The Taxpayer Relief Act of 1997: An Overview
CRS Report for Congress
The Taxpayer Relief Act of 1997: An Overview
Updated October 17, 1997
David L. Brumbaugh
Specialist in Public Finance
Economics Division
Congressional Research Service ˜ The Library of Congress
The Taxpayer Relief Act of 1997: An Overview
Summary
On July 31, the House and Senate both passed the Taxpayer Relief Act of 1997
(H.R. 2014). The President signed the measure on August 5; it became P.L. 105-34.
The bill provides a tax cut of modest size in the aggregate that consists of a variety
of measures applying to particular types of taxpayers, income, and activities. Its most
prominent features are a $500 per-child tax credit ($400 for 1998), a cut for capital
gains, several tax benefits for education, reduction of estate taxes, and expansion of
Individual Retirement Accounts. Along with these tax reductions, the bill contains
a number of revenue raising provisions that offset part (but substantially less than all)
of the revenue loss from the bill’s tax cuts. The largest revenue raiser is modification
and extension of a set of aviation-related excise taxes that were scheduled to expire.
An associated budget reconciliation Act (the Balanced Budget Act of 1997; P.L. 105-
33) that focuses on spending rather than outlays contains an increase in excise taxes
on cigarettes and tobacco products.
Contents
Tax Cut Provisions..............................................4
Child Tax Credit............................................4
Capital Gains...............................................4
Individual Retirement Accounts IRAs............................5
Education Tax Benefits.......................................6
Estate and Gift Tax Provisions..................................7
Alternative Minimum Tax.....................................8
Expiring Tax Provisions.......................................9
District of Columbia Tax Incentives..............................9
Welfare-to-Work Credit......................................10
Other Tax Reduction Provisions...............................11
Revenue Increase Provisions......................................11
Aviation Taxes.............................................11
Tobacco Taxes (in the Balanced Budget Act)......................12
Other Revenue-Raising Provisions..............................12
Line-Item Veto................................................12
Technical Corrections ...........................................13
Revenue Effects................................................14
Additional CRS Reports and Issue Briefs.............................17
List of Tables
Table 1. Revenue Effects of the Taxpayer Relief Act ...................15
The Taxpayer Relief Act of 1997: An Overview
In general, the Taxpayer Relief Act provides a modest aggregate tax reduction
consisting of several major tax cut measures aimed at particular categories of
taxpayers, income, and activities (e.g., families with children, capital gains, saving and
investment, education) along with a host of smaller, more narrow provisions. The bill
also contains a number of revenue raising items that fall far short of offsetting the
revenue loss from the bill’s tax cuts; the bulk of the revenue increases are from
aviation-related excise taxes. (A substantial amount of revenue is also raised by an
increase in tobacco taxes contained in an associated budget reconciliation Act, H.R.
2015.) The aggregate net revenue effect of P.L. 105-34 and associated provisions in
H.R. 2015 is estimated to be a reduction of $95.3 billion over 5 years and $275.4
billion over 10 years.
The origins of the Taxpayer Relief Act can be traced to the first days of the 104th
Congress, when, in early 1995, House Republicans introduced the “Contract with
America” as legislation. A number of tax cuts formed the centerpiece of the
Contract — a per-child tax credit, a broad reduction for capital gains, reduction of
estate taxes, and liberalized Individual Retirement Accounts — and were passed by
Congress in November 1995, as part of the Balanced Budget Act of 1995. However,
President Clinton vetoed the bill because of concerns that it favored upper-income
individuals and would increase the federal budget deficit. The Taxpayer Relief Act
that was passed by Congress in July 1997, and subsequently signed into law by
President Clinton, contains tax cuts quite similar to the principal provisions of the
1995 Contract, including the child credit and tax cuts for capital gains, more generous
IRA rules, and reduced estate taxes. The recent bill also contains a number of tax
benefits for education and a host of more narrow changes in the tax law.
In part, the intention of congressional supporters of the 1997 Act was simply to
reduce taxes as part of an effort to reduce the size of government and the aggregate
tax burden. The bill was not passed as a remedy for an economic emergency; at the1
time of enactment, the economy was at full employment and had been growing
without interruption since early 1991. Indeed, economic performance had been such
that the revenue-reducing tax cut was passed in the context of a plan to balance the
federal budget by the year 2002. But in targeting the tax reductions to certain2
activities and types of income, the bill was also intended to stimulate and encourage
activities that were argued to be economically or socially beneficial. The tax cut for
See, for example, the remarks of Representative Bill Archer, Chairman of the House Ways1
and Means Committee in the Congressional Record, June 26, 1997. P. H4668.
