IRS Restructuring, Reform Act
Includes Some Tax Provisions

By Jose G. Peña
Extension Economist

Since more than half of the year is behind us and even though agricultural income in Texas will be sparse this year due to the drouth and losses to excessive rain in August, it becomes important to start to review income tax needs as early as possible to be able to take advantage of any new provisions.

The Internal Revenue Service Restructuring and Reform Act of 1998 was passed into law in July 1998. Although this law addresses an internal reorganization of the Internal Revenues Service, the primary purpose of this complex new law was to provide many needed technical corrections to the Taxpayer Relief Act of 1997. The new law contains only a few new beneficial provisions.

Most notable, this new bill makes important changes to the concept of tax accountability, such as shifting the burden of proof to the IRS, extending attorney-client privilege to accountants and enrolled agents, facilitating more liberal compromise procedures, and introducing interest, penalty and innocent spouse relief. Thus, the many provisions in this law may focus more on practitioners and their need to understand the new rules laid out to deal with the IRS, which will be different than in the past.

In terms of new benefits, probably the biggest change in this new law is that the capital gains holding period was reduced to 12 months, down from 18 months.

Capital Gains

If property was held for 18 months or more, the TaxPayer Relief Act of 1997 lowered capital gains tax rates for individuals from 28 percent to 20 percent (10 percent rate for taxpayers in the 15 percent marginal rate); provided a 25 percent maximum tax rate for the long-term capital gain tax attributable to real estate depreciation; allowed a tax free "roll-over" of the gain from the sale of qualified small business stock held more than six months by an individual to other qualified small business stockholders; and beginning in 2001, a capital gains tax rate of 18 percent (eight percent for taxpayers in the 15 percent marginal rate) will apply to certain property held more than five years.

This new law reduces the 18-month holding period required under the Taxpayer Relief Act of 1997 to 12 months. Thus, in tax years ending after 1997, capital gains on most property held more than 12 months (rather than more than 18 months) will be eligible for the 10, 20- or 25-percent capital gains rates introduced in the 1997 Act.

With regard to tax-free roll-overs of qualified small business stocks, the new law clarifies the qualification rules and allows "a taxpayer other than a corporation" i.e. partnership and S corporations, to take advantage of this provision.

There are many complex provisions in the over 800-page IRS Restructuring and Reform Act of 1998. The following is a brief summary of some of the technical corrections.

• Roth IRA. The rules covering the conversion of regular IRAs into Roth IRAs were clarified to prevent the 10 percent early withdrawal tax on pre-mature, unqualified withdrawals; allow taxpayers to "undo" Roth IRA conversions (if later found not to qualify); and address the tax treatment of converted IRA's during the four-year tax payment spread period if the owner dies during the four-year period.

• Student Loan Interest. Individuals are allowed to deduct interest paid on qualified education loans beginning in 1998.

• Sale of Principal Residence. The $250,000 exclusion ($500,000 for certain joint filers) of gain on the sale or exchange of a principal residence is pro-rated for taxpayers who do not meet the two-year ownership and use requirements in the case of sales or exchanges attributable to a change in place of employment, health, or unforeseen circumstances.

• Family-Owned Businesses. The qualified family-owned business interest (QFOBI) exclusion which, in combination with the applicable exclusion amount, shields a maximum of $1.3 million from the estate tax, has been converted into a deduction. The deduction is not available for gift tax or generation-skipping transfer tax purposes.

• Deferred Compensation. Employers can deduct accrued vacation or severance pay in a particular year only if those amounts are actually received by their employees on or before two and a half months after the close of the tax year.

• Employer-Provided Meals. Where more than half of the employees receiving employer-provided meals on work premises are furnished those meals for the convenience of the employer, all meals furnished to employees at the employer's place of business are treated as provided for the convenience of the employer.

• Fuel Tax Refunds. The refund procedures for all taxable motor fuels have been combined, effective October 1, 1998. Once taxpayers have paid a single $750 minimum amount of motor fuel excise taxes for fuel used for a nontaxable purpose, they can file refund claims using the simplified procedures.