("AGI") in excess of $110,000 for taxpayers filing jointly, $75,000 for single taxpayers, and $55,000 for married taxpayers filing separately. Generally, the credit is limited to tax liability net of credits (other than EIC). However, families with three or more children may be entitled to a credit in excess of tax liability.

To claim the credit, taxpayers are required to provide the name and identification number of the qualifying child on the return.

The rule allowing tax-free employer payments for up to $5,250 of annual education expenses has been retroactively restored and extended through May 31, 2000. The exclusion had expired for courses beginning after May 31, 1997. Unfortunately, graduate courses remain ineligible for this benefit

For 1997, self-employed taxpayers can deduct 40% of their health insurance premiums. In future years, the deductible percentages will be gradually increased as follows: 45% for 1998 and 1999; 50% for 2000 and 2001; 60% for 2002; 80% for 2003 through 2005; 90% for 2006, and 100% for 2007 and later years.

Starting next year, when you use your car for charitable purposes, the mileage deduction will be increased from the current 12 cents per mile to 14 cents.

Education Incentives

HOPE Scholarship and Lifetime Learning Credits

The Act provides taxpayers two new nonrefundable tax credits for payments made for qualified tuition and related expenses (tuition and fees, but not books)for post-secondary education -- the HOPE Scholarship Credit and the Lifetime Learning Credit.

The HOPE Scholarship Credit allows taxpayers to claim a maximum credit of $1,500 (100 percent of the first $1,000 of tuition and fees and 50 percent of the next $1,000 of tuition and fees) for expenses paid on behalf of the taxpayer, the taxpayer's spouse, or a dependent for the first two years of post-secondary education at an eligible institution. The student must be enrolled on at least a half-time basis for at least one academic period during the year for the expenses to be qualified. The HOPE Scholarship Credit applies to expenses paid after December 31, 1997, for education furnished in academic periods beginning after that date.

The Lifetime Learning Credit allows taxpayers to claim a maximum credit equal to 20 percent of up to $5,000 of expenses ($10,000 beginning in 2003) incurred during the taxable year for qualified tuition and fees for eligible students for post-secondary education, including any course of instruction to acquire or improve job skills. The Lifetime Learning Credit applies to expenses paid after June 30, 1998, for education furnished in academic periods beginning after that date.

Both credits limit qualified expenses to the expenses of the taxpayer, the taxpayer's spouse, or a dependent of the taxpayer. Additionally, both credits are phased out for taxpayers with modified AGI between $40,000 and $50,000 (between $80,000 and $100,000 for joint filers). For each qualifying student, taxpayers must choose to claim either the HOPE Scholarship Credit, the Lifetime Learning Credit, or the exclusion for certain distributions from an education IRA for the taxable year. They cannot claim more than one of these benefits for a student for any year.

To claim the credits, taxpayers are required to provide the name and taxpayer identification number of the student on the return. Educational institutions are required to report information related to higher education tuition and related expenses, including refunds of such expenses, paid during the taxable year.

The Act also creates a new educational funding vehicle, called an Education Individual Retirement Account (education IRA), for the purpose of paying the qualified higher education expenses of a designated beneficiary. Qualified higher education expenses include tuition, fees, books, supplies, equipment, and room and board. Contributions are non-deductible, and earnings on the amount held in the IRA will be non-taxable until distributed. Annual contributions are limited to $500 per beneficiary under the age of 18. The contribution limit is phased out as a taxpayer's modified AGI increases from $95,000 to $110,000 ($150,000 to $160,000 for joint returns).

Distributions from an education IRA are excludable from income to the extent the amount does not exceed the qualified higher education expenses of the eligible student during the year. If the distribution from the education IRA exceeds the qualified higher education expenses, only a portion of the distribution is excludable. In addition, distributions not used for higher education are subject to a 10 percent addition to tax. The Act requires any balance remaining in an education IRA at the time a beneficiary becomes 30 years of age to be distributed and taxed to the beneficiary (and subject to the 10 percent addition to tax). However, the balance may be rolled over tax free to another education IRA benefiting another family member. This provision is effective for taxable years beginning after December 31, 1997.

Deduction for Interest on Education Loans: The Act provides an above-the-line maximum deduction for up to $2,500 of interest paid by taxpayers on qualified education loans. The $2,500 limit is phased in over 4 years (i.e., the maximum deduction is $1,000 in 1998, $1,500 in 1999, $2,000 in 2000, and $2,500 in 2001). Taxpayers may take a deduction on qualified education loans for the benefit of the taxpayer, the taxpayer's spouse, or any dependent of the taxpayer as of the time the indebtedness was incurred. Deductions are allowed only for the first 60 months that interest payments are required. The deduction is phased out for taxpayers with modified AGI between $40,000 and $55,000 ($60,000 and $75,000 for joint filers). Married taxpayers must file jointly to take the deduction, and the credit may not be claimed on the return of anyone who is claimed as a dependent on another person's return. This provision is effective for interest due and paid after December 31, 1997.

Starting next year, a new deduction will be allowed for interest paid on qualified education loans regardless of whether the taxpayer is able to itemize deductions. However, the deduction is limited as follows: $1,000 for 1998; $1,500 for 1999; $2,000 for 2000; and $2,500 for 2001 and later years. Also, only interest paid during the first 60 months that interest payments are required under the terms of the loan qualify for the deduction.

A qualified loan is one incurred to pay qualified higher education expenses of the taxpayer, his or her spouse, or any dependent individual. The deduction is phased out between AGI of $60,000 and $75,000 for joint filers and between $40,000 and $55,000 for other taxpayers (except that the deduction is not available to married taxpayers who file separate returns).

Prepaid Tuition Plans

Last year's legislation included tax breaks for contributions to qualified prepaid state tuition programs. The Act retroactively expands the break to cover contributions to pay for room and board as well as tuition and fees.

Individual Retirement Accounts

Under the Act, the AGI phase-out ranges for deductible IRAs of active participants in employer-sponsored retirement plans will increase annually beginning in 1998 until they reach double the current phase-out ranges in 2007. In 2007, the phase-out ranges will be between $50,000 and $60,000 for single filers and between $80,000 and $100,000 for married taxpayers filing jointly, double the current ranges of $40,000 to $50,000 for married couples filing jointly, and $25,000 to $35,000 for single filers. An individual is not an active participant in an employer- sponsored retirement plan merely because the individual's spouse is an active participant. However, in such cases, the individual's deductible amount is phased out for married couples with AGI between $150,000 and $160,000.

The new legislation expands the circumstances under which you may make tax-deductible contributions to your traditional IRA. This legislation is effective for taxable years beginning on or after January 1, 1998.

With this new legislation, you may make a fully deductible contribution to an IRA, regardless of your spouse's participation in an employer-sponsored plan, if:

Increasing the Income Limits for Full Deductibility of Your Contributions

Currently, active participants in an employer sponsored retirement plan cannot make fully deductible IRA contributions unless their adjusted gross income is less than $25,000 for individuals and $40,000 for couples. Under the new legislation, income caps for full deduction of IRA contributions will be gradually increased to $50,000 for individuals and $80,000 for couples.

Starting next year, an individual who is not an active participant in a qualified retirement plan (such as a nonworking spouse or an employed spouse who isn't covered by a pension plan) can contribute and deduct up to $2,000 to an IRA, even though the other spouse is an active participant

Starting next year, parents can establish education IRAs for each child and make annual nondeductible contributions of up to $500 to each. This privilege is above and beyond your ability to make contributions to traditional and Roth IRAs. Earnings on education IRA funds will be allowed to accumulate tax-free, and tax-free withdrawals can be made to pay for undergraduate or graduate education expenses for tuition, books, and room and board.

The ability to make contributions is phased out between AGI of $150,000 and $160,000 for joint filers and between $95,000 and $110,000 for single taxpayers. In addition, contributions cannot be made after the child reaches age 18. Subject to the preceding limitations, grandparents and others can establish education IRAs to benefit grandchildren and other designated individuals.

Starting next year, withdrawals from traditional IRAs can be taken to pay for qualified higher education expenses of the taxpayer, or his or her spouse, dependent child, or grandchild without having to pay the 10% penalty tax that generally applies to withdrawals before age 59½. However, these withdrawals will still be subject to the "regular" federal income tax and the AMT, if applicable. Qualified expenses include tuition, fees, books, room and board, and equipment required for enrollment or attendance at an eligible educational institution.

In addition, penalty-free withdrawals from traditional IRAs can be taken to help finance a first-time home purchase for the taxpayer; his or her spouse; or a child, grandchild, or ancestor of the taxpayer or his or her spouse. There is a $10,000 lifetime limit on withdrawals for this purpose. This change is also effective starting next year.

The legislation creates the new Roth IRA (IRA Plus) where all contributions are non-deductible and earnings can grow tax-free! Some of the features of this new IRA include:

Contribution Eligibility

Maximum Annual Contribution

Tax Deductibility of Contributions

Tax Treatment of Earnings

Tax Treatment of Withdrawals

Minimum Distribution Requirements

The Act provides for a new individual retirement account beginning in 1998 called a "Roth IRA". Key features are:

A "qualified distribution" is a distribution:

No payment can be a qualified distribution unless it is made after the 5-taxable-year period beginning with the taxable year in which the taxpayer first contributed to a Roth IRA.

Annual contributions to the Roth IRAs are limited to $2,000 less the taxpayer's deductible IRA contributions. Unlike deductible IRAs, there is no prohibition on making contributions after attaining age 70½. The $2,000 limit is phased out as AGI increases from

1. $150,000 to $160,000 in the case of a married couple filing jointly or

2. $95,000 to $110,000 in the case of a single filer.

Amounts in deductible IRAs may be transferred to Roth IRAs provided the taxpayer's AGI for the transfer year is $100,000 or less. Transferred amounts are includible in income but exempt from the early withdrawal tax. If the transfer occurs in 1998, income from the transfer is spread out over four years (i.e., 1/4th of the transferred amount is includible in 1998, 1999, 2000 and 2001). No payments allocable to the transferred amounts can be a qualified distribution unless it is made more than 5 years after the transfer.

Currently, any withdrawals from IRAs are generally subject to income taxes. A withdrawal may also be subject to a 10% early withdrawal penalty if the individual is under age 59½. Under the new legislation, an individual may make a penalty-free withdrawal from either the traditional IRA or the new Roth IRA for qualified first-time home purchase (up to $10,000) or for qualified higher education expenses. Note, however, that while a qualified higher education distribution from a Roth IRA would be penalty free for an individual who is under age 59½, it would not be tax-free.

Beginning in 1997, certain employers can set up SIMPLE retirement plans. A SIMPLE plan can be set up by an employer who had no more than 100 employees who received at least $5,000 in compensation from the employer last year. Generally, the SIMPLE plan must be the only retirement plan of the employer. The employers that qualify are:

SIMPLE plans are written qualified salary reduction arrangements that allow an employee to elect to reduce his or her compensation by a certain percentage each pay period and have the employer contribute the salary reductions to the SIMPLE plan on behalf of the employee. For 1997, the amount of the employee's salary reductions cannot exceed $6,000. Employers are also required to make contributions to the SIMPLE plan on behalf of eligible employees. Contributions to a SIMPLE plan are not subject to income tax until they are distributed.

SIMPLE plan can be set up either as an IRA or as part of a qualified cash or deferred arrangement (401(k) plan). SIMPLE plans are not subject to the nondiscrimination rules that generally apply to qualified plans. For more information on this new plan, get Publication 560, Retirement Plans for the Self-Employed.

Item

Contribution Eligibility

Individuals; phaseouts apply

Maximum Annual Contribution

Tax Deductibility of Contributions

Tax Treatment of Earnings

Tax Treatment of Withdrawals

Minimum Distribution Requirements

Home Office Deduction Rules Eased

Effective in 1999, home office expenses can be deducted as long as the office is used regularly and exclusively to perform substantial administrative or management functions (such as billing customers) and no fixed space is available at work locations. Deductions will be allowed even when the income-earning activities of the business take place elsewhere. This change effects a much-needed but delayed repeal of the Supreme Court's infamous Soliman decision which disallowed deductions for many self-employeds on the grounds that their home offices did not qualify as the "principal place of business."

CAPITAL GAINS

The tax on the sale of a long-term capital gain asset is now 20% in place of the previous 28%. For individuals in the 15% tax bracket, the rate is now 15%. Therefore, one of the gripes that have been widely promoted by the various mass media has been answered. The capital gains tax has been structured to all tax brackets.

Person Opinion: The capital gains tax was not structured to help only the wealthy. The individual married filing jointly moves out of the 15% tax bracket at $41,200. It is at this bracket for 1997 that the 28% tax rate is in effect. Whenever retirees received lump sum payments from retirement plans, took early retirement etc. the amounts, unless rolled over have exceeded that same amount. Usually, the sale of a personal residence did not produce a large gain for those outside metropolitan or heavily populated areas. Even with those factors, usually it has been very easy to be taxed at he 28% rate. Therefore, unless family and other income has been less than the $41,200 the family has been consider wealthy by the media. If a wife earns $20,600 and the husband earns $20,600 — there is by media definition a wealthy family. Even in an economically disadvantaged community, this is not a wealthy family. This family qualifies for the capital gain advantages. However, with the new law, we find an attempt to make this advantage available to all families, regardless of the tax bracket. Definitely more fair. However — the capital gain reduced rate can help each family. The advantage must be retained in the law. Do not let it be eliminated because the mass media publicizes it is only for the wealthy. Keep the benefit!

For individuals, the maximum tax rate on net capital gain from sales or exchanges occurring after May 6, 1997, will be reduced to:

1. A maximum tax rate of 20 percent for sales made after May 6, 1997, if the property had been held for more than 18 months at the time of sale. This 20 percent rate also is available for property sold after May 6, 1997, and before July 29, 1997, if the property had been held for more than 12 months (even if it had not been held for 18 months).

1. A maximum tax rate of 18 percent for sales of property acquired after December 31, 2000 that had been held for more than 5 years at the time of the sale.

2. 25 percent for real estate depreciation recapture treated as capital gain.

The current 28 percent maximum capital gain rate will continue to apply to

1. sales of collectibles,

2. sales before May 7, 1997, and

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The following table of tax consequences of the sale of capital assets will assist in the decision process:

Type of Asset

Date sold

Period Held

Maximum Tax Rate

ó Note regarding the above table: Accelerated or Accel and Depr or Depreciation refer to the excess of accelerated depreciation write-off in excess of the straight line depreciation claimed during periods prior to May 7^th, 1997. The terms All Depreciation or ALL Depr applies to depreciation claimed after May 6^th, 1997. The alternative minimum tax structure is revised to assure that the reduced maximum capital gains rate will not result in the imposition of AMT, merely because of the rate differential.

The Act allows taxpayers to exclude up to $250,000 of gain ($500,000 for married couples filing a joint return) realized on the sale or exchange of a principal residence occurring after May 6, 1997. Unlike the "one time" exclusion provided under prior law, the exclusion is allowed each time a taxpayer sells or exchanges a principal residence, although the exclusion generally may not be claimed more frequently than once every two years. In addition, unlike prior law, the taxpayer is not required to reinvest the sales proceeds in a new residence to claim the exclusion. To be eligible, the residence must have been owned and used as the taxpayer's principal residence for a combined period of at least two years out of the five years prior to the sale or exchange. The taxpayer must recognize gain to the extent of any depreciation allowable with respect to the rental or business use of such principal residence for periods after May 6, 1997.

Estate Taxes

Beginning in 1998, the unified estate and gift tax credit will increase annually, until the maximum value of estates exempt from tax reaches $1 million in 2006. The current limit is $600,000.

Beginning in 1999, the $10,000 annual exclusion for gifts, the $750,000 ceiling on special use valuation, the $1 million generation-skipping transfer tax exemption, and the $1 million ceiling on the value of a closely-held business eligible for the special low interest rate will all be indexed annually to reflect inflation. The provisions apply to estates of taxpayers dying and to gifts made after December 31, 1997.

Beginning in 1998, executors may elect special estate tax treatment for qualified "family-owned business interests" if these interests comprise more than 50 percent of a decedent's estate and certain other requirements are met. Because the Act limits the combined value of this credit and the unified estate and gift tax credit to $1.3 million, the amount of this exclusion that will be available each year will decrease as the value of the unified credit increases during its phase-in period. In 1998, the provision will exclude up to $675,000 of value in qualified family-owned business interests from a decedent's taxable estate (i.e., $1.3 million minus the $625,000 unified credit available in 1998).