Economic growth resulted in a downwards revision of the Congressional Budget Office’s2
projections for budget deficits. According to press reports, the smaller-than-expected budget
deficits helped form the basis of a budget agreement between Congress and the Administration
that included a tax cut. Tax Notes, May 19, 1997. P. 883.
capital gains and liberalized IRA rules, for example, were supported on the grounds
they would stimulate saving and investment; the tax benefits for education were
designed to encourage investment in education.
In terms of its aggregate size, the revenue reduction estimated to result from the
Taxpayer Relief Act might be termed modest, or even small. The revenue loss from
the bill is expected to grow over time because a number of its important provisions
are phased in and because a number of its provisions are “back loaded,” or structured
so as to postpone their revenue loss. Still, by its fifth year, when many of its phased-
in tax cuts have become fully effective, the Act is expected to reduce revenue by only
slightly over 1%; by its tenth year the Act is expected to reduce revenue by slightly
less than 2%. In either case, the reduction is small compared to the size of the
economy; the estimated revenue loss in either the fifth or tenth year is less than one-
half of one percent of projected Gross Domestic Product. The reduction is also small3
compared to that of the 1981 Economic Recovery Tax Act (ERTA), whose scheduled
tax reductions were expected to reduce tax revenues by an estimated 21% by the
Act’s fifth year. (Some of the 1981 Act’s tax cuts were rescinded by subsequent
legislation before they were fully implemented.) Of course, the targeted nature of the
1997 Act’s provisions hold forth the possibility that while the aggregate cut may not
be large, the bill may have significant effects for some groups or sectors of the
economy — for example, families with children or individuals with capital gains
income.
If the aggregate size of the Act is modest or small, its shape can be described as
irregular rather than even, or across-the-board. As suggested above, the measure
provides reductions applicable to particular activities, groups, and types of income
rather than across-the-board tax reductions that might, for example, be produced by
a general reduction in statutory rates. The bill consists of 20 titles that can separated
into 3 groups: the first 10 titles contain the measure’s principal tax cuts: a $500 per-
child tax credit, tax benefits for education, expansion of IRAs, reduced capital gains
taxes, reduced estate and gift taxes, extension of several expiring tax provisions, and
numerous other more narrow reductions. The second part of the bill is its Title X,
and contains the Act’s revenue-raising provisions. There are a large number of these,
but most are small and narrowly applicable. The principal revenue-raising item is
extension and modification of a set of aviation-related excise taxes. (As noted above,
an additional revenue raising item is the increase in tobacco excise taxes that is
provided by H.R. 2015 — the reconciliation bill generally devoted to outlays.) The
third part of the bill contains its final 10 titles, which are generally devoted to a host
of narrow provisions, most of which the bill terms “simplification” measures.
The shape of the bill can also be described in terms of its impact on equity.
Economists generally distinguish between two types of equity — horizontal equity,
which compares taxes paid by persons with equal incomes — and vertical equity,
CRS calculations based on revenue loss estimates by the Joint Tax Committee (Estimated3
Budget Effects of the Conference Agreement on the Revenue Provisions of HR 2014, the
“Taxpayer Relief Act of 1997,” JCX-39-91, July 30, 1997), and baseline revenue and GDP
estimates by the Congressional Budget Office (The Economic and Budget Outlook: Fiscal
years 1998 - 2007, January, 1997.)
which compares taxes paid by people at different income levels. The impact of the
bill on horizontal equity is relatively straightforward: its tax reduction for individuals
in certain specific circumstances likely reduces the tax system’s horizontal equity.
The effect of the bill on vertical equity has been hotly debated throughout the
bill’s path through Congress. The bill’s proponents have argued that it favors middle-
income taxpayers, while others — including the administration — criticized early
versions of the bill for favoring upper-income people. In part, the differing views
were a result of different methods of analyzing the bill and presenting conclusions.
A study by CRS, however, concluded that conventional economic analysis suggests
the separate House and Senate versions of the bill favored upper income individuals.4
The final conference committee version of the Act was modified from the House and
Senate versions to reflect a compromise with the Clinton administration. However,
the essential elements of the House and Senate bill remain in the final Act.
