Spousal IRA Deduction
Under prior law, deductible IRA contributions on behalf of a non-working spouse were limited to $250. For tax years beginning after December 31, 1996, non-working spouses may generally contribute up to $2,000 per year to a deductible IRA. This amount is proportionately reduced if the working spouse is an active participant in an employer-sponsored retirement plan and earns over $40,000, and it is completely phased out if the working spouse has $50,000 of income. Other limitations on deductible IRA's continue to apply.
Penalty-Free Distributions from Ariz for Payment of Certain Medical Expenses and Health Insurance Premiums. Commencing with distributions subsequent to 1996, the 10% penalty tax on early distributions from qualified retirement plans will no longer apply to distributions from an IRA used to pay medical expenses of a taxpayer and his or her spouse and dependents in excess of 7.5% of adjusted gross income. Further, the 10% penalty tax will not apply to distributions from certain terminated employees' IRAs used to pay health insurance premiums for the taxpayer and his or her spouse or dependents, subsequent to the taxpayers's separation from employment.
Long-Term Care Costs/Insurance. Unreimbursed Long-Term Care Costs. Unreimbursed long-term care expenses will be treated as medical expenses so long as the services are not provided by a relative.
Generally, long-term care insurance contracts issued subsequent to 1996 will be treated as accident and health insurance contracts for tax purposes. As a result of this change, taxpayers will have the following new tax benefits:
Exclusion of Employer Paid Premiums. The cost of employer provided long-term care insurance will be excluded from the insured's income. However, employer provided long-term care insurance premiums will not be excludable from the employee's income if provided through a cafeteria plan or other flexible spending arrangement.
Certain Expenses Deductible for Self-Employed Taxpayers. The deduction for health insurance premiums (see below) also will apply to long-term care insurance premiums. The annual amount of such premiums that may be deducted is limited based on the age of the insured.
Amounts Received Under Contracts Excluded. Amounts received under certain long-term care insurance contracts are excludable from income. However, the exclusion from income on per diem contracts is capped at $175.00 per day (this amount will be indexed for inflation subsequent to 1997).
The long-term care insurance provisions apply generally to contracts issued after December 31, 1996. However, certain contracts issued prior to January 1, 1997 that meet state long-term care insurance requirements when issued will be treated as long-term care insurance contracts.
Health Insurance Deduction for Self-Employed Individuals. Commencing in tax years beginning in 1997, the deduction for health insurance premiums of self-employed individuals and their spouses and dependents will be increased from 30% to 80%. The increase is phased in from 1997 through 2006 according to the following table:
Tax Year Beginning In: Percentage Deduction
1997 40%
1998 through 2002 45%
2003 50%
2004 60%
2005 70%
2006 and thereafter 80%
The increase in the health insurance deduction is available to self-employed individuals as well as individuals who are general partners (and limited partners receiving guaranteed payments), members of limited liability companies or shareholders owning more than 2% of the outstanding stock of S corporations.
Required Distribution Date Modified for Certain Participants in Qualified Plans. Participants in qualified plans (excluding IRAs), other than 5% owners, will no longer be required to commence distributions after attaining 70½ so long as they are still employed and the plan expressly provides for this deferral of distribution. Under the new law, qualified plans can provide that distributions must commence on or before April 1 of the calendar year following the later of (1) the year in which the employee attains age 70½; or (2) the calendar year in which the employee retires. The modified distribution rules are effective for years beginning subsequent to December 31, 1996. However, the Conference Report clarifies that a qualified plan may allow a participant who is currently receiving distributions to elect to stop such distributions until required to begin distributions under the new rule.
Suspension of Tax on Excess Distributions From Qualified Plans. The new law provides that the 15% excise tax on excess distributions (those distributions exceeding $155,000 per year or lump sum distributions exceeding $775,000) will be suspended during the years 1997 through 1999. However, the 15% estate excise tax on excess retirement accumulations will still apply. It is important to note that making distributions from qualified plans to take advantage of the suspension of the 15% excise tax on excess distributions may not always be advantageous. In order to make a determination as to whether a withdrawal would make sense, a taxpayer would have to evaluate the length of time the withdrawal could be postponed, the after-tax rate of return on withdrawn funds (keeping in mind early withdrawal penalties which continue to apply), and the rate of return on funds kept within the qualified plan.
Situations where a distribution to avoid the excise tax may be advantageous include the following:
1. Where the participant and spouse (if any) have short life expectancies and, therefore, will not benefit from tax-free build-up;
2. Where the participant desires to begin an aggressive gift-giving program funded by excess distributions; or
3. Where a participant wishes to fund an investment opportunity having an after-tax return that significantly exceeds the rate of return of assets in the plan and the impact of having a current tax on the distribution.
Deduction for Contribution of Appreciated Stock to Private Foundations. A deduction equal to the fair market value of publicly traded stock (that is capital gain property) contributed during the period from July 1, 1996, through May 31, 1997 to private foundations is now available. The deduction only applies to the extent that total contributions of the stock of a particular corporation do not exceed 10% of the outstanding stock of such corporation.
Resident Aliens Subject to New "Expatriation" Provisions. The Health Insurance Act includes changes which expand the present reach of U.S. income, estate and gift tax laws to former U.S. citizens who renounce their U.S. citizenship. Although the debate concerning these new rules was well-publicized, the most significant aspect of these changes may relate to their treatment of U.S. residents (e.g., so called "green card" holders) who are citizens of other countries, and who ultimately return to their country of citizenship. The new law expands the expatriation provisions to include long-term (residing in the U.S. for eight of the preceding 15 years) residents who terminate U.S. residency. Like expatriating citizens, for ten years after the "terminating event", they will be (i) taxable on their U.S. source income (determined under a newly expanded definition), (ii) subject to an expanded definition of U.S. gross estate (including stock in the foreign corporation in which the decedent had more than 50% of the vote or equity), and (iii) subject to U.S. gift tax on gifts of intangibles (which otherwise enjoy a blanket exclusion from gift tax if given by a nonresident). While some relief is available under the new law to certain former citizens who can demonstrate that renunciation of citizenship was not tax motivated, no similar provision is expressly made available to former non-citizen residents. The legislative history states that these new provisions are not to be defeated by any treaty provision.