Estimated Tax Payments

One way an individual can avoid a penalty for underpayment of estimated tax is to make quarterly payments based on the tax for the prior year. The act modifies the 110 percent-of-prior-year's-tax exception, according to the following table:

PRIOR-YEAR'S TAX SAFE HARBOR

Year Prior Year's Tax Required

1997 110%

1998 100%

1999-2001 105%

2002 112%

2003 and after 110%

In addition, effective for tax years after 1997, the act raises from $500 to $1,000 the threshold of total tax liability for the imposition of a penalty for underpaying estimated tax. (Act sections 1091 and 1202; section 6654)

An individual generally does not have an underpayment of estimated tax if he or she makes timely estimated tax payments at least equal to:

Effective date.--The $1,000 provision is effective for taxable years beginning after December 31, 1997. The remainder is true for 1997 and forward.

Understanding MSAs

To understand MSAs, you will want to know what an MSA is and what the benefits are of having one. You will also need to know whether you meet the rules for starting an MSA. If you meet the rules, then you will want to read the section titled Setting Up the Account.

What is an MSA? An MSA is a tax-exempt trust or custodial account with a financial institution (like a bank or an insurance company) where you can save money for future medical expenses. This account must be used in conjunction with a high deductible health plan. See High Deductible Health Plan, later.

What are the benefits of an MSA? You may enjoy several benefits from having an MSA: The interest or other earnings on the assets in your MSA are tax-free. You can have a tax deduction without having to itemize your deductions on Form 1040.

Corporations Both C and S Corporations Alt Min Tax

In general, the alternative minimum tax computations have been simplified for the small corporation.

Depreciation Changes made by the act will reduce the impact of the corporate alternative minimum tax (AMT) for some corporations, particularly those in capital-intensive industries. Specifically, effective for assets placed in service after 1998, regular-tax depreciation lives will be used for AMT purposes. There will still be an AMT depreciation adjustment for such assets, however, because the AMT method is different than for regular tax purposes. Moreover, the recordkeeping burden of the AMT is largely unaffected by this change. (Act section 402; section 56)

Small business corporations. For tax years beginning in 1998, certain small business corporations are effectively exempt from the corporate AMT. To qualify, a "small business" must have average gross receipts of $5 million or less for the three years prior to its 1998 tax year. To continue to qualify after 1998, or to qualify as a small business for the first time, a company's three-year average gross receipts cannot exceed $7.5 million. Corporations qualifying for the exemption will not be subject to any of the multiple calculations or recordkeeping requirements of the AMT system. However, businesses that fail to qualify in a later tax year will have to apply the AMT rules to transactions, income, and deductions arising in and after that nonqualifying year.

Qualifying small business corporations with unused minimum tax credits after 1997, that would otherwise be available to offset regular tax in excess of tentative minimum tax (TMT), are subject to a new credit-utilization limitation. Because the tentative minimum tax of a small business corporation will be zero, the maximum credit available generally will be 75 percent of regular tax. This change will significantly accelerate a corporation's ability to use available minimum tax credits. (Act section 401; section 55)

S Corporations

No major legislation was specific to S Corporations.

Partnerships

'Hot assets.' A new rule applies to a partner who is considered to dispose of a partnership's ordinary-income assets in connection with a sale or exchange of a partnership interest. Specifically, the partner no longer can avoid ordinary income recognition merely because certain "hot assets" of the partnership have not appreciated significantly in value.

Previously, gain on the sale or exchange of a partnership interest was treated as capital gain unless the partnership owned unrealized receivables (including depreciation recapture assets) and substantially appreciated inventory items. For these purposes, inventory includes all partnership assets that are not capital assets or section 1231 property, as well as traditional inventory items.

As a general rule, inventory items are treated as substantially appreciated only if their value is more than 120 percent of their basis. This rule will continue to apply to partnership distributions that cause a shift in the ownership of assets among partners. However, generally effective for sales or exchanges of partnership interests occurring after August 5, 1997, all inventory items are treated as "hot assets," regardless of whether they are substantially appreciated. A binding contract exception applies to transactions that occur after August 5, 1997, pursuant to a binding contract in effect on June 8, 1997. (Act section 1062; section 751)

Basis-allocation rules modified. Opportunities to create artificial tax losses or accelerate depreciation deductions through certain partnership distributions are significantly reduced for property distributed after August 5, 1997. When a partnership makes certain property distributions (e.g., a liquidating distribution), substitute basis rules apply, so that the basis of the assets in the hands of the distributee partner is determined by reference to the basis of the distributee's partnership interest.

Under prior law, the allocation of such basis among distributed assets was generally based on the distributed property. The modified basis rules included in the act generally require that any difference between the aggregate basis of the distributed property and the basis of the distributee partner's interest in the partnership (after taking into account cash distributions) be allocated among such assets first in a manner that reduces the differences between such assets' tax basis and their fair market value (except that the basis of unrealized receivables and inventory items cannot be increased). Any remaining difference is allocated based on the assets' relative fair market values. While these changes reduce opportunities to generate tax losses, the new law does not impose a fair market value "cap" on the basis that may be assigned to distributed property. As a result, there will still be opportunities to create artificially high basis in distributed property in certain situations. (Act section 1061, section 732(c))

Precontribution gains. New holding-period requirements will make it more difficult to use "mixing bowl" transactions to shift built-in gain or loss associated with one piece of property into other property. In these transactions, the owner of property contributes the property to a partnership and subsequently receives other property from the partnership in liquidation of its interest. The substitute-basis rules described earlier are used to shift the built-in gain or loss associated with the original property into the distributed property.

Previously, a distribution of property other than the contributed property to the contributing partner or distributions of the contributed property to a partner other than the contributing partner would generally trigger gain or loss unless the distribution was made at least five years after the contribution. The new law extends, to seven years, the "waiting period" between the date of contribution of property and the date of such property distributions in order to avoid triggering the built-in gain or loss recognition. This provision is effective for property contributed to a partnership after June 8, 1997. A transition rule applies to binding contracts in effect on June 8, 1997, and at all times thereafter.

As a result of these changes, taxpayers engaging in mixing-bowl transactions will need to wait an additional two years to complete the transaction to avoid triggering the built-in gain or loss on the contributed property. (Act section 1063; sections 704(c)(1)(B), 737(b)(1))

Large-partnership simplification. Several sets of provisions simplify tax reporting for electing large partnerships and their partners. The rules, which are effective for tax years beginning in 1998, have several objectives:

Reduce the number of items required to be separately stated on Schedule K-1. For example, income or loss from all passive activities of the partnership are combined into a single activity; all tax preferences are combined into a single line item; and capital gains and losses are netted at the partnership level, with short-term capital gains in excess of short-term capital losses added to ordinary income rather than being reported separately.

Provide simplified audit procedure rules for large partnerships. The most significant change to the audit procedure rules allows a partnership to generally report audit adjustments as additional distributive share items in the year the adjustment is imposed, rather than the year to which the adjusted item relates (i.e., the current-year partners pay any additional tax relating to the adjustment even if it relates to a tax year in which they were not a partner).Alternatively, the partnership may elect to pay the tax at the entity level, on behalf of the partners, rather than flowing the adjustment through on the partners' Schedules K-1. In either situation, the partnership is liable for any interest and penalties associated with the adjustment. If the partnership is no longer in existence at the time the adjustment is made, the adjustment generally must be taken into account by the former partners, based on future regulations.

Moratorium on Limited Partner SE Tax Regulations

The Treasury Department has issued two sets of proposed regulations attempting to deal with the issue of when the self-employment (SE) tax applies to limited partners and LLC members. Both sets have proven to be controversial because many commentators interpreted them as increasing taxes without the benefit of legislation. Now Congress has prohibited the release of any temporary or final regulations on the subject before 7/1/98. This effectively ensures that taxpayers will not be required to follow any Treasury or IRS guidance issued before that date.

Miscellaneous Business Provisions

Effective in 1998, employers can give employees the option of receiving tax-free monthly parking allowances up to $170 (adjusted for inflation) or equal amounts of additional taxable cash compensation. Under current rules, giving employees this option would make the parking allowances count as additional taxable compensation.

Effective for tax years beginning after August 5, 1997, net operating losses (NOLs) will generally be able to be carried back two years or forward 20 years (versus three and 15 years under current rules). However, the three-year carryback rule is retained for certain casualty losses and small business and farming losses attributable to presidential declared disasters. For tax credits arising in tax years beginning after 1997, the carryback period will be one year and the carryforward period will be 20 years (versus three and 15 years under current law).

Effective for property placed in service after August 5, 1997, use of the income forecast depreciation method will be limited to films, videotapes, sound recordings, copyrights, books, patents, and other property specified in regulations.

Effective for property placed in service after August 5, 1997, qualified rent-to-own property will be classified as three-year property for depreciation purposes. Use of the income forecast method of depreciation for such property will be prohibited.

Taxpayers will be permitted to use estimates in determining write-offs for inventory shrinkage costs—effective for tax years ending after August 5, 1997.

For partnership distributions after August 5, 1997, the basis of distributed property will be allocated to more closely reflect the fair market value of the property at the time of distribution.

For sales of partnership interests after August 5, 1997, gain will be treated as ordinary income to the extent of the selling partner's share of inventory appreciation. Under prior law, the ordinary income rule applied only when the partnership's inventory was worth more than 120% of its basis.

When partnership property is distributed to partners following contributions of appreciated property, taxable gain may be triggered to the contributing partner(s) under certain circumstances. Under prior law, the gain recognition rules applied only when distributions occurred within five years of the contribution of appreciated property. For property contributions after 6/8/97, the five-year rule is replaced by a seven-year rule—thus making it more likely the gain recognition rules will apply.

Partnerships with 100 or more partners will be able to elect to use simplified procedures to report required tax information to partners (for example AMT adjustments, passive activity information, and oil and gas depletion). Electing large partnerships will be required to furnish tax information to their partners by March 15th of the following year. In addition, electing large partnerships will be subject to streamlined IRS audit procedures. The changes are effective for partnership tax years ending on or after 12/31/97.

For partnership taxable years beginning after 1997, the death of a partner will close the partnership year with respect to that partner. Under current rules, the partnership year remains open, which results in 100% of partnership income or loss for the year of death being included in the estate income tax return or the return of the heir who holds the partnership interest at year-end.

Chapter 2 — Interesting Current Proposals

Burden of Proof Legislation

Internal Revenue Service Accountability Act

From the Tax Analysts Section:

After nearly two years of debate on the IRS's future, the House of Representatives last week approved almost unanimously the most sweeping changes to the agency in half a century.

The House voted 426-4 November 5 to place the IRS under the control of a mostly private sector board of directors, fundamentally alter the congressional oversight process of the IRS, and give the IRS commissioner greater flexibility to hire and fire personnel.

The IRS Restructuring and Reform Act of 1997 (H.R. 2676) also shifts the burden of proof to the IRS in judicial civil tax cases and makes long-awaited changes to innocent spouse laws, global interest netting differential, and equitable tolling. A package of technical corrections to the Taxpayer Relief Act of 1997 is attached to the bill.

A jubilant Rep. Rob Portman, R-Ohio, who co-chaired the bipartisan congressional commission on restructuring the IRS and steered the legislation to the House floor, called the vote "historic." He said he was pleased with its overwhelming approval. "I thought we'd get 400 [votes]," he told Tax Analysts. The near unanimous support proves that "this is a good bill," he said.

However, Portman acknowledged his effort was far from over. Even as the House was debating the bill, House Speaker Newt Gingrich, R-Ga., was naming the Ohio taxwriter to head a new panel that would continue monitoring the IRS and begin work on a second IRS restructuring bill in 1998.

As the bill steamrolled through the House, attention turned to the Senate, where Finance Committee Chair William V. Roth Jr., R- Del., reasserted his prerogative to move slowly on IRS legislation. Roth is determined to peg IRS reform to issues raised during his panel's September hearings on agency abuses of taxpayers. A committee spokeswoman said there is not enough time this congressional session to adequately address those issues.

"It would not be fair to American taxpayers to rush to pass something and then find that it is inadequate in its solutions," Roth said. He pledged to "act on a comprehensive IRS reform and restructuring bill next spring."

Senate Democrats responded with a letter to Senate Majority Leader Trent Lott, R-Miss., calling on the upper chamber to act before the end of the session. "In the Senate, well over thirty Senators -- including a majority of the Senate Finance Committee -- have cosponsored [IRS reform] legislation" similar to the House- passed bill, according to the letter, signed by 42 Democrats. "Any delay in taking up the IRS reform legislation will hurt American taxpayers. We urge you to take up IRS reform legislation before the end of the year."

Senate Minority Leader Tom Daschle of South Dakota told reporters "the Senate could pass that bill today -- if Sen. Lott would schedule the vote." Sen. J. Robert Kerrey, D-Neb., vowed to attach the bill to any piece of legislation he could, a strategy he first announced a week earlier during debate over tax- preferred education savings accounts.

With its vote, the House closed a significant chapter in the ongoing saga of IRS reform. The bill's nucleus can be traced to 1995, when Kerrey got the National Commission on Restructuring the IRS created in connection with the fiscal 1996 IRS budget. Although modified in some ways, the legislation is remarkably similar to the package of 50-plus recommendations made by the restructuring commission.

The passage of IRS reform became imminent after an 11th hour about-face of the Clinton administration, which dropped its staunch philosophical opposition to the bill on October 22. Administration officials tried to explain their reversal of position by saying enough changes had been made in the legislation's wording to make it more palatable to Treasury officials. House Ways and Means Committee Chair Bill Archer, R-Texas, said however that none of the changes in his version of the bill were intended as concessions.

The administration's concerns lingered with the four Democrats who voted against the bill. They included Ways and Means members Fortney Pete Stark and Robert T. Matsui, both of California, and Jim McDermott of Washington, as well as Steny H. Hoyer of Maryland, the ranking member of the House Appropriations Subcommittee on Treasury, Postal Service, and General Government.

Hoyer told Tax Analysts the four voted no to make a point. "I could have voted for this bill," said Hoyer, whose subcommittee funds the IRS. He complained that the bill obscures the "substantial progress" the agency has made in the last couple of years and adds "management confusion" with its new governance structure.

On the House floor, Hoyer criticized Congress for whipsawing the IRS and admonished his colleagues to act more consistently. "If you're not for IRS reform on appropriations bills and tax bills, you are not for reform," the Maryland Democrat said.

In light of Roth's determination to reflect his September hearings on IRS abuses in a Senate IRS reform bill, Hoyer conceded that "this is the best the bill's going to be." That underscored the possibility that Roth would change the bill so much that the Clinton administration would once again reverse its position and reiterate its previous objections.

Outlook

Roth is determined to put his signature on IRS reform. His staff said he intends to do so in part by extending the independence of the 11-member board of directors, which had been a major flash point for Treasury officials who objected to congressionally driven reform.

Further, Roth has indicated he has reservations about the burden of proof provision. After the Finance Committee's hearings on IRS abuses, a committee spokeswoman said the chairman was concerned that shifting the burden of proof would make revenue agents more intrusive.

Last week, the spokeswoman signaled a shift from the senator's previous position. "The senator is going to look at [burden of proof]," she said. "He has indicated he might want to strengthen it."

The shift came as House Ways and Means Chair Archer said last week that he would fight to keep the burden of proof shift in the bill. "We will very strongly insist on that provision," Archer said.

Roth's spokeswoman said there are "many areas" in the House bill that Roth wants to build on or modify. For example, Roth may want to extend to the board authority under section 6103 to investigate confidential taxpayer matters, to ensure that it is independent. "If they have a board, it needs to be an independent check on the agency," she said.

When asked whether a change of that magnitude would re-ignite Clinton administration opposition to the legislation, the spokeswoman sighed. "C'est la vie," she said.

Portman told Tax Analysts he did not think Roth would ultimately kill the IRS reform effort by adding provisions that are offensive to the administration.

"There are ways to strengthen and improve the legislation," he said. That includes the agency governance provisions, Portman added. He did say that Charles O. Rossotti, whom the Senate confirmed on November 3 to be the next IRS commissioner, would be better served in his new job with the tools afforded him in the IRS Restructuring and Reform Act of 1997.

Rep. Benjamin L. Cardin, D-Md., said he "welcomed any improvement by the Senate in the legislation." He also predicted the bill on the Senate side will look very similar to the bill passed by the House.

Portman told reporters he expects some bumps along the way while the Senate debates the bill. But overall, he said, there is "too much momentum for the bill to stop."

"I think there will be a similar type of vote in the Senate: 99 percent passage in the Senate and 99 percent support among the public," Portman said.

Meanwhile, Roth gave no indication last week that he would bow to pressure to move on IRS reform before the end of the session. His position remained unchanged even as Archer joined the chorus of IRS reformers calling on Roth to act sooner than later. "I hope that he might reconsider his position," the Ways and Means chairman said.