Before turning to a closer look at the provisions of P.L. 105-34, it helps to put
it in perspective by comparing its policy direction to the two landmark tax acts of the
1980s — the Economic Recovery Tax Act of 1981 (mentioned above) and the Tax
Reform Act of 1986. The 1981 and 1986 Acts are generally recognized to have been
guided by opposing views of the appropriate role of tax policy in the economy. The
1981 Act was, in part, based on a belief in the economic efficacy of targeted tax
incentives — that judiciously selected and aimed tax reductions could enhance
economic performance. For example, one of ERTA’s most prominent measures was
expansion of Individual Retirement Accounts, which were designed to stimulate
saving. Only 5 years later, however, the Tax Reform Act of 1986 was designed to
promote economic efficiency, equity, and simplicity. It was based, in part, on the
notion that the economy functions best when tax-induced distortions of behavior are
minimized; both this idea and the Act’s goal of horizontal equity led to an emphasis
in its provisions on reducing differences in how different activities and types of
income are taxed.
While a full assessment of the Taxpayer Relief Act is, of course, premature at
this point, it is clear that the measure is closer to ERTA’s guiding principles than
those of the Tax Reform Act. For example, the 1997 Act’s liberalized IRAs build on
the IRA concept that was expanded with ERTA. And both the Taxpayer Relief Act’s
IRA provisions and its cut for capital gains are based on the same belief in the efficacy
of tax incentives for saving and investment that underlay much of the 1981 Act.
In contrast to the 1986 Tax Reform Act, there is little doubt that the 1997 Act
complicates the tax system. (See, for example, the discussion below of the Act’s
multiple alternative education tax benefits and its various holding periods and rates
for capital gains. And, as noted above, the 1997 Act likely reduces horizontal equity.
We note, however, an important difference between the 1997 Act and both ERTA
and the Tax Reform Act. The 1997 Act is substantially smaller than ERTA; and while
the net revenue impact of the 1986 Act was quite small, it was substantially broader
in scope than the Taxpayer Relief Act.
U.S. Library of Congress. Congressional Research Service. Distributional Effects of the4
Proposed Tax Cut. CRS Report 97-669 E, by Jane G. Gravelle. Washington, 1997. P. 1.
For further information, see: Distributional Effects of the Proposed Tax Cut. CRS
Report 97-669 E, by Jane G. Gravelle; Federal Tax Policy, 1980-89: A Brief
Overview. CRS Report 90-612, by David L. Brumbaugh. For a detailed explanation
of the bill, see: U.S. Congress. Conference Committees. Taxpayer Relief Act ofth
the House and Senate versions of H.R. 2014, see: Taxes and FY1998 Budget
Reconciliation: Highlights of the House, Senate, and Conference Bills. CRS Report
Tax Cut Provisions
Child Tax Credit
The bill provides a $500 ($400 for tax year 1998) per-child tax credit for children
under 17. The credit is phased out for taxpayers with Adjusted Gross Income (AGI)
in excess of $110,000 in the case of joint returns, $55,000 for married persons filing
separately, and $75,000 in the case of single returns. The phaseout thresholds are not
indexed for inflation; the phaseout reduces the credit by $50 for each $1,000 above
the phaseout threshold.
For families with 1 or 2 children, the credit is calculated before the family
calculates its Earned Income Tax Credit (EITC) — an important ordering rule, since
the EITC is refundable and will therefore not be reduced even if the child credit
offsets some or all of the family’s pre-credit tax liability. For families with 3 or more
children, the child credit itself is refundable, but it and the EITC together cannot
exceed the employee’s share of FICA taxes the taxpayer has paid.
The credit is effective for tax years beginning in 1998. Again, however, the
credit for 1998 is $400, rising to $500 in subsequent years..
For further information, see: Child Tax Credits: Comparison of Proposals for
Low-Income Taxpayers. CRS Report 97-687 E, by Gregg Esenwein and Jack Taylor;
and Federal Income Tax Treatment of the Family. CRS Report 91-694 RCO, by
Jane G. Gravelle.
Capital Gains
The bill contains several provisions that reduce taxes on capital gains. First, it
provides a set of reduced tax rates for capital gains in general. Under both the Act
and prior law, a graduated set of 5 tax rates apply to ordinary income: 15%, 28%,
31%, 36%, and 39.6%. Under prior law a maximum tax rate of 28% applied to
capital gains from the sale of assets held more than 1 year. The Act applies two
reduced maximum rates: a maximum 10% rate to gains that would be taxed at 15%
if ordinary income rates applied; and a maximum 20% rate to gains that would be
subject to rates higher than 15% if they were ordinary income. The lower rates apply
to sales after May 6, 1997; for amounts taken into account before July 29, 1997, the
lower rates apply only to assets held longer than 1 year (as did the 28% rate under
prior law). Beginning on July 29, however, the new reduced rates apply only to assets
held longer than 18 months. Prior law’s maximum rate of 28% continues to apply to
assets held longer than 1 year but not longer than 18 months. The 28% rate also
continues to apply to gains from the sale of collectibles.