Rep. Charles B. Rangel of New York, the ranking Democrat on the House Ways and Means Committee, said the Democrats' sudden desire to see IRS reform passed this year was based on political reality. "Something happens to us with a new election year," he said. He said he fears too many incumbents would be inclined to bash the agency on the campaign trail, which would derail efforts to bring meaningful reform.

The Bill

The House-passed bill changes agency management at the top and gives taxpayers more tools in dealing with the IRS. Highlights include:

Confusing the Issues

Some House Republicans now are openly supporting IRS reform on the grounds that they ultimately want to use it as a springboard to a fundamental overhaul of the tax code.

At a Republican press conference during deliberation of the bill on the House floor, House Majority Leader Richard K. Armey, R-Texas, renewed his call for a flat tax. Armey said the bill would ensure "more civilized enforcement of an uncivilized tax code" and said the "vast majority of Americans are just fed up with the tax code as it is."

Armey made his remarks without a hint of irony standing next to a chart depicting a thermometer of tax code changes since 1995 with the headline "What a difference a Republican Congress makes." The ultimate goal, the chart declared, is a "flatter, fairer, honest tax code."

On the floor, some members also segued from IRS reform into fundamental tax reform, and talked up legislation to abolish the Internal Revenue Code at the start of the new millennium.

Such notions were immediately dismissed as "silly" by Rangel, who wondered how long it would take to draft legislation that would replace the current system, work its way through Congress, and get the president's signature. "It's like `show me the money,'" Rangel said. "Show me the [tax] code."

Certified Public Accountant / Client Privilege

From the Tax Analysts Section:

IRS Bill Extends Attorney-Client Privilege to CPAs, Enrolled Agents

Among the many new features in the IRS restructuring and reform bill passed by the Ways and Means Committee October 22 is a proposal that would extend, in noncriminal proceedings, the common-law privilege of confidentiality to communications between a taxpayer and any individual authorized to practice before the IRS. Thus, if the bill becomes law, that coveted privilege -- which historically has existed only between attorneys and their clients -- would apply to tax advice furnished by CPAs and enrolled agents.

The proposal, which some see as leveling the playing field between attorneys and accountants, is intended to "allow taxpayers to consult with other qualified tax advisors in the same manner they currently may consult with tax advisors that are licensed to practice law," according to a Joint Committee on Taxation summary of the provision. (For text of the JCT description (JCX-62-93), see Doc 97- 28988 (56 pages). For the text of H.R. 2676, the "IRS Restructuring and Reform Act" approved by Ways and Means, see Doc 97-29176 (101 pages).)

It does not, however, "otherwise modify the attorney-client privilege" as it already applies to tax practice. For example, the JCT summary explains, "the proposal does not extend the privilege of confidentiality to work product that would not be eligible for the privilege if prepared by an attorney."

The confidentiality provision -- section 341 of the Ways and Means bill -- was probably born out of the Taxpayer Confidentiality Act (H.R. 2563), introduced in September by Reps. Jennifer Dunn, R- Wash., and John S. Tanner, D-Tenn. (For text of H.R. 2563, see Doc 97-27107 (3 pages).) That proposal would have protected taxpayers from having to turn over "nonfactual" information, such as opinions and mental impressions, to the IRS during noncriminal examinations. (H.R. 2563 also would have effectively limited the controversial financial status or economic reality audits conducted by the IRS. Section 343 of the restructuring legislation expressly limits those types of audits to situations where the IRS "has a reasonable indication that there is a likelihood" of unreported income.)

In contrast to the provision in the IRS reform legislation, H.R. 2563 was not touted as an extension of attorney-client privilege, but rather as a means to protect tax advice provided to a taxpayer -- from any tax adviser -- and to focus the IRS, during administrative proceedings, on the original books and records of the taxpayer instead of thought processes.

Potential problems with drawing the distinction between factual and nonfactual information for applying H.R. 2563 apparently prompted the makeover of the proposal, according to Ed Karl of the AICPA's tax division. "Factual information," which still would have been accessible by the IRS under the Taxpayer Confidentiality Act, was not defined, he said. The proposal mentioned only what factual information was not. Consequently, the JCT turned to the concept of privilege, which has a greater depth of existing definition under both common law and court cases.

Reaction

H.R. 2563 received broad support from those representing taxpayers and tax return preparers. Similarly, various associations have been quick to point out the potential benefits to taxpayers from invoking the privilege of confidentiality. Under the proposal in the restructuring bill, the extension of confidentiality will allow taxpayers the broadest choice of competent professionals, Karl said. However, he cautioned that CPAs and EAs will still need to be aware of circumstances in which a client should seek legal counsel.

Timothy J. McCormally, general counsel for the Tax Executives Institute, said the proposal would generally be a positive change for taxpayers by removing some of the considerations they have faced when choosing a tax practitioner. However, from the perspective of the IRS, he said, with more taxpayers relying on privileged communications, the agency will want a clearer definition of which communications are protected and which are not.

David Keating, executive vice president of the National Taxpayers Union (NTU) and a member of the National Commission on Restructuring the IRS expressed satisfaction with the latest confidentiality measure. "It will do!" he exclaimed. NTU had likewise endorsed the Taxpayer Confidentiality Act. Keating also expressed confidence that both chambers of Congress would approve the new provision.

As for the proposal's effect on the tax practitioner community, Lawrence M. Hill, a tax litigator at Brown & Wood LLP, New York, describes it as a watershed for the accounting profession. "It would, as a practical matter, create a statutory privilege, for the first time, for certain communications between taxpayers and their nonlawyer representatives, in noncriminal tax matters. . . . The application of privilege to communications between a lawyer and client to date has been one of the main advantages that lawyers enjoy over accountants in the tax context," he said.

Others too have noted the potential windfall for nonlawyers. One source commenting on H.R. 2563 said the fundamental issue is whether there should be an accountant-client privilege and noted that the earlier proposal was supported "most aggressively by folks like the AICPA."

Notably absent from the list of supporters for H.R. 2563 was the American Bar Association's Taxation Section. Phillip L. Mann, its chair, said before the release of the statutory language of section 341 that the tax section had not taken a formal position on the issue.

Chapter 3 — The War Against Insolvency, Who Is The Enemy

Cyclical Characteristics

Whenever a manager makes plans s/he is usually anticipating a set of future events, and make decisions today, for the occurance of the future events. Since none of us can accurately predict, we use experience and history to guide us for the future. As impractical, or as simplistic as cycle may seem they does have merit. Why? For the reason that some events occurr at predicted intervals with predictable results. To cover the logic and reasoning of "cycles" is entirely too lengthy for this writing and is not needed. The only cycles that are covered herein are those that everyone knows and understands.

The manager should look for known and expected cycles. The manager must look for "unexpected" events which occur on a regular basis. There will be may different cycles in each busines.

Known Cycles:

Each segment of a business will have an operational cycle. This seasonal characteristic will be obvious and the reason therefore will be obvious when the business consists of mainly one product or service with one cycle. The reasons are innumerable:

The listing culd be continued, however a continuation would be pointless, as the list may never be completed.

* The manager must identify his various business segments and identify cycles for those segments. The manager must then make decisions to do the following:

Warning: Plan on both the tops and the bottoms. Failure of a business to produce sufficient cash flow sometimes is a failure to plan for the trough of the cycle. Enemies of planning for the bottom of the cycle are fixed costs. Those fixed costs cannot be controlled by management. A second enemy of the same planning are the sem-variable costs. Semi-variable costs are those costs that vary (are related to, or corralated with the cause or the resources of the cycle being considered), but cannot be entirely controlled be the manager. A utility bill is a simplified example of this type of cost. The useage of the utility can be controlled to some extent but cannot be eliminated.

I have had many business owners and managers tell me that it is extremely difficult to manage a very fast and large increase in business — sometimes referred to as a boom. This statement introduces another variable of the cycle — that of the slope or steepness of the slope, both before and after the trough or the top. Gentle slopes are less costly and much easier to manage for.

The steep curves of a cycle can be quite costly. Costs are incurred before the production and before the receipt of the income. Where personnel must be trained, the training time is very expensive and time consuming. Cycles can be predicted to some extent. The predeiction of the slope of the cycles is not always precise.

These costs I will refer to as "gear up costs". The probability of predicting what the manager needs to accomplish the objectives is quite high. However, the manager must also keep the resources as low as is reasonable. The manager must receive more money than the cost of the resources.

These costs I will refer to as "Wind Down Costs". The predcting of the length of a cycle can be precise for some cycles. For example the length of winter, the length of a school break, the length of a tourist season can all be predicted with enough accuracy to manage for them.

The manager is always burdened to plan for what is missing. At the bottom of the cycle, one must plan for increased costs and time when the two items are always at the lowest available (inventory of the money and inventory of the time for staff is at its lowest). These "gearup costs" are spent when, there is no money, and the training, when there is no staff to train and no staff available for doing the training. At the top of the cycle the costs and customer/client/consumer demands are the greatest when the manager must plan to reduce the capacity of the business so that the excess capacity is not a drain on the resources at the bottom of the cycle.

Please consider other factors and cycles. Examples:

Calendar

Weather

Other

Unexpected events can sometimes be classified:

Intermittment and one time events

Chronic unexpected events

Others?

The events that are not expected to occurr again, should be segragated and not considered to be cyclical. However, if the business has "unexpected" events which are chronic, then the manager should look for common factors, common underlying events, or any event which might serive as an indicator of "unexpected events". Perhaps if the business has chronic unexpected events, the events do have precursor signs and can be predicted.

Cost containment

Tax Costs

In order to reduce the costs of operations the tax costs must be reduced. Obviously, the tax cost is not the only cost category on the income statement. Usually, the tax costs for a business are not the largest cost. There are many tax costs to consider, however, the focus of this document is on federal income tax cost. The following costs are real, but are not addressed herein:

Tax computed upon the payroll paid to employees.

Tax computed upon the personal property bases.

Tax computed upon the real estate bases.

Tax computed upon the costs of consumables used in the business or manufacturing process.

Tax computed upon the sales prices of products and services.

Excise, road, gas guzzler, luxury and other similar taxes.

These taxes are real, and the costs can be large. These items are not to be ignored, and the ommission herefrom, is not to be read as a diminuation of the planning for these items.

Travel for business is a tax deductible item. These costs must be tracked, written down and documented. Documentation means proving the taxpayer is away from home overnight. See the section on defending the buisness assets from an Internal Revenue Service attack.

Entertainment for busines is deductible. Entertainment is presumed to be personal and not deductible from the business income unless the manager proves the following items and documents each item:

In lieu of depreciation, a taxpayer now may elect to deduct up to $17,500 of the cost of depreciable tangible personal property placed in service for the tax year. The SBJPA increases the $17,500 amount that may be expensed under code section 179 to $25,000. The increase is phased in as follows:

Tax year beginning in -- Maximum expensing

1997 $18,000

1998 $18,500

1999 $19,000

2000 $20,000

2001 $24,000

2002 $24,000

2003 and after $25,000

• SBJPA section 1111 amends code section 179 for property placed in service in tax years beginning after December 31, 1996, subject to the phase-in schedule.

Property Not Eligible

The SBJPA restores a provision that denies section 179 expensing for property used outside the United States, property used in furnishing lodging, property used by tax-exempt organizations, property used by governments and foreign persons, and heating or air conditioning units.

• SBJPA section 1702(h)(19) amends code section 179 effective for property placed in service after December 31, 1990.

Lack of Direction

Surviving the War Against Success

This portion is a story copyrighted by SBDC:

When you start a business, you are optimistic and full of hope. You know you will succeed. Few will tell you to think of how you plan to get out of it. Actually, it is smart to consider your exit strategy even before you start. Sooner or later you will get out of business. You will either fail, sell, die or get out of it in some other way, but you will eventually get out. By thinking about this when you start, you have a more complete picture of the whole process.

This is not to suggest that you must have a complete plan for getting out in each of these situations, but that is not a bad idea. If you fail and must close your business, which statistically is more likely than not, how will you handle it? What will you do? Will you take bankruptcy? Will you lose most of your personal assets? Will it ruin your life?

If you are hit by a truck and killed, what will happen to your business? How will your heirs handle it? Will they be able to cope? Will they have to take bankruptcy? If you grow tired of the business grind, will you sell it or liquidate it? Will you be able to sell it? How will you liquidate it?

These questions are usually not raised during start-up, but they should be. You should have some idea of how you will exit your business ownership under various circumstances. The advantage of having at least a general plan for exit is its beneficial effect on your emotional state when exit becomes a possibility or reality. Think about it. If the ceiling starts to fall in on your business, having an exit strategy will prevent you from wringing your hands and thinking, "I don’t know what I am going to do now." You will know what to do.

Having an exit plan also has benefits because it often causes you to operate your business differently. For example, if part of your exit plan is to sell the business, you will do things that will maintain the financial health of the business. The income statements and balance sheets make up the financial history of a firm. A future sale is enhanced if these statements look good. Your day-to-day decisions in operating your business influence these statements.

The reality of small business start-ups is that money is usually scarce and costs are high. Coupled with these is significant competition in most areas of business. Customers you seek to serve are already getting by without you and your business. Here you come with a new business. You want them to change their ways from trading with others to doing business with you. To accomplish this, you have to put out money to get your business set up and running. You have to spend more on advertising and promotion to let them know about you. You have to suffer with less revenue because they don’t know you very well yet. So you are spending more than your competitors and you are taking in less revenue.

This is the picture WITHOUT debt. If you add debt, now you have the interest expense to pay plus setting aside money for principle repayments. It is difficult enough starting up without this principle and interest burden. The debt makes it much more difficult because not only do you have these payments to make, but if you falter, you can lose everything. To get the debt in the first place, you will probably have to pledge everything you have in your business -- and probably your personal things as well.

Advice: Start your business with as little borrowing as possible. None if you can do it. If you borrow most of the money the business needs -- meaning that you are providing little of it -- your chances of success are much reduced. You chances of losing a great deal are substantial.

You know that ours is a free enterprise system and that you will be facing competition in the market. This means there will be other businesses out there who want the same customers you want. What they sometimes fail to tell you is that competition is not at all friendly -- and neither are the customers.

Competitors want you out of the picture. They will undercut your prices, advertise that you are inferior, tell the customers you are bad, try to do things for your customers that you can’t, and anything else that will give them advantage. Many will run deceiving advertising to beat you or use dishonest or unlawful pricing practices. Some will lie to your mutual suppliers about you. The tricks and dirty practices that businesses use against other businesses are many and varied.

The longer you are in business, the more of these tricks and shady practices you learn. Usually you learn by having a competitor use them against you. "Unfair!" you shout at first. "They can’t do that!" you insist. "There is a law against that". You will be correct, but they will do it anyway. To stop them usually takes more money and effort than you are willing to spend. What happens is that you end up either ignoring their practices -- and suffering in the process -- or you fight fire with fire. You employ some of the same tricks and shady practices. You run your own deceptive ads or use your own unlawful pricing practices. You get into dog fights. In such fights, the big dog often wins. As a new business start-up, you are usually not the big dog.

Your market is also made up of customers. Customers care little or nothing about you or your business. They are in the market to get the best they can at the least cost. They will shop around, skip from business to business, jump at your promotions, but buy nothing else, and do anything else that is to their selfish benefit. They will trade with you only if you give them some good reasons to do so -- the best price, the best quality, the most convenience, or whatever they happen to want -- and they will quit trading with you just as soon as they locate another business that does it better. They have no loyalty, don’t care if you make a profit, and will take every advantage from you they can. Some will cheat you at every opportunity and many will steal from you. If you go out of business, they will come to your going-out-of-business sale, stock up, and be happy about the benefit you gave them for failing in your business.

Franchise advertising is especially good at telling you that "anybody can do it" or that "you can learn how with only two days of training." "No experience needed. We will train you." "All it takes is hard work." Advocates of small business are sometimes just as guilty of leading you to think that starting and running a small business does not require much knowledge.

All too often, this misleading advice is coming from folks who have never done it. They have never started or operated a small business. Some educators are guilty of giving bad advice about knowledge requirements because they have learned much over a period of years studying business and they project this knowledge to you; or they think you can pick it up quickly simply by listening to one of their lectures or reading one of their books. Even some Small Business Development Centers can be faulted for painting this knowledge requirement picture with vague colors.

Make no mistake, running even a very small business requires knowing something about a lot of things. There are, to begin, the technical skills of the business. Then there are the business practices skills. Added to this must be knowledge of the market and the customers. Knowledge of the competition and the economy is also necessary. Knowledge of technological developments in your area is important.