Beginning in 2001, the Act reduces its 20% and 10% maximum rates to 18% and
rate), the holding period can only begin with tax year 2001.
Instead of the 28% rate or either the 20%/10% or 18%/8% structure, a separate
“recapture” rate applies to real estate. Under its terms, gain from the sale of
depreciable real estate is generally subject to a maximum 25% rate to the extent of
prior depreciation deductions that have been claimed on the property.
The Act also replaces prior law’s benefits for gains from the sale of homes.
Under prior law, taxpayers could exclude gain from the sale of a principal residence
from taxation if the gain was reinvested in another home (“rolled over”). Also,
taxpayers 55 or over were allowed a one-time exclusion of gain from the sale of a
home, up to a maximum of $125,000. The Act provides, instead, a $250,000
exclusion of gain from the sale of a principal residence ($500,000 for joint returns)
that is not contingent on rollovers and is not restricted to those over 55. The
exclusion can be used for one sale every 2 years. It is available for sales made after
May 6, 1997.
As described below, the Act’s provisions for allocating capital losses among the
various classes of capital gains income contained a certain amount of vagueness.
Legislation clarifying the rules has been introduced as technical corrections legislation,
in H.R. 2645.
For further information, see: Capital Gains Tax Issues and Proposals. CRS
Report 96-769 E, by Jane G. Gravelle; The Revenue Cost of Capital Gains Cuts.
CRS Report 97-559 E, by Jane G. Gravelle; and Depreciation Recapture and the
Taxation of Capital Gains. CRS Report 97-609 E, by Gregg A. Esenwein.
Individual Retirement Accounts IRAs
The Act has a number of different provisions related to IRAs, including both
liberalization of rules and restrictions governing the type of IRAs allowed under prior
law; and creation of 2 new types of IRAs — so-called “back loaded” IRAs and
education IRAs.
Under prior law, individuals not participating in employer-sponsored pension
plans were permitted to deduct up to $2,000 in contributions to IRAs annually
($4,000 in the case of couples). In the case of individuals who participate in
retirement plans themselves or whose spouses participate, the deduction was phased
out beginning at AGIs of $25,000 ($40,000 for couples). The 1997 Act gradually
doubles the phase-out threshold for deductions to $50,000 by the year 2005 ($80,000
for couples). The Act also provides that persons will not be disqualified from
deducting IRA contributions if they, themselves, do not participate in a pension, but
their spouse does. Finally, withdrawals from IRAs prior to age 59 ½ are subject to
a 10% early withdrawal tax; the 1997 Act permits penalty free withdrawals of funds
used to pay higher education expenses or first-time home purchases.
The 1997 creates a new type of “back loaded” IRA — so called because
contributions are not deductible, but qualified withdrawals are not taxed. If a person
expects to have the same tax rate upon retirement as when contributions are made,
the back loaded IRAs (designated “Roth IRAs” by the Act) deliver the same
magnitude of tax benefit, per dollar of contribution, as deductible IRAs. Somewhat
different rules, however, apply to back-loaded IRAs: allowable contributions to them
are phased out at higher AGIs than is the deduction — between $95,000 and
$110,000 for singles (between $150,000 and $160,000 for couples). In addition,
contributions to all an individual’s IRAs (i.e., deductible and back-loaded IRAs
combined) are not permitted to exceed $2,000 in one year. As with deductible IRAs,
penalty free withdrawals are permitted under the Act for first-time home purchases
or higher education expenses.
The Act provides that funds can generally be shifted from prior-law type IRAs
to Roth IRAs. The shifted amounts are included in taxable income ratably over 4
years (assuming they would be taxed if they were normal distributions), and the 10%
penalty tax on early withdrawals would not apply. As noted below in the section on
technical corrections, the Act inadvertently permits Roth IRAs to be used as a means
of withdrawing funds from prior-law type IRAs without incurring the early
withdrawal tax. Technical corrections legislation (H.R. 2645) has been introduced
that would rule out this unintended benefit.
Finally, the Act permits taxpayers to establish education IRAs; as with back-
loaded IRAs, qualified withdrawals — in this case, for post-secondary education
expenses that include tuition, books, and room and board — are not taxed but
contributions are not deductible. Annual contributions are limited to $500 per
beneficiary (i.e., per student); allowable contributions are phased out for AGIs
between $95,000 and $110,000 ($150,000 and $160,000 for joint returns).
For further information: Individual Retirement Accounts (IRAs) and Related
Proposals. CRS Report 97-629, by Jane G. Gravelle; and Individual Retirement
Accounts (IRAs): Legislative Issues in the 105 Congress. CRS Report 96-20 EPW,th
by James Storey.
Education Tax Benefits
The Taxpayer Relief Act contains a number of different tax benefits related to
education; the most prominent are three interrelated provisions: two tax credits the
bill terms the “Hope Scholarship” credit and the “Lifetime Learning” credit; and the
education IRAs described in the preceding section. The provisions are interrelated
in that for a particular taxable year, the taxpayer can only use one of the 3 benefits
with respect to the education expenses of a particular student. (However, a taxpayer
— for example, a parent — can claim the benefit of one provision for one dependent
student and use a different benefit for another student.)
The Hope Scholarship credit applies to educational expenses incurred for the
first 2 years of a student’s postsecondary education; it is further limited to 2 taxable
years. The credit is 100% (per student and per year) of the first $1,000 of qualified
educational expenses and 50% of the next $1,000, for a maximum annual credit of
$1,500. The credit can be used for expenses incurred on behalf of the taxpayer, the
taxpayer’s spouse, or a dependent. The student in question must be at least half-time;
qualified expenses include tuition and fees required for enrollment, but not books,
room, or board. The credit is phased out for AGIs between $40,000 and $50,000
($80,000 and $100,000 in the case of joint returns). It is effective beginning January
The Lifetime Learning credit is 20% of qualified expenses; it is calculated on a
per-taxpayer rather than a per-student basis as with the Hope credit. Unlike the Hope
credit, it can be claimed for an unlimited number of years rather than just 2 years. For
expenses paid after June 30, 1998 (when the credit is first effective) and before
January 1, 2003, the credit applies to a maximum of $5,000 of expenses, for a
maximum credit of $1,000 per taxpayer return. Beginning in 2003, the credit applies
to a maximum of $10,000 of qualified expenses, for a maximum credit of $2,000. As
with the Hope credit, the Lifetime credit only applies to tuition and fees, and is phased
out over the same income ranges.
As noted above, withdrawals from education IRAs that are used to pay
education expenses — including, in this case, room and board and books as well as
tuition — are generally excluded from taxable income under the Act. Again,
however, only one of the 3 benefits — the 2 credits and exclusion of education IRA
withdrawals — can be claimed for a particular students. However, the same taxpayer
can claim different tax benefits for different students.
Among the other tax benefits in the bill that are related to education are: a
deduction for interest on student loans; extension of the exclusion for employer-
provided undergraduate education expenses (until June 1, 2000), a phased-in increase
in the cap on tax-exempt state and local bonds that can finance private, charitable
(501(c)(3)) organizations; an augmented deduction for corporate charitable
contributions of computer equipment and technology.
For additional information, see: Tax Benefits for Education in the Budget
Reconciliation Legislation. CRS Report 97-650 EPW, by Bob Lyke; and Tax
Subsidies for Education: An Analysis of the Administration’s Proposal. CRS Report
Estate and Gift Tax Provisions
The Act reduces the estate and gift tax in a number of ways, but by far the
largest reduction is a phased-in increase of the unified credit, which provides an
effective tax exemption for transfers below a certain level. Under prior law, the credit
provided an effective exemption of $600,000; the 1997 Act gradually increases the
exemption to $1,000,000, as follows: $625,000 in 1998; $650,000 in 1999; $675,000
in 2000 and 2001; $700,000 in 2002 and 2003; $850,000 in 2004; $950,000 in 2005;
and $1,000,000 in 2006 and thereafter.
The Act provides an additional benefit for estates comprised of family-owned
businesses. Under its terms, up to $1,000,000 of a qualified estate can be excluded
from tax. The special family business exclusion is in addition to the general unified
credit. However, the effective combined exemption from the exclusion and the
unified credit is not permitted to exceed $1.3 million. Note also that the special
exclusion is fully effective beginning in 1998, while the increase in the unified credit
is phased in, as described above. Thus, the relative advantage for family-business
estates gradually diminishes to $300,000 as the unified credit increases to $1,000,000.
Among the other estate tax reductions are: indexation of several existing
provisions that have the effect of reducing estate and gift taxes (e.g., the limit on
“special use” valuation); reduction of estate tax for land subject to a conservation
easement; and reduction of the interest rate applicable to installment payments of
estate tax.
As noted below, the phase in of the unified credit’s increase unintentionally
reduces the total tax cut provided to family business estates. This unintended
interaction is corrected by technical corrections legislation in HR 2645.
For further information, see: Estate Tax Issues and Proposals: An Overview. CRS
Report 97-610 E, by Salvatore Lazzari.