Within each of these areas, the list is long of the things you need to know. In just the business practices area, for example, consider these:

From a knowledge standpoint, working as an employee for someone else and working as the owner/operator of your own business are worlds apart. As an employee, your knowledge requirement is usually confined to a single area of business. As a business owner, your knowledge requirements must cover every area of business and all aspects of it.

Ask those who have failed in small business. They will tell you that their failure was caused by, or helped along by, their inability to cope with one or more problems. Not enough cash. Could not borrow more money. Customers would not buy. Suppliers would not ship. The IRS was unreasonable. Employees were incompetent.

Underlying all of these reasons for failure was a deficiency in knowledge about what to do in these situations. This knowledge deficiency prevented them from properly recognizing and analyzing the problem. This knowledge deficiency prevented them from considering alternative solutions or picking the best solution. This knowledge deficiency prevented the foresight that is important in anticipating business problems. Rather than seeing something coming, a cash shortage or customer problem hit them hard without warning.

All businesses face these difficulties. Those operated by knowledgeable people are better able to anticipate and see what is coming. Those with knowledgeable people are better able to cope and solve problems. Those without, flounder and fail. Some of the failures knew they didn’t know. Some don’t even know they didn’t know.

Most people who start their own business are employees, working for someone else doing some specialized task. They are mechanics, food service workers, electricians, accountants, teachers or sales specialists, to name a few. When these people go into business for themselves, they often start a business that does the specialized work they know. An accountant will start a bookkeeping service. A mechanic will open a garage. A food service specialist will open a restaurant.

Many small businesses are started primarily to create a job for the owner. An unemployed nurse may start a home care service business to create her own job. An unemployed teacher may start a seminar training business in order to have a teaching job.

Most of these folks think that if they know how to do the specialized work, they know how to run a business that does that specialized work. This thinking is wrong. Doing specialized work requires certain skills and knowledge. Running a business that does that specialized work requires different skills and different knowledge. One is concerned with doing specialized work. The other is concerned with running a business. The two are not the same.

One of the saddest facts in American small business is that this reality is not discovered until the specialist fails in his or her own business. And even then, many do not understand the difference.

If you listen to the advertising by banks and government agencies that is directed at small business, you might get the impression that getting loans or government loan guarantees is easy and for everybody who asks. Not so on either count.

They are not easy to get because of the preparation that is required. They are not for everybody because there is always a list of qualifications to meet, such as equity requirements, collateral, business plans, profit and cash flow projections, etc. etc.

If you take all of the people who would like a small business loan or a government program, most of them will not even apply because of the requirements. They can’t meet the requirements or won’t go to the trouble to try. Of those who do, only a fraction will succeed. More often than not, they will not succeed. They will fail in their preparation or will become discouraged because they didn’t know it would take so much effort. Those who succeed are the select few. They are the few who receive the benefit.

Numbers are the language of business. Virtually everything in business is reduced to a number for understanding. Business results are reported with numbers. Bankers think in terms of numbers. Products are sold, supplies are purchased, and taxes are paid -- all using numbers. It is difficult for business people to talk about business without talking about numbers.

True, you don’t have to know accounting or bookkeeping to run a small business. But you MUST KNOW YOUR NUMBERS. You must know your cash numbers. You must know number relationships, such as how much gross profit numbers you need to cover your expense numbers; or what your price numbers have to be to pay all of your cost numbers. These basics are the lifeblood of business. You can’t make good decisions in business if you can’t make good decisions about numbers; and you can’t make good decisions about numbers if you don’t understand them.

I was once told by a client that she wanted to have her own business, but she didn’t want to sell. She hated selling. There are a lot of people like her. They look upon selling as something they can’t do or don’t care to do. Many feel that it is a skill they do not have and to attempt it would be to fail.

In business, it is often said that nothing happens until a sale is made. A sale takes place when a customer decides to give you money for the product or service you are offering. The customer will usually not do this without some selling effort on your part. If there is no selling effort, the business you get will be small and infrequent. To be sure, there are many small businesses that have little or no selling effort. There are small retailers who open the doors and wait for customers to come in and buy. A few do, but usually not many and not for long. ,

The more competitive your particular business environment, the more selling you must do to get revenue. The more options and alternatives your customers have -- and they usually have many, the more they must be sold with skillful selling techniques. To start a business and ignore the need to sell is similar to building a house and ignoring the need for a roof.

The new business owner is filled with enthusiasm for the new business. A great deal of time, effort and money went into starting this business and it is a great business! It is going to make money and be vary satisfying to the owner. You will be your own boss and call all the shots. You will not have to share the profits with anybody and you can run things exactly as you please. What a great country this is that permits an ordinary person to do this.

What they don’t tell you is that you are probably the only one who cares about your business. If you tried to get a bank loan, you discovered that the banks don’t care about your business. If you applied for a government program, you learned that the government didn’t much care. If you tried to find a private investor, you learned that they didn’t care. If you don’t follow the rules of the IRS and other government agencies, you will find that they don’t care either.

And the saddest discovery of all is when you find out that the customers don’t care either. Oh, sure, a few may seem to care at first, but they are more curious than caring. Your relatives may give you some business, but their caring is motivated not by your business, but by your personal relationship. For the most part, your customers don’t care a flip about your business. The only way they will do any business with you is if you offer them more value than what their cost could buy them elsewhere. Not only that, but you must go to the trouble and expense to tell them what you can do for them. Not only must you tell them, but you must sell them -- convince them. You must overcome their many reasons for not doing business with you.

If you go into your business believing that anyone other than you really cares about your business, you are in for a big disappointment. If, on the other hand, you accept the fact that nobody cares, you will do the things that need to be done to find, inform and sell your customers.

Even if it were not true that nobody cares, you are best advised to assume they don’t care. By assuming this and going into business anyway, you will be motivated to organize your business, to design your advertising, and to offer your product or service in such a way that you convince customers to buy. You will make things happen in spite of the fact that nobody cares.

In business, you are continuously working to convince others to do your bidding. You must convince the banker to loan money to you to start. You must convince the landlord to lease you office space and convince suppliers to give you thirty days credit on your purchases. You spend a lot of time convincing customers to trade with you, and then convincing them to pay their accounts on time. If you have employees, you strive to convince them to follow company policies, treat the customers well, and don’t steal from your company.

The job of convincing others to agree with your views is a never-ending part of business. If you are good at it, running your business is much easier than if you have trouble doing it.

Training and practice in negotiations, communications and human relations is very helpful if you aren’t already a good convincer.

Chapter 4 — The War Against Insolvency Intelligence and Surveillance Results, Events Requiring Special Attention

Sale or Trade of Capital Assets

Entering into a contract of any type

Hiring, Firing or continued employment relations

Investing excess profits

Computing excess profits

Transferrign excess profits

Purchasing or starting a new business

Daily operations management

MONTHLY REPORT TO MANAGEMENT

Cash Transactions

Beginning balance

Deposits:

Subtractions from a/r

Other sources of cash receipts

Total additions to cash

Total cash available for the period

Cash outlays:

A/P paid

Salaries & wages

Other expenses

Total includes checks _________ through ________

Ending balance of cash

ACOUNTS RECEIVABLE TRANSACTIONS

Beginning accounts receivable

Additions to accounts receivable

Subtractions from accounts receivable

Ending accounts receivable

ACCOUNTS PAYABLE TRANSACTIONS

Beginning accounts payable (all current debt)

New bills

Payments to vendors

Ending accounts payable (all current debt)

Sales and Jobs Completed Ready For Billing

Total hours to be billed

Rate

Calculated total

Total on report

Work clients are waiting on is approximately

CASH - CHECKING

Balance - beginning of year

Receipts:

Receipts on prior reports

This reports receipts

Total received to date

Disbursements:

Disbursements on prior reports

Disbursements on this report

Total disbursed to date

Net year to date change

Ending cash balance

MONTHLY REPORT TO MANAGEMENT

Item

Current assets in excess of current liabilities

Equity

Total income

Gross profit %

Net

MONTHLY REPORT TO MANAGEMENT

Cash expenditures were as follows:

Sales tax paid

Withheld p/r and p/r tax

Paid on accounts payable

Company life insurance loan

Car Loan 1

Car Loan 2

Purchases

Officers salaries

Wages

Less amounts withheld

Advertising

Gas oil & lube

Repairs

Dues

Employer p/r taxes

Freight

Uniforms

Interest expense

Professional expenses

Misc

Maint.

Office

Bank charges

Rents

Supplies

Telephone

Utilities

Taxes & licneses

Workers' comp

Employee insurance

Building insurance

Vehicle insurance

Officers' life insurance

Total of checks written

Daily balancing for the gasoline station

To be included at a later date.  Call if you need this.

Daily balancing for the Independent Insurance Agent

To be included at a later date.  Call if you need this.

Industries and events receiving special attention from the Internal Revenue Service

The Internal Revenue Service has a list of industries and financial transactions that it watches closely. The audit rate for these business may be more than that of other businesses. The Service has special instructions to the examination personnel and special directives. At times, personnel are trained on these types and develop special skills on these industries and transactions.

If you find that one of these items interests you, then I will furnish you a copy of the Internal Revenue Service’s papers. One can learn the terminology, the special records of the business, the management of events in the company and other interesting details. In addition, the reading will inform the manager or consultant of what to expect from an Internal Revenue Service examination of the company’s records and tax return.

The following is the listing:

Chapter 5 — The War Against Insolvency — Home Base, Choosing An Entity Type

Planning for Income and Loss

You may be interested in Related Documents (click on each to open it):

Introduction To Business Entity Types

Entity Types Questions and Answers

If a business is expected to have significant losses in the early years of operation, it may be desirable to operate as a pass-through entity in order to make the losses available to the owners. The use of a partnership or S corporation can accomplish this goal. A major difference between an S corporation and a general partnership is that, within certain limits and subject to the at-risk and passive activity loss rules, losses financed by a business's borrowing from third parties can be passed through to partners by partnerships but not to shareholders by S corporations. The losses from an S Corporation are limited. The limit is based upon the amount invested in the stock and loans from the shareholder to the corporation. (Other factors can play a part in this computation, I will not cover them here.)

The choice of business entity involves selecting among four options:

The sole proprietorship

the partnership (general or limited partnership),

the corporation (S corporation, the C corporation), and

the limited liability company (LLC).

The partnership, whether general or limited, and the LLC afford the most favorable tax consequences to most business organizers. If taxes were the only concern, almost all businesses would be operated in these forms.

Some choices, such as between a general or limited partnership and a C corporation, affect both the legal relationships involved in doing business and the tax consequences. Other choices, however, affect only the legal relationships or the tax consequences, but not both.

Thus, the choice between an S corporation and a C corporation affects only taxes; the choice between a general partnership and a limited partnership generally affects only the business relationships among partners and between the partnership and third parties, but generally does not affect the way in which the partnership is taxed. The sole proprietorship, which is an option for a business conducted by a single individual, is not a separate legal entity.

In most cases, the tax burden of operating a business through a C corporation is significantly greater than if a pass-through entity is used. The C corporation usually should be selected only if there are significant advantages that cannot be achieved through a partnership or S corporation.

As compared with an S corporation, the partnership has the advantage of providing significant flexibility in the economic and tax allocations of financial interests. Moreover, the ability to pass through tax losses and distribute proceeds of refinancing without immediate tax consequences is greater for partnerships, largely because of the rules regarding debt. It is also much easier for a partnership to avoid unintended consequences; depending upon particular circumstances, a corporation may encounter formidable hurdles regarding qualification as an S corporation and maintaining S corporation status. There are many cases in which an S corporation or a C corporation might provide tax advantages over a partnership. For a small business, or a sole owner business, the S Corporation may be the best alternative.

Although the partnership generally has its own tax advantages, there may be nontax advantages of the corporate form that make a corporation the preferred entity for many businesses. The most notable advantage of the corporate form is limited liability. Some businesses select the corporate form to insulate the owners from personal liability. This does not mean that the corporation should be selected whenever the members are concerned about incurring personal liability. As a matter of state law, personal liability arising from many types of activities, including the practice of law and medicine, cannot be avoided by the use of a corporation. Moreover, when personal liability can be limited by the choice of entity, the partnership form can provide some measure of protection. Members not active in the day-to-day operations of the business may achieve limited liability if the partnership becomes a limited partnership under state law. Partners active in the day-to-day operations of the business (for whom the limited partnership does not offer protection) may, in certain cases, achieve some protection through the use of a corporate general partner or an LLC.

As a broad generalization, the tax advantages of the partnership form, weighed against the limited liability generally provided by the corporate form, have resulted in the following pattern.

Personal service businesses and real estate operations are generally conducted through partnerships. In these situations, either (1) personal liability cannot be avoided, (2) sufficient insulation from liability is provided through the limited partnership, contractually with lenders, or through liability insurance, or (3) the tax advantages of the partnership form outweigh personal liability concerns.

Other activities, including many manufacturing businesses where insulation from personal liability for all members is usually important and can be achieved under state law, operate through corporations. In these situations, if the requirements of an S corporation can be met, the S corporation is usually selected because of its pass-through character.

Large publicly owned businesses operate as C corporations because limited liability for all members is important and the requirements for S corporations cannot be met.

Choices Available

Proprietorship

The proprietorship is more simple to operate than some of the other entity types. However, the owner is liable for all debts of the business. It is not usually the moest desirable form of operations. In addition secured creditors may prefer the owner to operate as a corporation if there are cash flow problems. The secured creditors are always protected, while the proprietor may have some protection from unsecured creditors in a bankruptcy. The "may" part of the scenario would be where the secured creditors were owed by the individual and the unsecured creditors owed by the corporation.

Generally, real property should be owned by the individual and personal property, inventory etc., owned by the corporation. This type of planning offers future tax advantages in addition to other advantages.

Entities Taxed As A Partnership

These business types include the following:

Partnerships are nontaxable entities that act as conduits for transferring income or loss and such items as tax credits directly to the individual partners, who then report the appropriate amounts on their own tax returns.

The following definitions are crucial to an understanding of how partnerships operate.

Corporations

An excellent choice. This eliminates double taxation. It serves as a "safety valve" for any potential "constructive dividends". It is not subject to the Florida Income tax. Dividen income is not subject to self-employment tax.

It can now have 75 shareholders. Certain trusts can hold S Corporation stock. After 1996, the S Corporation may own a controlling interest in a C Corporation, but may not file a consoldiated return with its affiliates. The S Corporation may also set up a qualified S subsidiary in which it owns 100% of the stock.

Also — it now possible to cure an imperfect S Corporation election.

Generally the S Corp election must be made on or before the 15^th day of the 3^rd month of the current year. Otherwise the election is not available untill the following year. All shareholders and spouses must join in the election.

The S Corporation is a flow through entity and therefore losses and income pass to the shareholders’ invidual return.

The S Corporation shareholder enjoys the same corporate shell as the C Corporation shareholder.

While partnerships and S corporations have many similarities, they also have significant differences in their operation and in their tax treatment of some items. Therefore, before deciding on whether to operate as either a partnership or an S corporation, a careful comparison must be made between the two forms of operation and a decision must be made as to which form of doing business offers the most advantages to the individual investors.

This can be a good choice if a combination of limited liability, more than 75 shareholders and other attributes are required. Dangers are double taxation and constructive diviends. The C Corporation is subject to both state and federal income taxes.

C Corporations can file consolidated tax returns. If many corporations are owned and controlled by one or few individuals, the brother sister and controlled group rules must be applied. This restricts the group to a single set of tax brackets, first year bonus depreciation allowances and other restrictions may apply.

Here is a summary sheet

PROPRIETORSHIP

One person owner

Pew employees

Relatively low income

Relatively low start up costs

No double tax on business earnings

Not possible to "time" or "split" income

Administration of estate difficult

Valuation freezing techniques not available

Should not be operated as part of a trust

No shield against personal liability

Income reportable on owner's individual income tax return

Not possible to borrow from available type of retirement plan Keogh plan)

Funds in Keogh plan generally not safe from creditors

Generally may avoid franchise tax imposed by many states on operating as a corporation

Self employment (payroll) tax now equal to total of employer and employee federal payroll tax

PARTNERSHIP & LLC

Sharing of net profits

Presence of loss sharing

Pass through of losses

Avoidance of double taxation on profits

Relatively low start up costs

Relatively economical operation costs

Taxable years must match those of partners or members

No restrictions on whom can invest or number of investors

Easy to convert to another form of entity

No accumulated earnings tax

No personal holding company tax

Unlimited personal liability unless limited partnership

or LLC used to protect limited partners or members

Subject to "at risk" limitations

Losses not deductible in excess of basis

Interest deduction limits at personal level

Equity received for services creates income

On contribution of encumbered property, generally, only liabilities assumed by other

Partners or members in excess of contributing partner's basis is taxable

Income splitting wealth shifting potential

IRS can reallocate income if member of family renders services without reasonable

Compensation

Partners who render services are treated as employees for certain fringe benefit purposes

But tax law typically precludes nontaxable fringe benefits for most partners or members

Separate income tax return required

Not possible to borrow from available type of retirement plan Keogh plan)

Funds in Keogh plan generally not safe from creditors of partner

Franchise tax imposed on partnerships or LLCs by some states

Another Summary

Tax 'reatment of wiedical, DisabIlity, and Group-Term Life Insurance on Owners

Not deductible, except part of medical expense may be an itemized deduction on owner's tax return, Including medical insurance pre miums. However. 25% of medical insurance on an owner is allowed as a deduction from adjusted gross income.