Alternative Minimum Tax
In general, the Alternative Minimum Tax (AMT) functions much like a parallel
tax system; it has its own rules for determining taxable income (more stringent than
those of the regular tax), and it has its own rates (lower than those of the regular tax).
A person or corporation pays either their AMT or their regular tax, whichever is
greater. The Act reduces the AMT in several ways.
First, the Act reduces (but does not repeal entirely) the so-called “adjustment”
for depreciation, which under prior law was the most important aggregate difference
between AMT taxable income and that of the regular tax. Under prior law, the AMT
required depreciation deductions to be claimed at a slower rate than did the regular
tax. It did this through two mechanisms: by specifying longer recovery periods for
assets (i.e., depreciation deductions for different assets must be spread over more
years under the AMT than under the regular tax); and by requiring the use of slower
depreciation methods (meaning that a smaller share of an asset’s cost can be deducted
in the first years of the recovery period). The 1997 Act conforms AMT recovery
periods (but not depreciation methods) with those of the regular tax, effective for
assets placed in service after 1998.
The Act contains two additional AMT reductions. First, it repeals the AMT,
beginning in 1998, for corporations whose gross receipts averaged less than $5 million
in 1995, 1996, and 1997. Such corporations continue to be exempt from the AMT
in any tax year as long as their average gross receipts for the preceding 3 years does
not exceed $7.5 million. Second, the Act repeals the AMT adjustment for installment
accounting in the case of farmers. The conference agreement on the Act did not
include an earlier proposal to increase the AMT exemption for individuals.
For additional information, see: The Corporate Alternative Minimum Tax:
Economic Implications of the Taxpayer Relief Act of 1997. CRS Report 97-814 E,
by Gary Guenther.
Expiring Tax Provisions
The income tax contains a number of tax benefits that are temporary — that is,
they apply for limited periods of time, and then are scheduled to expire. In the past,
the temporary terms of most of the provisions have expired on a number of occasions,
but Congress has acted to extend the provisions for additional temporary periods, or
make them permanent. The temporary provisions (sometimes called “extenders”)
include: the exclusion for employer provided educational assistance; the research and
experimentation tax credit; the work opportunity tax credit; the orphan drug tax
credit; and the special treatment of contributions of stock to private foundations. The
Taxpayer Relief Act extends each of the temporary provisions as follows:
Exclusion for employer providedthrough May 31, 2000
education assistance
Research and experimentation taxthrough June 30, 1998
credit
Work opportunity tax creditthrough June 30, 1998
Orphan drug tax creditmade permanent
Contributions of stock to privatethrough June 30, 1998
foundations
For additional information, see: Expiring Tax Provisions. Issue Brief 95064, by
Sylvia Morrison; The Research and Experimentation Tax Credit. Issue Brief 92039,
by Gary Guenther; Gifts of Appreciated Stock to Private Foundations. CRS Report
Congress. CRS Report 97-540 E, by Linda Levine.
District of Columbia Tax Incentives
The Act provides two federal tax benefits for the District of Columbia. One
provision creates a new, expanded “DC Enterprise Zone” in the District and
associates a capital gains exemption with the new zone; the second provision provides
a tax credit for buyers of homes in the District. The DC Enterprise Zone
encompasses a broader area than prior law’s enterprise community; the Act’s new
Zone include several specified census tracts that are economically distressed as well
as any District tract that registers a poverty rate of 20% or greater. Like prior law’s
enterprise communities, businesses in the DC Enterprise Zone qualify for a 20% wage
credit, an additional $20,000 expensing benefit for equipment investment, and relaxed
rules for tax-exempt private activity bonds. In addition, a 0% capital gains rate
applies to sales of qualified assets in the DC Enterprise Zone and any District census
tract whose poverty rate is no less than 10%. Qualified assets include stock or
partnership shares in a business within the qualified area, as well as tangible assets of
the businesses.
The homebuyer tax credit is $5,000 and applies to the first-time purchase of
either a new or a previously owned principal residence. The credit is phased out for
individuals with Adjusted Gross Incomes between $70,000 and $90,000 ($110,000
and $130,000 for joint filers).
For further information, see: District of Columbia Revitalization: Legislation
Enacted by the 105 Congress, Coordinated by Eugene Boyd. CRS Report 97-766th
GOV.
Welfare-to-Work Credit
The Act authorizes the Welfare-to-Work Credit (WWTC) that provides a tax
credit to firms that hire members of families that are relatively long-time recipients of
benefits under the Aid to Families with Dependent Children or its successor,
Temporary Assistance to Needy Families, program. The new credit is in addition to
the existing Work Opportunity Tax Credit (WOTC) which also provides a tax credit
for employment of members of families who have received public assistance benefits
along with members of certain other targeted groups. However, the requirements and
rates of the new credit are somewhat different; the new credit is generally targeted at
longer-term recipients and recipients whose benefits have ceased because of time
limitations. Further, an employer cannot claim both the WOTC and the WWTC for
wages paid to the same person.
The WWTC’s rate is somewhat higher than that of the WOTC. The new credit
is 35% of the first $10,000 of an eligible recipient’s first year of employment and 50%
of the first $10,000 earned in the employee’s second year. WOTC’s rate is generally
of the first $6,000 earned by an employee retained for a longer period. The new
WWTC applies to persons who received benefits for the 18 months ending on the date
of hire; persons who have received benefits for an 18-month period after the date of
enactment and hired no more than 2 years after the end of the 18-month period; and
members of families whose eligibility for public benefits ended because of time
limitations on the benefits and hired not more than 2 years after the date of benefit
cessation. For its part, the WOTC requires eligible employees to have received
benefits for 9 months during the 18-month period ending on the hiring date.
The WWTC is effective from January 1, 1998 through April 30, 1999. Based
on the Joint Tax Committee’s revenue loss estimate of $106 million (FY1998 -
FY2007), expectations appear low concerning the credit’s ability to generate much
job creation for welfare recipients.
For further information, see: The Welfare-to-Work Tax Credit: A Fact Sheet, by
Linda Levine. CRS Report 97-784 E.
Other Tax Reduction Provisions
The Act contains numerous additional tax cut provisions which are generally
smaller in magnitude or narrower in their scope than those outlined above. Here is
a partial list:
Repeal of the excise tax on diesel fuel used in recreational motorboats;
Reduced excise tax on hard cider;
Delay of penalties related to the Electronic Federal Tax Payment System;
Liberalized rules for home office deductions;
Phased-in increase (to 100% by 2007) of for the deduction of health
insurance costs of self-employed persons;
Increased business meal deduction for certain transportation workers (truck
drivers, pilots, and others);
Expensing of environmental remediation costs (“brownfields”);
Temporary suspension of income limitations for percentage depletion
on marginal wells;
Designation of additional empowerment zones and modification of
empowerment zone and enterprise community criteria; and
Income averaging for farmers.
Revenue Increase Provisions
The Taxpayer Relief Act contains a large number of revenue-raising provisions.
Most of the measures are quite narrow and small, but a few — notably the extension
of and modification of aviation-related excise taxes — raise a significant amount of
revenue. In addition, the reconciliation act related to spending — the Balanced
Budget Act of 1997 — contains a substantial increase in the excise tax on tobacco.
The total revenue estimated to be raised by the revenue increase provisions in both
Acts is $56.4 billion over 5 years and $126.0 billion over 10 years. This offsets
roughly one-third of the gross revenue loss from the act’s revenue-losing provisions.
Aviation Taxes
The single largest revenue-raiser by far is the extension and modification of the
aviation related excise taxes that are paid into the Airport and Airway Trust Fund.
The taxes were scheduled under prior law to expire on October 1, 1997. The Act’s
extension is for 10 years and are estimated to account for almost two-thirds of the
estimated revenue gain from the two reconciliation Acts.
The Taxpayer Relief Act modified the structure of the aviation taxes by gradually
reducing prior law’s 10% tax on all domestic tickets to 7.5% while phasing in a $3.00
tax on each flight segment (i.e., a single takeoff and landing). The new flight segment
tax is more akin to a user fee than the ad valorem ticket tax, and tended to be favored
by larger airlines. In addition, the Act increases prior law’s $6 international departure
tax to $12, and extends it to international arrivals. The act also applies the air
passenger tax to purchases of the right to award frequent flyer miles. Prior law’s
extended without modification. The 4.3 cent tax on aviation gasoline and jet fuel that
previously was deposited in the Treasury Department’s general fund was shifted to
the Airport and Airway Trust Fund.
For further information, see: Aviation Taxes and the Airport and Airway Trust
Fund. CRS Report 97-657 E, by John W. Fischer.
Tobacco Taxes (in the Balanced Budget Act)
The Balanced Budget Act of 1997 (the BBA; P.L. 105-33) was also approved
by Congress in late July; like the Taxpayer Relief Act, it was a budget reconciliation
measure, but contained primarily provisions related to entitlement spending (e.g., food
stamps, Medicare, and Medicaid). An exception was a substantial increase in the
federal excise tax on cigarettes and related products, which was included in the
spending act rather than the tax act. Beginning in 2000, the BBA provides a 10-cent
per pack increase in the federal excise tax on cigarettes, thus raising the tax from
current law’s 24 cents per pack to 34 cents; the act increases taxes on other tobacco
products — for example, cigars, chewing tobacco, snuff, and pipe tobacco — by the
same proportion. Effective in 2002, the BBA increases the tax by an additional 5
cents per pack, and increases the other tobacco taxes proportionally.