Not deductible, except part of medicai expen ses may be an itemized deduction on owner's tax return, including medical insurance pre miums. However, 25% of medical insurance on an owner is allowed as a deduction from adjusted gross income.

Not clear yet, but probably same as a partnership. If treated as a partnership by IRS.

Corporations may be allowed to deduct corporation medical insurance premium or reimbursements paid under medical reimbursement plan. Generally not taxable to the employee, even if employee is an owner. Similar treatment for disability and group- term life insurance plans.

Chapter 6 — The War Against Insolvency, Preventative Management – Defensive Weapons

Audit Proof Home Office Deductions

To be completed at a later date. Call if you want a copy of this section.

Audit Proof Meal Deductions

To be completed at a later date. Call if you want a copy of this section.

Audit Proof Travel Deductions

To be completed at a later date. Call if you want a copy of this section.

Audit Proof Car and Local Transportation Deductions

To be completed at a later date. Call if you want a copy of this section.

Audit Proof an Internal Revenue Service Assertion That Non-Income Deposits Are Taxable

To be completed at a later date. Call if you want a copy of this section.

Chapter 7 — Letters From The Government, Crisis Management and Damage Control, Defcon 1

Your Rights

To be completed at a later date. Call if you want a copy of this section.

Examination of Tax Returns – What To Expect

To be completed at a later date. Call if you want a copy of this section.

Late Filing of Returns

To be completed at a later date. Call if you want a copy of this section.

Late Paying of Returns

To be completed at a later date. Call if you want a copy of this section.

Offer In Compromise

To be completed at a later date. Call if you want a copy of this section.

Installment Payments

To be completed at a later date. Call if you want a copy of this section.

Bankruptcy

To be completed at a later date. Call if you want a copy of this section.

Appendix - Table of Contents "Taxpayer Relief Act of 1997"

HR 2014

Note this is a hand enrollment pursuant to Public Law 105–32.

H. R. 2014

One Hundred Fifth Congress

of the

United States of America

AT THE FIRST SESSION

Begun and held at the City of Washington on Tuesday,

the seventh day of January, one thousand nine hundred and ninety-seven

An Act

To provide for reconciliation pursuant to subsections (b)(2) and (d) of section 105 of the concurrent resolution on the budget for fiscal year 1998.

Be it enacted by the Senate and House of Representatives of

the United States of America in Congress assembled,

SECTION 1. SHORT TITLE; ETC.

(a) SHORT TITLE.—This Act may be cited as the ‘‘Taxpayer

Relief Act of 1997’’.

(b) AMENDMENT OF 1986 CODE.—Except as otherwise expressly provided, whenever in this Act an amendment or repeal is expressed in terms of an amendment to, or repeal of, a section or other provision, the reference shall be considered to be made to a section or other provision of the Internal Revenue Code of 1986.

(c) SECTION 15 NOT TO APPLY.—No amendment made by this

Act shall be treated as a change in a rate of tax for purposes of section 15 of the Internal Revenue Code of 1986.

(d) WAIVER OF ESTIMATED TAX PENALTIES.—No addition to tax shall be made under section 6654 or 6655 of the Internal Revenue Code of 1986 for any period before January 1, 1998, for any payment the due date of which is before January 16, 1998, with respect to any underpayment attributable to such period to the extent such underpayment was created or increased by any provision of this Act.

(e) TABLE OF CONTENTS.—The table of contents for this Act is as follows:

Sec. 1. Short title; etc.

TITLE I—CHILD TAX CREDIT

Sec. 101. Child tax credit.

TITLE II—EDUCATION INCENTIVES

Subtitle A—Tax Benefits Relating to Education Expenses

Sec. 201. Hope and lifetime learning credits.

Sec. 202. Deduction for interest on education loans.

Sec. 203. Penalty-free withdrawals from individual retirement plans for higher edu-cation expenses.

Subtitle B—Expanded Education Investment Savings Opportunities

PART I—QUALIFIED TUITION PROGRAMS

Sec. 211. Modifications of qualified State tuition programs.

PART II—EDUCATION INDIVIDUAL RETIREMENT ACCOUNTS

Sec. 213. Education individual retirement accounts.

H. R. 2014—2

Subtitle C—Other Education Initiatives

Sec. 221. Extension of exclusion for employer-provided educational assistance.

Sec. 222. Repeal of limitation on qualified 501(c)(3) bonds other than hospital bonds.

Sec. 223. Increase in arbitrage rebate exception for governmental bonds used to fi-nance education facilities.

Sec. 224. Contributions of computer technology and equipment for elementary or secondary school purposes.

Sec. 225. Treatment of cancellation of certain student loans.

Sec. 226. Incentives for education zones.

TITLE III—SAVINGS AND INVESTMENT INCENTIVES

Subtitle A—Retirement Savings

Sec. 301. Restoration of IRA deduction for certain taxpayers.

Sec. 302. Establishment of nondeductible tax-free individual retirement accounts.

Sec. 303. Distributions from certain plans may be used without penalty to purchase first homes.

Sec. 304. Certain bullion not treated as collectibles.

Subtitle B—Capital Gains

Sec. 311. 20 percent maximum capital gains rate for individuals.

Sec. 312. Exemption from tax for gain on sale of principal residence.

Sec. 313. Rollover of gain from sale of qualified stock.

Sec. 314. Amount of net capital gain taken into account in computing alternative

tax on capital gains for corporations not to exceed taxable income of the corporation.

TITLE IV—ALTERNATIVE MINIMUM TAX REFORM

Sec. 401. Exemption from alternative minimum tax for small corporations.

Sec. 402. Repeal of separate depreciation lives for minimum tax purposes.

Sec. 403. Minimum tax not to apply to farmers’ installment sales.

TITLE V—ESTATE, GIFT, AND GENERATION-SKIPPING TAX PROVISIONS

Subtitle A—Estate and Gift Tax Provisions

Sec. 501. Cost-of-living adjustments relating to estate and gift tax provisions.

Sec. 502. Family-owned business exclusion.

Sec. 503. Modifications to rate of interest on portion of estate tax extended under section 6166.

Sec. 504. Extension of treatment of certain rents under section 2032A to lineal de-scendants.

Sec. 505. Clarification of judicial review of eligibility for extension of time for pay-ment of estate tax.

Sec. 506. Gifts may not be revalued for estate tax purposes after expiration of stat-ute of limitations.

Sec. 507. Repeal of throwback rules applicable to certain domestic trusts.

Sec. 508. Treatment of land subject to a qualified conservation easement.

Subtitle B—Generation-Skipping Tax Provision

Sec. 511. Expansion of exception from generation-skipping transfer tax for trans-fers to individuals with deceased parents.

TITLE VI—EXTENSIONS

Sec. 601. Research tax credit.

Sec. 602. Contributions of stock to private foundations.

Sec. 603. Work opportunity tax credit.

Sec. 604. Orphan drug tax credit.

TITLE VII—INCENTIVES FOR REVITALIZATION OF THE DISTRICT OF COLUMBIA

Sec. 701. Tax incentives for revitalization of the District of Columbia.

TITLE VIII—WELFARE-TO-WORK INCENTIVES

Sec. 801. Incentives for employing long-term family assistance recipients.

TITLE IX—MISCELLANEOUS PROVISIONS

Subtitle A—Provisions Relating to Excise Taxes

Sec. 901. General revenue portion of highway motor fuels taxes deposited into Highway Trust Fund.

Sec. 902. Repeal of tax on diesel fuel used in recreational boats.

Sec. 903. Continued application of tax on imported recycled Halon-1211.

Sec. 904. Uniform rate of tax on vaccines.

Sec. 905. Operators of multiple gasoline retail outlets treated as wholesale distribu-tor for refund purposes.

Sec. 906. Exemption of electric and other clean-fuel motor vehicles from luxury automobile classification.

Sec. 907. Rate of tax on certain special fuels determined on basis of BTU equiva-lency with gasoline.

Sec. 908. Modification of tax treatment of hard cider.

Sec. 909. Study of feasibility of moving collection point for distilled spirits excise tax.

Sec. 910. Clarification of authority to use semi-generic designations on wine labels.

Subtitle B—Revisions Relating to Disasters

Sec. 911. Authority to postpone certain tax-related deadlines by reason of presi-dentially declared disaster.

Sec. 912. Use of certain appraisals to establish amount of disaster loss.

Sec. 913. Treatment of livestock sold on account of weather-related conditions.

Sec. 914. Mortgage financing for residences located in disaster areas.

Sec. 915. Abatement of interest on underpayments by taxpayers in presidentially declared disaster areas.

Subtitle C—Provisions Relating to Employment Taxes

Sec. 921. Clarification of standard to be used in determining employment tax sta-tus of securities brokers.

Sec. 922. Clarification of exemption from self-employment tax for certain termi-nation payments received by former insurance salesmen.

Subtitle D—Provisions Relating to Small Businesses

Sec. 931. Waiver of penalty through June 30, 1998, on small businesses failing to make electronic fund transfers of taxes.

Sec. 932. Clarification of treatment of home office use for administrative and man-agement activities.

Sec. 933. Averaging of farm income over 3 years.

Sec. 934. Increase in deduction for health insurance costs of self-employed individ-uals.

Sec. 935. Moratorium on certain regulations.

Subtitle E—Brownfields

Sec. 941. Expensing of environmental remediation costs.

Subtitle F—Empowerment Zones, Enterprise Communities, Brownfields, and Community Development Financial Institutions

CHAPTER 1—ADDITIONAL EMPOWERMENT ZONES

Sec. 951. Additional empowerment zones.

CHAPTER 2—NEW EMPOWERMENT ZONES

Sec. 952. Designation of new empowerment zones.

Sec. 953. Volume cap not to apply to enterprise zone facility bonds with respect to new empowerment zones.

Sec. 954. Modification to eligibility criteria for designation of future enterprise zones in Alaska or Hawaii.

CHAPTER 3—TREATMENT OF EMPOWERMENT ZONES AND ENTERPRISE COMMUNITIES

Sec. 955. Modifications to enterprise zone facility bond rules for all empowerment zones and enterprise communities.

Sec. 956. Modifications to enterprise zone business definition for all empowerment zones and enterprise communities.

Subtitle G—Other Provisions

Sec. 961. Use of estimates of shrinkage for inventory accounting.

Sec. 962. Assignment of workmen’s compensation liability eligible for exclusion re-lating to personal injury liability assignments.

Sec. 963. Tax-exempt status for certain State worker’s compensation act companies.

Sec. 964. Election for 1987 partnerships to continue exception from treatment of publicly traded partnerships as corporations.

Sec. 965. Exclusion from unrelated business taxable income for certain sponsorship payments.

Sec. 966. Associations of holders of timeshare interests to be taxed like other home-owners associations.

Sec. 967. Additional advance refunding of certain Virgin Island bonds.

Sec. 968. Nonrecognition of gain on sale of stock to certain farmers’ cooperatives.

Sec. 969. Increased deductibility of business meal expenses for individuals subject to Federal hours of service.

Sec. 970. Clarification of de minimis fringe benefit rules to no-charge employee meals.

Sec. 971. Exemption of the incremental cost of a clean fuel vehicle from the limits on depreciation for vehicles.

Sec. 972. Temporary suspension of taxable income limit on percentage depletion for marginal production.

Sec. 973. Increase in standard mileage rate expense deduction for charitable use of passenger automobile.

Sec. 974. Clarification of treatment of certain receivables purchased by cooperative hospital service organizations.

Sec. 975. Deduction in computing adjusted gross income for expenses in connection with service performed by certain officials.

Sec. 976. Combined employment tax reporting demonstration project.

Sec. 977. Elective carryback of existing carryovers of National Railroad Passenger Corporation.

Subtitle H—Extension of Duty-Free Treatment Under Generalized System of Preferences

Sec. 981. Generalized System of Preferences.

TITLE X—REVENUES

Subtitle A—Financial Products

Sec. 1001. Constructive sales treatment for appreciated financial positions.

Sec. 1002. Limitation on exception for investment companies under section 351.

Sec. 1003. Gains and losses from certain terminations with respect to property.

Sec. 1004. Determination of original issue discount where pooled debt obligations subject to acceleration.

Sec. 1005. Denial of interest deductions on certain debt instruments.

Subtitle B—Corporate Organizations and Reorganizations

Sec. 1011. Tax treatment of certain extraordinary dividends.

Sec. 1012. Application of section 355 to distributions in connection with acquisi-tions and to intragroup transactions.

Sec. 1013. Tax treatment of redemptions involving related corporations.

Sec. 1014. Certain preferred stock treated as boot.

Sec. 1015. Modification of holding period applicable to dividends received deduc-tion.

Subtitle C—Administrative Provisions

Sec. 1021. Reporting of certain payments made to attorneys.

Sec. 1022. Decrease of threshold for reporting payments to corporations performing services for Federal agencies.

Sec. 1023. Disclosure of return information for administration of certain veterans programs.

Sec. 1024. Continuous levy on certain payments.

Sec. 1025. Modification of levy exemption.

Sec. 1026. Confidentiality and disclosure of returns and return information.

Sec. 1027. Returns of beneficiaries of estates and trusts required to file returns con-sistent with estate or trust return or to notify Secretary of inconsist-ency.

Sec. 1028. Registration and other provisions relating to confidential corporate tax shelters.

Subtitle D—Excise and Employment Tax Provisions

Sec. 1031. Extension and modification of taxes funding Airport and Airway Trust Fund; increased deposits into such Fund.

Sec. 1032. Kerosene taxed as diesel fuel.

Sec. 1033. Restoration of Leaking Underground Storage Tank Trust Fund taxes.

Sec. 1034. Application of communications tax to prepaid telephone cards.

Sec. 1035. Extension of temporary unemployment tax.

Subtitle E—Provisions Relating to Tax-Exempt Entities

Sec. 1041. Expansion of look-thru rule for interest, annuities, royalties, and rents derived by subsidiaries of tax-exempt organizations.

Sec. 1042. Termination of certain exceptions from rules relating to exempt organi-zations which provide commercial-type insurance.

Subtitle F—Foreign Provisions

Sec. 1051. Definition of foreign personal holding company income.

Sec. 1052. Personal property used predominantly in the United States treated as not property of a like kind with respect to property used predominantly outside the United States.

Sec. 1053. Holding period requirement for certain foreign taxes.

Sec. 1054. Denial of treaty benefits for certain payments through hybrid entities.

Sec. 1055. Interest on underpayments not reduced by foreign tax credit carrybacks.

Sec. 1056. Clarification of period of limitations on claim for credit or refund attrib-utable to foreign tax credit carryforward.

Sec. 1057. Repeal of exception to alternative minimum foreign tax credit limit.

Subtitle G—Partnership Provisions

Sec. 1061. Allocation of basis among properties distributed by partnership.

Sec. 1062. Repeal of requirement that inventory be substantially appreciated with respect to sale or exchange of partnership interest.

Sec. 1063. Extension of time for taxing precontribution gain.

Subtitle H—Pension Provisions

Sec. 1071. Pension accrued benefit distributable without consent increased to $5,000.

Sec. 1072. Election to receive taxable cash compensation in lieu of nontaxable park-ing benefits.

Sec. 1073. Repeal of excess distribution and excess retirement accumulation tax.

Sec. 1074. Increase in tax on prohibited transactions.

Sec. 1075. Basis recovery rules for annuities over more than one life.

Subtitle I—Other Revenue Provisions

Sec. 1081. Termination of suspense accounts for family corporations required to use accrual method of accounting.

Sec. 1082. Modification of taxable years to which net operating losses may be car-ried.

Sec. 1083. Modifications to taxable years to which unused credits may be carried.

Sec. 1084. Expansion of denial of deduction for certain amounts paid in connection with insurance.

Sec. 1085. Improved enforcement of the application of the earned income credit.

Sec. 1086. Limitation on property for which income forecast method may be used.

Sec. 1087. Expansion of requirement that involuntarily converted property be re-placed with property acquired from an unrelated person.

Sec. 1088. Treatment of exception from installment sales rules for sales of property by a manufacturer to a dealer.

Sec. 1089. Limitations on charitable remainder trust eligibility for certain trusts.

Sec. 1090. Expanded SSA records for tax enforcement.

Sec. 1091. Modification of estimated tax safe harbors.

TITLE XI—SIMPLIFICATION AND OTHER FOREIGN-RELATED PROVISIONS

Subtitle A—General Provisions

Sec. 1101. Certain individuals exempt from foreign tax credit limitation.

Sec. 1102. Exchange rate used in translating foreign taxes.

Sec. 1103. Election to use simplified section 904 limitation for alternative minimum tax.

Sec. 1104. Treatment of personal transactions by individuals under foreign cur-rency rules.

Sec. 1105. Foreign tax credit treatment of dividends from noncontrolled section 902 corporations.

Subtitle B—Treatment of Controlled Foreign Corporations

Sec. 1111. Gain on certain stock sales by controlled foreign corporations treated as dividends.

Sec. 1112. Miscellaneous modifications to subpart F.

Sec. 1113. Indirect foreign tax credit allowed for certain lower tier companies.

Subtitle C—Treatment of Passive Foreign Investment Companies

Sec. 1121. United States shareholders of controlled foreign corporations not subject to PFIC inclusion.

Sec. 1122. Election of mark to market for marketable stock in passive foreign in-vestment company.

Sec. 1123. Valuation of assets for passive foreign investment company determina-tion.

Sec. 1124. Effective date.

Subtitle D—Repeal of Excise Tax on Transfers to Foreign Entities

Sec. 1131. Repeal of excise tax on transfers to foreign entities; recognition of gain on certain transfers to foreign trusts and estates.

Subtitle E—Information Reporting

Sec. 1141. Clarification of application of return requirement to foreign partner-ships.

Sec. 1142. Controlled foreign partnerships subject to information reporting com-parable to information reporting for controlled foreign corporations.

Sec. 1143. Modifications relating to returns required to be filed by reason of changes in ownership interests in foreign partnership.

Sec. 1144. Transfers of property to foreign partnerships subject to information re-porting comparable to information reporting for such transfers to foreign corporations.

Sec. 1145. Extension of statute of limitations for foreign transfers.

Sec. 1146. Increase in filing thresholds for returns as to organization of foreign cor-porations and acquisitions of stock in such corporations.

Subtitle F—Determination of Foreign or Domestic Status of Partnerships

Sec. 1151. Determination of foreign or domestic status of partnerships.

Subtitle G—Other Simplification Provisions

Sec. 1161. Transition rule for certain trusts.

Sec. 1162. Repeal of stock and securities safe harbor requirement that principal of-fice be outside the United States.

Sec. 1163. Miscellaneous clarifications.

Subtitle H—Other Provisions

Sec. 1171. Treatment of computer software as FSC export property.

Sec. 1172. Adjustment of dollar limitation on section 911 exclusion.

Sec. 1173. United States property not to include certain assets acquired by dealers in ordinary course of trade or business.

Sec. 1174. Treatment of nonresident aliens engaged in international transportation services.

Sec. 1175. Exemption for active financing income.

TITLE XII—SIMPLIFICATION PROVISIONS RELATING TO INDIVIDUALS AND

BUSINESSES

Subtitle A—Provisions Relating to Individuals

Sec. 1201. Basic standard deduction and minimum tax exemption amount for cer-tain dependents.

Sec. 1202. Increase in amount of tax exempt from estimated tax requirements.

Sec. 1203. Treatment of certain reimbursed expenses of rural mail carriers.

Sec. 1204. Treatment of traveling expenses of certain Federal employees engaged in criminal investigations.

Sec. 1205. Payment of tax by commercially acceptable means.

Subtitle B—Provisions Relating to Businesses Generally

Sec. 1211. Modifications to look-back method for long-term contracts.

Sec. 1212. Minimum tax treatment of certain property and casualty insurance com-panies.

Sec. 1213. Qualified lessee construction allowances for short-term leases.

Subtitle C—Simplification Relating to Electing Large Partnerships

PART I—GENERAL PROVISIONS

Sec. 1221. Simplified flow-through for electing large partnerships.

Sec. 1222. Simplified audit procedures for electing large partnerships.

Sec. 1223. Due date for furnishing information to partners of electing large part-nerships.

Sec. 1224. Returns required on magnetic media.

Sec. 1225. Treatment of partnership items of individual retirement accounts.

Sec. 1226. Effective date.

PART II—PROVISIONS RELATED TO TEFRA PARTNERSHIP PROCEEDINGS

Sec. 1231. Treatment of partnership items in deficiency proceedings.

Sec. 1232. Partnership return to be determinative of audit procedures to be fol-lowed.

Sec. 1233. Provisions relating to statute of limitations.

Sec. 1234. Expansion of small partnership exception.

Sec. 1235. Exclusion of partial settlements from 1-year limitation on assessment.

Sec. 1236. Extension of time for filing a request for administrative adjustment.

Sec. 1237. Availability of innocent spouse relief in context of partnership proceed-ings.

Sec. 1238. Determination of penalties at partnership level.

Sec. 1239. Provisions relating to court jurisdiction, etc.

Sec. 1240. Treatment of premature petitions filed by notice partners or 5-percent groups.

Sec. 1241. Bonds in case of appeals from certain proceeding.

Sec. 1242. Suspension of interest where delay in computational adjustment result-ing from certain settlements.

Sec. 1243. Special rules for administrative adjustment requests with respect to bad debts or worthless securities.

PART III—PROVISION RELATING TO CLOSING OF PARTNERSHIP TAXABLE YEAR WITH

RESPECT TO DECEASED PARTNER, ETC.

Sec. 1246. Closing of partnership taxable year with respect to deceased partner, etc.

Subtitle D—Provisions Relating to Real Estate Investment Trusts

Sec. 1251. Clarification of limitation on maximum number of shareholders.

Sec. 1252. De minimis rule for tenant services income.

Sec. 1253. Attribution rules applicable to stock ownership.

Sec. 1254. Credit for tax paid by REIT on retained capital gains.

Sec. 1255. Repeal of 30-percent gross income requirement.

Sec. 1256. Modification of earnings and profits rules for determining whether REIT as earnings and profits from non-REIT year.

Sec. 1257. Treatment of foreclosure property.

Sec. 1258. Payments under hedging instruments.

Sec. 1259. Excess noncash income.

Sec. 1260. Prohibited transaction safe harbor.

Sec. 1261. Shared appreciation mortgages.

Sec. 1262. Wholly owned subsidiaries.

Sec. 1263. Effective date.

Subtitle E—Provisions Relating to Regulated Investment Companies

Sec. 1271. Repeal of 30-percent gross income limitation.

Subtitle F—Taxpayer Protections

Sec. 1281. Reasonable cause exception for certain penalties.

Sec. 1282. Clarification of period for filing claims for refunds.

Sec. 1283. Repeal of authority to disclose whether prospective juror has been au-dited.

Sec. 1284. Clarification of statute of limitations.

Sec. 1285. Awarding of administrative costs.

TITLE XIII—SIMPLIFICATION PROVISIONS RELATING TO ESTATE AND GIFT

TAXES

Sec. 1301. Gifts to charities exempt from gift tax filing requirements.

Sec. 1302. Clarification of waiver of certain rights of recovery.

Sec. 1303. Transitional rule under section 2056A.

Sec. 1304. Treatment for estate tax purposes of short-term obligations held by non-resident aliens.

Sec. 1305. Certain revocable trusts treated as part of estate.

Sec. 1306. Distributions during first 65 days of taxable year of estate.

Sec. 1307. Separate share rules available to estates.

Sec. 1308. Executor of estate and beneficiaries treated as related persons for dis-allowance of losses, etc.

Sec. 1309. Treatment of funeral trusts.

Sec. 1310. Adjustments for gifts within 3 years of decedent’s death.

Sec. 1311. Clarification of treatment of survivor annuities under qualified ter-minable interest rules.

Sec. 1312. Treatment under qualified domestic trust rules of forms of ownership which are not trusts.

Sec. 1313. Opportunity to correct certain failures under section 2032A.

Sec. 1314. Authority to waive requirement of United States trustee for qualified do-mestic trusts.

TITLE XIV—SIMPLIFICATION PROVISIONS RELATING TO EXCISE TAXES,

TAX-EXEMPT BONDS, AND OTHER MATTERS

Subtitle A—Excise Tax Simplification

PART I—EXCISE TAXES ON HEAVY TRUCKS AND LUXURY CARS

Sec. 1401. Increase in de minimis limit for after-market alterations for heavy trucks and luxury cars.

Sec. 1402. Credit for tire tax in lieu of exclusion of value of tires in computing price.

PART II—PROVISIONS RELATED TO DISTILLED SPIRITS, WINES, AND BEER

Sec. 1411. Credit or refund for imported bottled distilled spirits returned to dis-tilled spirits plant.

Sec. 1412. Authority to cancel or credit export bonds without submission of records.

Sec. 1413. Repeal of required maintenance of records on premises of distilled spirits plant.

Sec. 1414. Fermented material from any brewery may be received at a distilled spirits plant.

Sec. 1415. Repeal of requirement for wholesale dealers in liquors to post sign.

Sec. 1416. Refund of tax to wine returned to bond not limited to unmerchantable wine.

Sec. 1417. Use of additional ameliorating material in certain wines.

Sec. 1418. Domestically produced beer may be withdrawn free of tax for use of for-eign embassies, legations, etc.

Sec. 1419. Beer may be withdrawn free of tax for destruction.

Sec. 1420. Authority to allow drawback on exported beer without submission of records.

Sec. 1421. Transfer to brewery of beer imported in bulk without payment of tax.

Sec. 1422. Transfer to bonded wine cellars of wine imported in bulk without pay-ment of tax.

PART III—OTHER EXCISE TAX PROVISIONS

Sec. 1431. Authority to grant exemptions from registration requirements.

Sec. 1432. Repeal of expired provisions.

Sec. 1433. Simplification of imposition of excise tax on arrows.

Sec. 1434. Modifications to retail tax on heavy trucks.

Sec. 1435. Skydiving flights exempt from tax on transportation of persons by air.

Sec. 1436. Allowance or credit of refund for tax-paid aviation fuel purchased by reg-istered producer of aviation fuel.

Subtitle B—Tax-Exempt Bond Provisions

Sec. 1441. Repeal of $100,000 limitation on unspent proceeds under 1-year excep-tion from rebate.

Sec. 1442. Exception from rebate for earnings on bona fide debt service fund under construction bond rules.

Sec. 1443. Repeal of debt service-based limitation on investment in certain nonpur-pose investments.

Sec. 1444. Repeal of expired provisions.

Sec. 1445. Effective date.

Subtitle C—Tax Court Procedures

Sec. 1451. Overpayment determinations of Tax Court.

Sec. 1452. Redetermination of interest pursuant to motion.

Sec. 1453. Application of net worth requirement for awards of litigation costs.

Sec. 1454. Proceedings for determination of employment status.

Subtitle D—Other Provisions

Sec. 1461. Extension of due date of first quarter estimated tax payment by private foundations.

Sec. 1462. Clarification of authority to withhold Puerto Rico income taxes from sal-aries of Federal employees.

Sec. 1463. Certain notices disregarded under provision increasing interest rate on large corporate underpayments.

TITLE XV—PENSIONS AND EMPLOYEE BENEFITS

Subtitle A—Simplification

Sec. 1501. Matching contributions of self-employed individuals not treated as elec-tive employer contributions.

Sec. 1502. Modification of prohibition of assignment or alienation.

Sec. 1503. Elimination of paperwork burdens on plans.

Sec. 1504. Modification of 403(b) exclusion allowance to conform to 415 modifica-tions.

Sec. 1505. Extension of moratorium on application of certain nondiscrimination rules to State and local governments.

Sec. 1506. Clarification of certain rules relating to employee stock ownership plans of S corporations.

Sec. 1507. Modification of 10-percent tax for nondeductible contributions.

Sec. 1508. Modification of funding requirements for certain plans.

Sec. 1509. Clarification of disqualification rules relating to acceptance of rollover contributions.

Sec. 1510. New technologies in retirement plans.

Subtitle B—Other Provisions Relating to Pensions and Employee Benefits

Sec. 1521. Increase in current liability funding limit.

Sec. 1522. Special rules for church plans.

Sec. 1523. Repeal of application of unrelated business income tax to ESOPs.

Sec. 1524. Diversification of section 401(k) plan investments.

Sec. 1525. Section 401(k) plans for certain irrigation and drainage entities.

Sec. 1526. Portability of permissive service credit under governmental pension plans.

Sec. 1527. Removal of dollar limitation on benefit payments from a defined benefit plan maintained for certain police and fire employees.

Sec. 1528. Survivor benefits for public safety officers killed in the line of duty.

Sec. 1529. Treatment of certain disability benefits received by former police officers or firefighters.

Sec. 1530. Gratuitous transfers for the benefit of employees.

Subtitle C—Provisions Relating to Certain Health Acts

Sec. 1531. Amendments to the Internal Revenue Code of 1986 to implement the Newborns’ and Mothers’ Health Protection Act of 1996 and the Mental

Health Parity Act of 1996.

Sec. 1532. Special rules relating to church plans.

Subtitle D—Provisions Relating to Plan Amendments

Sec. 1541. Provisions relating to plan amendments.

TITLE XVI—TECHNICAL AMENDMENTS RELATED TO SMALL BUSINESS

JOB PROTECTION ACT OF 1996 AND OTHER LEGISLATION

Sec. 1600. Coordination with other titles.

Sec. 1601. Amendments related to Small Business Job Protection Act of 1996.

Sec. 1602. Amendments related to Health Insurance Portability and Accountability

Act of 1996.

Sec. 1603. Amendments related to Taxpayer Bill of Rights 2.

Sec. 1604. Miscellaneous provisions.

TITLE XVII—IDENTIFICATION OF LIMITED TAX BENEFITS SUBJECT TO

LINE ITEM VETO

Sec. 1701. Identification of limited tax benefits subject to line item veto.

Limited Liability Companies

To be completed at a later date. Call if you want a copy of this section.

1997 Tax Law Update

Table Of Contents

Introduction

What We Will Cover Today

HR2014 "Taxpayer Relief Act of 1997". We are not going to discuss how to prepare a tax return or how to compute tax liabilities. I am making an attempt to discuss and cover the subject without discussing numbers, percentages or tax brackets. The coverage is going to be from the manager’s view as much as is possible. The coverage is going to be discussing the details without discussing the number crunching.

The Tax Planning Pyramid

Do not get your priority triange upside down.  You might "find your self behind the 8 Ball"!

Keep your priority triangle "right side up" with placing the most important objectives on the foundation (bottom) of the pyramid (triangle)!

This pyramid places the tax-planning portion in perspective. Tax planning has two foci. One is the compliance issue and one is the controlling of the costs of the tax liability.  When the tax costs and tax liabilities are so small that incurring expenses with the only objective for tax write-offs, being only objecive - the decision maker must consider the prudence of the decision to incur unnecessary expenditures.  When the tax cost is significant, then the decision maker must make prudent business decisions to reduce the costs to an acceptable level.

I make this presentation for the person or persons whose sole intention is to reduce or eliminate the income tax, at the expense of lost opportunities to increase net worth through a broad based operations management.

A broad based operations management will focus on the increasing of liquidity, operations profit and equity.  The broad based manager will use (among other things) planning, monitoring results, adjusting (actions, decisions, policies and procedures), planning for product and service development and quality control, marketing to both new and existing clients and markets, staffing and training, and tax planning.

* Any anticipated business decision must have one or more tests applied in order to determine the feasibility of the proposal. Structuring decisions around Income Tax Legislation is no different. When making a business decision, the decision must be based upon tests other than tax cost. If the tax cost can be reduced with prudent actions, then do so. Do not make rash decisions be structuring a decision based only the tax cost. Whenever making a decision based heavily upon the tax implications, then test cash or checking account balances with and without the decision based upon tax effect.

* Neither tax nor current cash balances are conclusive or sole criteria for making decisions. Please, do not use the income tax savings as the only criteria.

Chapter 1 - 1997 Tax Briefing – New Threats to Wealth? -or- new ARMISTICE agreements?

Income Tax Provisions

Characteristics of Taxpayers Effected

Individuals

Dependent Children < 14

Buying a home – or selling a home

Own stocks, bonds, or other securities

Have or will have an IRA

Will be incurring educational expenses

Child Tax Credit

The Act provides taxpayers with a child tax credit for each qualifying child under 17 years of age. The credit is first available for the 1998 taxable year, and so may be claimed on tax returns to be filed in 1999. For that first year, taxpayers may claim a maximum credit of $400 per qualifying child. The maximum credit increases to $500 for subsequent years. This credit is phased out by $50 for each $1,000 of the taxpayer's modified adjusted gross income ("AGI") in excess of $110,000 for taxpayers filing jointly, $75,000 for single taxpayers, and $55,000 for married taxpayers filing separately. Generally, the credit is limited to tax liability net of credits (other than EIC). However, families with three or more children may be entitled to a credit in excess of tax liability.

To claim the credit, taxpayers are required to provide the name and identification number of the qualifying child on the return.

The rule allowing tax-free employer payments for up to $5,250 of annual education expenses has been retroactively restored and extended through May 31, 2000. The exclusion had expired for courses beginning after May 31, 1997. Unfortunately, graduate courses remain ineligible for this benefit

For 1997, self-employed taxpayers can deduct 40% of their health insurance premiums. In future years, the deductible percentages will be gradually increased as follows: 45% for 1998 and 1999; 50% for 2000 and 2001; 60% for 2002; 80% for 2003 through 2005; 90% for 2006, and 100% for 2007 and later years.

Starting next year, when you use your car for charitable purposes, the mileage deduction will be increased from the current 12 cents per mile to 14 cents.

Education Incentives

HOPE Scholarship and Lifetime Learning Credits

The Act provides taxpayers two new nonrefundable tax credits for payments made for qualified tuition and related expenses (tuition and fees, but not books)for post-secondary education -- the HOPE Scholarship Credit and the Lifetime Learning Credit.

The HOPE Scholarship Credit allows taxpayers to claim a maximum credit of $1,500 (100 percent of the first $1,000 of tuition and fees and 50 percent of the next $1,000 of tuition and fees) for expenses paid on behalf of the taxpayer, the taxpayer's spouse, or a dependent for the first two years of post-secondary education at an eligible institution. The student must be enrolled on at least a half-time basis for at least one academic period during the year for the expenses to be qualified. The HOPE Scholarship Credit applies to expenses paid after December 31, 1997, for education furnished in academic periods beginning after that date.

The Lifetime Learning Credit allows taxpayers to claim a maximum credit equal to 20 percent of up to $5,000 of expenses ($10,000 beginning in 2003) incurred during the taxable year for qualified tuition and fees for eligible students for post-secondary education, including any course of instruction to acquire or improve job skills. The Lifetime Learning Credit applies to expenses paid after June 30, 1998, for education furnished in academic periods beginning after that date.

Both credits limit qualified expenses to the expenses of the taxpayer, the taxpayer's spouse, or a dependent of the taxpayer. Additionally, both credits are phased out for taxpayers with modified AGI between $40,000 and $50,000 (between $80,000 and $100,000 for joint filers). For each qualifying student, taxpayers must choose to claim either the HOPE Scholarship Credit, the Lifetime Learning Credit, or the exclusion for certain distributions from an education IRA for the taxable year. They cannot claim more than one of these benefits for a student for any year.

To claim the credits, taxpayers are required to provide the name and taxpayer identification number of the student on the return. Educational institutions are required to report information related to higher education tuition and related expenses, including refunds of such expenses, paid during the taxable year.

The Act also creates a new educational funding vehicle, called an Education Individual Retirement Account (education IRA), for the purpose of paying the qualified higher education expenses of a designated beneficiary. Qualified higher education expenses include tuition, fees, books, supplies, equipment, and room and board. Contributions are non-deductible, and earnings on the amount held in the IRA will be non-taxable until distributed. Annual contributions are limited to $500 per beneficiary under the age of 18. The contribution limit is phased out as a taxpayer's modified AGI increases from $95,000 to $110,000 ($150,000 to $160,000 for joint returns).

Distributions from an education IRA are excludable from income to the extent the amount does not exceed the qualified higher education expenses of the eligible student during the year. If the distribution from the education IRA exceeds the qualified higher education expenses, only a portion of the distribution is excludable. In addition, distributions not used for higher education are subject to a 10 percent addition to tax. The Act requires any balance remaining in an education IRA at the time a beneficiary becomes 30 years of age to be distributed and taxed to the beneficiary (and subject to the 10 percent addition to tax). However, the balance may be rolled over tax free to another education IRA benefiting another family member. This provision is effective for taxable years beginning after December 31, 1997.

Deduction for Interest on Education Loans: The Act provides an above-the-line maximum deduction for up to $2,500 of interest paid by taxpayers on qualified education loans. The $2,500 limit is phased in over 4 years (i.e., the maximum deduction is $1,000 in 1998, $1,500 in 1999, $2,000 in 2000, and $2,500 in 2001). Taxpayers may take a deduction on qualified education loans for the benefit of the taxpayer, the taxpayer's spouse, or any dependent of the taxpayer as of the time the indebtedness was incurred. Deductions are allowed only for the first 60 months that interest payments are required. The deduction is phased out for taxpayers with modified AGI between $40,000 and $55,000 ($60,000 and $75,000 for joint filers). Married taxpayers must file jointly to take the deduction, and the credit may not be claimed on the return of anyone who is claimed as a dependent on another person's return. This provision is effective for interest due and paid after December 31, 1997.

Starting next year, a new deduction will be allowed for interest paid on qualified education loans regardless of whether the taxpayer is able to itemize deductions. However, the deduction is limited as follows: $1,000 for 1998; $1,500 for 1999; $2,000 for 2000; and $2,500 for 2001 and later years. Also, only interest paid during the first 60 months that interest payments are required under the terms of the loan qualify for the deduction.

A qualified loan is one incurred to pay qualified higher education expenses of the taxpayer, his or her spouse, or any dependent individual. The deduction is phased out between AGI of $60,000 and $75,000 for joint filers and between $40,000 and $55,000 for other taxpayers (except that the deduction is not available to married taxpayers who file separate returns).

Prepaid Tuition Plans

Last year's legislation included tax breaks for contributions to qualified prepaid state tuition programs. The Act retroactively expands the break to cover contributions to pay for room and board as well as tuition and fees.

Individual Retirement Accounts

Under the Act, the AGI phase-out ranges for deductible IRAs of active participants in employer-sponsored retirement plans will increase annually beginning in 1998 until they reach double the current phase-out ranges in 2007. In 2007, the phase-out ranges will be between $50,000 and $60,000 for single filers and between $80,000 and $100,000 for married taxpayers filing jointly, double the current ranges of $40,000 to $50,000 for married couples filing jointly, and $25,000 to $35,000 for single filers. An individual is not an active participant in an employer- sponsored retirement plan merely because the individual's spouse is an active participant. However, in such cases, the individual's deductible amount is phased out for married couples with AGI between $150,000 and $160,000.

The new legislation expands the circumstances under which you may make tax-deductible contributions to your traditional IRA. This legislation is effective for taxable years beginning on or after January 1, 1998.

With this new legislation, you may make a fully deductible contribution to an IRA, regardless of your spouse's participation in an employer-sponsored plan, if:

Increasing the Income Limits for Full Deductibility of Your Contributions

Currently, active participants in an employer sponsored retirement plan cannot make fully deductible IRA contributions unless their adjusted gross income is less than $25,000 for individuals and $40,000 for couples. Under the new legislation, income caps for full deduction of IRA contributions will be gradually increased to $50,000 for individuals and $80,000 for couples.

Starting next year, an individual who is not an active participant in a qualified retirement plan (such as a nonworking spouse or an employed spouse who isn't covered by a pension plan) can contribute and deduct up to $2,000 to an IRA, even though the other spouse is an active participant

Starting next year, parents can establish education IRAs for each child and make annual nondeductible contributions of up to $500 to each. This privilege is above and beyond your ability to make contributions to traditional and Roth IRAs. Earnings on education IRA funds will be allowed to accumulate tax-free, and tax-free withdrawals can be made to pay for undergraduate or graduate education expenses for tuition, books, and room and board.

The ability to make contributions is phased out between AGI of $150,000 and $160,000 for joint filers and between $95,000 and $110,000 for single taxpayers. In addition, contributions cannot be made after the child reaches age 18. Subject to the preceding limitations, grandparents and others can establish education IRAs to benefit grandchildren and other designated individuals.

Starting next year, withdrawals from traditional IRAs can be taken to pay for qualified higher education expenses of the taxpayer, or his or her spouse, dependent child, or grandchild without having to pay the 10% penalty tax that generally applies to withdrawals before age 59½. However, these withdrawals will still be subject to the "regular" federal income tax and the AMT, if applicable. Qualified expenses include tuition, fees, books, room and board, and equipment required for enrollment or attendance at an eligible educational institution.

In addition, penalty-free withdrawals from traditional IRAs can be taken to help finance a first-time home purchase for the taxpayer; his or her spouse; or a child, grandchild, or ancestor of the taxpayer or his or her spouse. There is a $10,000 lifetime limit on withdrawals for this purpose. This change is also effective starting next year.

The legislation creates the new Roth IRA (IRA Plus) where all contributions are non-deductible and earnings can grow tax-free! Some of the features of this new IRA include:

Contribution Eligibility

Maximum Annual Contribution

Tax Deductibility of Contributions

Tax Treatment of Earnings

Tax Treatment of Withdrawals

Minimum Distribution Requirements

The Act provides for a new individual retirement account beginning in 1998 called a "Roth IRA". Key features are:

A "qualified distribution" is a distribution:

No payment can be a qualified distribution unless it is made after the 5-taxable-year period beginning with the taxable year in which the taxpayer first contributed to a Roth IRA.

Annual contributions to the Roth IRAs are limited to $2,000 less the taxpayer's deductible IRA contributions. Unlike deductible IRAs, there is no prohibition on making contributions after attaining age 70½. The $2,000 limit is phased out as AGI increases from

1. $150,000 to $160,000 in the case of a married couple filing jointly or

2. $95,000 to $110,000 in the case of a single filer.

Amounts in deductible IRAs may be transferred to Roth IRAs provided the taxpayer's AGI for the transfer year is $100,000 or less. Transferred amounts are includible in income but exempt from the early withdrawal tax. If the transfer occurs in 1998, income from the transfer is spread out over four years (i.e., 1/4th of the transferred amount is includible in 1998, 1999, 2000 and 2001). No payments allocable to the transferred amounts can be a qualified distribution unless it is made more than 5 years after the transfer.

Currently, any withdrawals from IRAs are generally subject to income taxes. A withdrawal may also be subject to a 10% early withdrawal penalty if the individual is under age 59½. Under the new legislation, an individual may make a penalty-free withdrawal from either the traditional IRA or the new Roth IRA for qualified first-time home purchase (up to $10,000) or for qualified higher education expenses. Note, however, that while a qualified higher education distribution from a Roth IRA would be penalty free for an individual who is under age 59½, it would not be tax-free.

Beginning in 1997, certain employers can set up SIMPLE retirement plans. A SIMPLE plan can be set up by an employer who had no more than 100 employees who received at least $5,000 in compensation from the employer last year. Generally, the SIMPLE plan must be the only retirement plan of the employer. The employers that qualify are:

SIMPLE plans are written qualified salary reduction arrangements that allow an employee to elect to reduce his or her compensation by a certain percentage each pay period and have the employer contribute the salary reductions to the SIMPLE plan on behalf of the employee. For 1997, the amount of the employee's salary reductions cannot exceed $6,000. Employers are also required to make contributions to the SIMPLE plan on behalf of eligible employees. Contributions to a SIMPLE plan are not subject to income tax until they are distributed.

SIMPLE plan can be set up either as an IRA or as part of a qualified cash or deferred arrangement (401(k) plan). SIMPLE plans are not subject to the nondiscrimination rules that generally apply to qualified plans. For more information on this new plan, get Publication 560, Retirement Plans for the Self-Employed.

Item

Contribution Eligibility

Individuals; phaseouts apply

Maximum Annual Contribution

Tax Deductibility of Contributions

Tax Treatment of Earnings

Tax Treatment of Withdrawals

Minimum Distribution Requirements

Home Office Deduction Rules Eased

Effective in 1999, home office expenses can be deducted as long as the office is used regularly and exclusively to perform substantial administrative or management functions (such as billing customers) and no fixed space is available at work locations. Deductions will be allowed even when the income-earning activities of the business take place elsewhere. This change effects a much-needed but delayed repeal of the Supreme Court's infamous Soliman decision which disallowed deductions for many self-employeds on the grounds that their home offices did not qualify as the "principal place of business."

CAPITAL GAINS

The tax on the sale of a long-term capital gain asset is now 20% in place of the previous 28%. For individuals in the 15% tax bracket, the rate is now 15%. Therefore, one of the gripes that have been widely promoted by the various mass media has been answered. The capital gains tax has been structured to all tax brackets.

Person Opinion: The capital gains tax was not structured to help only the wealthy. The individual married filing jointly moves out of the 15% tax bracket at $41,200. It is at this bracket for 1997 that the 28% tax rate is in effect. Whenever retirees received lump sum payments from retirement plans, took early retirement etc. the amounts, unless rolled over have exceeded that same amount. Usually, the sale of a personal residence did not produce a large gain for those outside metropolitan or heavily populated areas. Even with those factors, usually it has been very easy to be taxed at he 28% rate. Therefore, unless family and other income has been less than the $41,200 the family has been consider wealthy by the media. If a wife earns $20,600 and the husband earns $20,600 — there is by media definition a wealthy family. Even in an economically disadvantaged community, this is not a wealthy family. This family qualifies for the capital gain advantages. However, with the new law, we find an attempt to make this advantage available to all families, regardless of the tax bracket. Definitely more fair. However — the capital gain reduced rate can help each family. The advantage must be retained in the law. Do not let it be eliminated because the mass media publicizes it is only for the wealthy. Keep the benefit!

For individuals, the maximum tax rate on net capital gain from sales or exchanges occurring after May 6, 1997, will be reduced to:

1. A maximum tax rate of 20 percent for sales made after May 6, 1997, if the property had been held for more than 18 months at the time of sale. This 20 percent rate also is available for property sold after May 6, 1997, and before July 29, 1997, if the property had been held for more than 12 months (even if it had not been held for 18 months).

1. A maximum tax rate of 18 percent for sales of property acquired after December 31, 2000 that had been held for more than 5 years at the time of the sale.

2. 25 percent for real estate depreciation recapture treated as capital gain.

The current 28 percent maximum capital gain rate will continue to apply to

1. sales of collectibles,

2. sales before May 7, 1997, and

- Continue to next page -

The following table of tax consequences of the sale of capital assets will assist in the decision process:

Type of Asset

Date sold

Period Held

Maximum Tax Rate

ó Note regarding the above table: Accelerated or Accel and Depr or Depreciation refer to the excess of accelerated depreciation write-off in excess of the straight line depreciation claimed during periods prior to May 7^th, 1997. The terms All Depreciation or ALL Depr applies to depreciation claimed after May 6^th, 1997. The alternative minimum tax structure is revised to assure that the reduced maximum capital gains rate will not result in the imposition of AMT, merely because of the rate differential.

The Act allows taxpayers to exclude up to $250,000 of gain ($500,000 for married couples filing a joint return) realized on the sale or exchange of a principal residence occurring after May 6, 1997. Unlike the "one time" exclusion provided under prior law, the exclusion is allowed each time a taxpayer sells or exchanges a principal residence, although the exclusion generally may not be claimed more frequently than once every two years. In addition, unlike prior law, the taxpayer is not required to reinvest the sales proceeds in a new residence to claim the exclusion. To be eligible, the residence must have been owned and used as the taxpayer's principal residence for a combined period of at least two years out of the five years prior to the sale or exchange. The taxpayer must recognize gain to the extent of any depreciation allowable with respect to the rental or business use of such principal residence for periods after May 6, 1997.

Estate Taxes

Beginning in 1998, the unified estate and gift tax credit will increase annually, until the maximum value of estates exempt from tax reaches $1 million in 2006. The current limit is $600,000.

Beginning in 1999, the $10,000 annual exclusion for gifts, the $750,000 ceiling on special use valuation, the $1 million generation-skipping transfer tax exemption, and the $1 million ceiling on the value of a closely-held business eligible for the special low interest rate will all be indexed annually to reflect inflation. The provisions apply to estates of taxpayers dying and to gifts made after December 31, 1997.

Beginning in 1998, executors may elect special estate tax treatment for qualified "family-owned business interests" if these interests comprise more than 50 percent of a decedent's estate and certain other requirements are met. Because the Act limits the combined value of this credit and the unified estate and gift tax credit to $1.3 million, the amount of this exclusion that will be available each year will decrease as the value of the unified credit increases during its phase-in period. In 1998, the provision will exclude up to $675,000 of value in qualified family-owned business interests from a decedent's taxable estate (i.e., $1.3 million minus the $625,000 unified credit available in 1998).

Estimated Tax Payments

One way an individual can avoid a penalty for underpayment of estimated tax is to make quarterly payments based on the tax for the prior year. The act modifies the 110 percent-of-prior-year's-tax exception, according to the following table:

PRIOR-YEAR'S TAX SAFE HARBOR

Year Prior Year's Tax Required

1997 110%

1998 100%

1999-2001 105%

2002 112%

2003 and after 110%

In addition, effective for tax years after 1997, the act raises from $500 to $1,000 the threshold of total tax liability for the imposition of a penalty for underpaying estimated tax. (Act sections 1091 and 1202; section 6654)

An individual generally does not have an underpayment of estimated tax if he or she makes timely estimated tax payments at least equal to:

Effective date.--The $1,000 provision is effective for taxable years beginning after December 31, 1997. The remainder is true for 1997 and forward.

Understanding MSAs

To understand MSAs, you will want to know what an MSA is and what the benefits are of having one. You will also need to know whether you meet the rules for starting an MSA. If you meet the rules, then you will want to read the section titled Setting Up the Account.

What is an MSA? An MSA is a tax-exempt trust or custodial account with a financial institution (like a bank or an insurance company) where you can save money for future medical expenses. This account must be used in conjunction with a high deductible health plan. See High Deductible Health Plan, later.

What are the benefits of an MSA? You may enjoy several benefits from having an MSA: The interest or other earnings on the assets in your MSA are tax-free. You can have a tax deduction without having to itemize your deductions on Form 1040.

Corporations Both C and S Corporations Alt Min Tax

In general, the alternative minimum tax computations have been simplified for the small corporation.

Depreciation Changes made by the act will reduce the impact of the corporate alternative minimum tax (AMT) for some corporations, particularly those in capital-intensive industries. Specifically, effective for assets placed in service after 1998, regular-tax depreciation lives will be used for AMT purposes. There will still be an AMT depreciation adjustment for such assets, however, because the AMT method is different than for regular tax purposes. Moreover, the recordkeeping burden of the AMT is largely unaffected by this change. (Act section 402; section 56)

Small business corporations. For tax years beginning in 1998, certain small business corporations are effectively exempt from the corporate AMT. To qualify, a "small business" must have average gross receipts of $5 million or less for the three years prior to its 1998 tax year. To continue to qualify after 1998, or to qualify as a small business for the first time, a company's three-year average gross receipts cannot exceed $7.5 million. Corporations qualifying for the exemption will not be subject to any of the multiple calculations or recordkeeping requirements of the AMT system. However, businesses that fail to qualify in a later tax year will have to apply the AMT rules to transactions, income, and deductions arising in and after that nonqualifying year.

Qualifying small business corporations with unused minimum tax credits after 1997, that would otherwise be available to offset regular tax in excess of tentative minimum tax (TMT), are subject to a new credit-utilization limitation. Because the tentative minimum tax of a small business corporation will be zero, the maximum credit available generally will be 75 percent of regular tax. This change will significantly accelerate a corporation's ability to use available minimum tax credits. (Act section 401; section 55)

S Corporations

No major legislation was specific to S Corporations.

Partnerships

'Hot assets.' A new rule applies to a partner who is considered to dispose of a partnership's ordinary-income assets in connection with a sale or exchange of a partnership interest. Specifically, the partner no longer can avoid ordinary income recognition merely because certain "hot assets" of the partnership have not appreciated significantly in value.

Previously, gain on the sale or exchange of a partnership interest was treated as capital gain unless the partnership owned unrealized receivables (including depreciation recapture assets) and substantially appreciated inventory items. For these purposes, inventory includes all partnership assets that are not capital assets or section 1231 property, as well as traditional inventory items.

As a general rule, inventory items are treated as substantially appreciated only if their value is more than 120 percent of their basis. This rule will continue to apply to partnership distributions that cause a shift in the ownership of assets among partners. However, generally effective for sales or exchanges of partnership interests occurring after August 5, 1997, all inventory items are treated as "hot assets," regardless of whether they are substantially appreciated. A binding contract exception applies to transactions that occur after August 5, 1997, pursuant to a binding contract in effect on June 8, 1997. (Act section 1062; section 751)

Basis-allocation rules modified. Opportunities to create artificial tax losses or accelerate depreciation deductions through certain partnership distributions are significantly reduced for property distributed after August 5, 1997. When a partnership makes certain property distributions (e.g., a liquidating distribution), substitute basis rules apply, so that the basis of the assets in the hands of the distributee partner is determined by reference to the basis of the distributee's partnership interest.

Under prior law, the allocation of such basis among distributed assets was generally based on the distributed property. The modified basis rules included in the act generally require that any difference between the aggregate basis of the distributed property and the basis of the distributee partner's interest in the partnership (after taking into account cash distributions) be allocated among such assets first in a manner that reduces the differences between such assets' tax basis and their fair market value (except that the basis of unrealized receivables and inventory items cannot be increased). Any remaining difference is allocated based on the assets' relative fair market values. While these changes reduce opportunities to generate tax losses, the new law does not impose a fair market value "cap" on the basis that may be assigned to distributed property. As a result, there will still be opportunities to create artificially high basis in distributed property in certain situations. (Act section 1061, section 732(c))

Precontribution gains. New holding-period requirements will make it more difficult to use "mixing bowl" transactions to shift built-in gain or loss associated with one piece of property into other property. In these transactions, the owner of property contributes the property to a partnership and subsequently receives other property from the partnership in liquidation of its interest. The substitute-basis rules described earlier are used to shift the built-in gain or loss associated with the original property into the distributed property.

Previously, a distribution of property other than the contributed property to the contributing partner or distributions of the contributed property to a partner other than the contributing partner would generally trigger gain or loss unless the distribution was made at least five years after the contribution. The new law extends, to seven years, the "waiting period" between the date of contribution of property and the date of such property distributions in order to avoid triggering the built-in gain or loss recognition. This provision is effective for property contributed to a partnership after June 8, 1997. A transition rule applies to binding contracts in effect on June 8, 1997, and at all times thereafter.

As a result of these changes, taxpayers engaging in mixing-bowl transactions will need to wait an additional two years to complete the transaction to avoid triggering the built-in gain or loss on the contributed property. (Act section 1063; sections 704(c)(1)(B), 737(b)(1))

Large-partnership simplification. Several sets of provisions simplify tax reporting for electing large partnerships and their partners. The rules, which are effective for tax years beginning in 1998, have several objectives:

Reduce the number of items required to be separately stated on Schedule K-1. For example, income or loss from all passive activities of the partnership are combined into a single activity; all tax preferences are combined into a single line item; and capital gains and losses are netted at the partnership level, with short-term capital gains in excess of short-term capital losses added to ordinary income rather than being reported separately.

Provide simplified audit procedure rules for large partnerships. The most significant change to the audit procedure rules allows a partnership to generally report audit adjustments as additional distributive share items in the year the adjustment is imposed, rather than the year to which the adjusted item relates (i.e., the current-year partners pay any additional tax relating to the adjustment even if it relates to a tax year in which they were not a partner).Alternatively, the partnership may elect to pay the tax at the entity level, on behalf of the partners, rather than flowing the adjustment through on the partners' Schedules K-1. In either situation, the partnership is liable for any interest and penalties associated with the adjustment. If the partnership is no longer in existence at the time the adjustment is made, the adjustment generally must be taken into account by the former partners, based on future regulations.

Moratorium on Limited Partner SE Tax Regulations

The Treasury Department has issued two sets of proposed regulations attempting to deal with the issue of when the self-employment (SE) tax applies to limited partners and LLC members. Both sets have proven to be controversial because many commentators interpreted them as increasing taxes without the benefit of legislation. Now Congress has prohibited the release of any temporary or final regulations on the subject before 7/1/98. This effectively ensures that taxpayers will not be required to follow any Treasury or IRS guidance issued before that date.

Miscellaneous Business Provisions

Effective in 1998, employers can give employees the option of receiving tax-free monthly parking allowances up to $170 (adjusted for inflation) or equal amounts of additional taxable cash compensation. Under current rules, giving employees this option would make the parking allowances count as additional taxable compensation.

Effective for tax years beginning after August 5, 1997, net operating losses (NOLs) will generally be able to be carried back two years or forward 20 years (versus three and 15 years under current rules). However, the three-year carryback rule is retained for certain casualty losses and small business and farming losses attributable to presidential declared disasters. For tax credits arising in tax years beginning after 1997, the carryback period will be one year and the carryforward period will be 20 years (versus three and 15 years under current law).

Effective for property placed in service after August 5, 1997, use of the income forecast depreciation method will be limited to films, videotapes, sound recordings, copyrights, books, patents, and other property specified in regulations.

Effective for property placed in service after August 5, 1997, qualified rent-to-own property will be classified as three-year property for depreciation purposes. Use of the income forecast method of depreciation for such property will be prohibited.

Taxpayers will be permitted to use estimates in determining write-offs for inventory shrinkage costs—effective for tax years ending after August 5, 1997.

For partnership distributions after August 5, 1997, the basis of distributed property will be allocated to more closely reflect the fair market value of the property at the time of distribution.

For sales of partnership interests after August 5, 1997, gain will be treated as ordinary income to the extent of the selling partner's share of inventory appreciation. Under prior law, the ordinary income rule applied only when the partnership's inventory was worth more than 120% of its basis.

When partnership property is distributed to partners following contributions of appreciated property, taxable gain may be triggered to the contributing partner(s) under certain circumstances. Under prior law, the gain recognition rules applied only when distributions occurred within five years of the contribution of appreciated property. For property contributions after 6/8/97, the five-year rule is replaced by a seven-year rule—thus making it more likely the gain recognition rules will apply.

Partnerships with 100 or more partners will be able to elect to use simplified procedures to report required tax information to partners (for example AMT adjustments, passive activity information, and oil and gas depletion). Electing large partnerships will be required to furnish tax information to their partners by March 15th of the following year. In addition, electing large partnerships will be subject to streamlined IRS audit procedures. The changes are effective for partnership tax years ending on or after 12/31/97.

For partnership taxable years beginning after 1997, the death of a partner will close the partnership year with respect to that partner. Under current rules, the partnership year remains open, which results in 100% of partnership income or loss for the year of death being included in the estate income tax return or the return of the heir who holds the partnership interest at year-end.

Chapter 2 — Interesting Current Proposals

Burden of Proof Legislation

Internal Revenue Service Accountability Act

From the Tax Analysts Section:

After nearly two years of debate on the IRS's future, the House of Representatives last week approved almost unanimously the most sweeping changes to the agency in half a century.

The House voted 426-4 November 5 to place the IRS under the control of a mostly private sector board of directors, fundamentally alter the congressional oversight process of the IRS, and give the IRS commissioner greater flexibility to hire and fire personnel.

The IRS Restructuring and Reform Act of 1997 (H.R. 2676) also shifts the burden of proof to the IRS in judicial civil tax cases and makes long-awaited changes to innocent spouse laws, global interest netting differential, and equitable tolling. A package of technical corrections to the Taxpayer Relief Act of 1997 is attached to the bill.

A jubilant Rep. Rob Portman, R-Ohio, who co-chaired the bipartisan congressional commission on restructuring the IRS and steered the legislation to the House floor, called the vote "historic." He said he was pleased with its overwhelming approval. "I thought we'd get 400 [votes]," he told Tax Analysts. The near unanimous support proves that "this is a good bill," he said.

However, Portman acknowledged his effort was far from over. Even as the House was debating the bill, House Speaker Newt Gingrich, R-Ga., was naming the Ohio taxwriter to head a new panel that would continue monitoring the IRS and begin work on a second IRS restructuring bill in 1998.

As the bill steamrolled through the House, attention turned to the Senate, where Finance Committee Chair William V. Roth Jr., R- Del., reasserted his prerogative to move slowly on IRS legislation. Roth is determined to peg IRS reform to issues raised during his panel's September hearings on agency abuses of taxpayers. A committee spokeswoman said there is not enough time this congressional session to adequately address those issues.

"It would not be fair to American taxpayers to rush to pass something and then find that it is inadequate in its solutions," Roth said. He pledged to "act on a comprehensive IRS reform and restructuring bill next spring."

Senate Democrats responded with a letter to Senate Majority Leader Trent Lott, R-Miss., calling on the upper chamber to act before the end of the session. "In the Senate, well over thirty Senators -- including a majority of the Senate Finance Committee -- have cosponsored [IRS reform] legislation" similar to the House- passed bill, according to the letter, signed by 42 Democrats. "Any delay in taking up the IRS reform legislation will hurt American taxpayers. We urge you to take up IRS reform legislation before the end of the year."

Senate Minority Leader Tom Daschle of South Dakota told reporters "the Senate could pass that bill today -- if Sen. Lott would schedule the vote." Sen. J. Robert Kerrey, D-Neb., vowed to attach the bill to any piece of legislation he could, a strategy he first announced a week earlier during debate over tax- preferred education savings accounts.

With its vote, the House closed a significant chapter in the ongoing saga of IRS reform. The bill's nucleus can be traced to 1995, when Kerrey got the National Commission on Restructuring the IRS created in connection with the fiscal 1996 IRS budget. Although modified in some ways, the legislation is remarkably similar to the package of 50-plus recommendations made by the restructuring commission.

The passage of IRS reform became imminent after an 11th hour about-face of the Clinton administration, which dropped its staunch philosophical opposition to the bill on October 22. Administration officials tried to explain their reversal of position by saying enough changes had been made in the legislation's wording to make it more palatable to Treasury officials. House Ways and Means Committee Chair Bill Archer, R-Texas, said however that none of the changes in his version of the bill were intended as concessions.

The administration's concerns lingered with the four Democrats who voted against the bill. They included Ways and Means members Fortney Pete Stark and Robert T. Matsui, both of California, and Jim McDermott of Washington, as well as Steny H. Hoyer of Maryland, the ranking member of the House Appropriations Subcommittee on Treasury, Postal Service, and General Government.

Hoyer told Tax Analysts the four voted no to make a point. "I could have voted for this bill," said Hoyer, whose subcommittee funds the IRS. He complained that the bill obscures the "substantial progress" the agency has made in the last couple of years and adds "management confusion" with its new governance structure.

On the House floor, Hoyer criticized Congress for whipsawing the IRS and admonished his colleagues to act more consistently. "If you're not for IRS reform on appropriations bills and tax bills, you are not for reform," the Maryland Democrat said.

In light of Roth's determination to reflect his September hearings on IRS abuses in a Senate IRS reform bill, Hoyer conceded that "this is the best the bill's going to be." That underscored the possibility that Roth would change the bill so much that the Clinton administration would once again reverse its position and reiterate its previous objections.

Outlook

Roth is determined to put his signature on IRS reform. His staff said he intends to do so in part by extending the independence of the 11-member board of directors, which had been a major flash point for Treasury officials who objected to congressionally driven reform.

Further, Roth has indicated he has reservations about the burden of proof provision. After the Finance Committee's hearings on IRS abuses, a committee spokeswoman said the chairman was concerned that shifting the burden of proof would make revenue agents more intrusive.

Last week, the spokeswoman signaled a shift from the senator's previous position. "The senator is going to look at [burden of proof]," she said. "He has indicated he might want to strengthen it."

The shift came as House Ways and Means Chair Archer said last week that he would fight to keep the burden of proof shift in the bill. "We will very strongly insist on that provision," Archer said.

Roth's spokeswoman said there are "many areas" in the House bill that Roth wants to build on or modify. For example, Roth may want to extend to the board authority under section 6103 to investigate confidential taxpayer matters, to ensure that it is independent. "If they have a board, it needs to be an independent check on the agency," she said.

When asked whether a change of that magnitude would re-ignite Clinton administration opposition to the legislation, the spokeswoman sighed. "C'est la vie," she said.

Portman told Tax Analysts he did not think Roth would ultimately kill the IRS reform effort by adding provisions that are offensive to the administration.

"There are ways to strengthen and improve the legislation," he said. That includes the agency governance provisions, Portman added. He did say that Charles O. Rossotti, whom the Senate confirmed on November 3 to be the next IRS commissioner, would be better served in his new job with the tools afforded him in the IRS Restructuring and Reform Act of 1997.

Rep. Benjamin L. Cardin, D-Md., said he "welcomed any improvement by the Senate in the legislation." He also predicted the bill on the Senate side will look very similar to the bill passed by the House.

Portman told reporters he expects some bumps along the way while the Senate debates the bill. But overall, he said, there is "too much momentum for the bill to stop."