The conference agreement on the Taxpayer Relief Act provided that the
payments by firms under future federal legislation implementing the June 1997
tobacco industry settlement would be reduced by the amount of the Act’s increase in
excise taxes. In September, however, legislation repealing the provision was being
considered by Congress. The Senate voted to repeal the measure on September 10.
Other Revenue-Raising Provisions
The act contains numerous other revenue-raising provisions, generally more
narrow in scope and raising smaller amounts of revenue that the aviation and tobacco
excise tax provisions. The act separates the provisions into the following categories:
financial products; corporate organizations, reorganizations and other corporate
provisions; administrative provisions; provisions relating to tax-exempt organizations;
foreign provisions; pension and employee benefit provisions; and other revenue-
increase provisions.
Line-Item Veto
On August 11, 1997, President Clinton vetoed 2 tax items contained in The
Taxpayer Relief Act and one contained in the Balanced Budget Act under authority
provided to him by the Line Item Veto Act of 1996 (P.L. 104-130). Under the Act,
the President is permitted to exercise a line-item veto with respect to tax benefits that
apply to only a limited number of taxpayers.
The Line Item Veto Act requires the Joint Tax Committee to identify items
eligible for the veto; in the case of the Taxpayer Relief Act, the Committee identified
measure granting special treatment to foreign-source financial services income; and
favorable treatment of stock sales to certain farmer’s cooperatives. The vetoed item
contained in the Balanced Budget Act concerned Medicaid-related taxes imposed by
States.
For further information, see: Citations to Provisions in 1997 Reconciliation Acts
Canceled under the Line Item Veto Act. CRS Report 97-773 GOV, by Robert Keith;
and Item Veto and Expanded Impoundment Proposals. CRS Issue Brief 89148, by
Virginia McMurtry.
Technical Corrections
The need for legislation to make technical corrections in the Taxpayer Relief Act
became apparent shortly after the bill was enacted. On October 9, the House Ways5
and Means Committee approved H.R. 2645, which contained over 40 provisions
generally aimed at clarifying vague parts of the Taxpayer Relief Act and ruling out
unintended consequences. The three most prominent changes were: closing of an
unintended benefit for conversion of amounts into Roth IRAs; clarification of rules for
the netting of capital losses; and modification of certain estate and gift tax provisions.
As described above in the section on IRAs, the Taxpayer Relief Act contemplated
an easing of the normal rules for taxing IRA withdrawals in the case of amounts
withdrawn from an IRA established under prior law rules and reinvested (“rolled
over”) into a Roth IRA. Under the bill, the normal 10% tax on early withdrawals did
not apply to amounts rolled into Roth IRAs, and withdrawals that would ordinarily be
immediately included in taxable income would be included only over 4 years. The Act
apparently unintentionally permitted amounts rolled into Roth IRAs to be subsequently
withdrawn without incurring the 10% early-withdrawal tax. HR 2645 contains
provisions that foreclose this possibility.
HR 2645 also clarifies the “netting” rules for capital gains that determine which
of the Taxpayer Relief Act’s various categories of capital gains are offset by which
capital losses. Gain from assets subject to the 28% rate (in the 28% “basket” as it is
sometimes called) is grouped with losses in the same basket — losses from assets that
would be subject to the 28% rate if they had produced a gain instead of a loss. For
example, a loss from an asset held more than a year and less than 18 months that is
sold after July 18, 1997, is deducted under the bill from gain subject to the 28% rate.
In addition, short-term capital loss and long-term capital losses that have been carried
forward are deducted from gains in the 28% basket. If a taxpayer registers a net
capital loss from assets in the 28% basket, the loss is deducted from gains subject to
the next highest rate — the 25% rate that applies to gains subject to depreciation
See, for example, Efforts Under Way to Fix Technical Errors, Restore Vetoed Line Items.5
Tax Notes. Sept. 22, 1997. P. 1515-6.
recapture. If a capital loss still remains, it is deducted from gains subject to the next
highest rate, and so forth.6
The correction to the estate tax provisions concerns the interaction between the
Act’s gradual increase in the unified credit and its extra exemption for family
businesses. As noted above, the Taxpayer Relief Act scheduled a gradual increase in
the effective exemption provided by the unified credit from its current level of
$600,000 to $1,000,000 by the year 2006. Estates comprised of family businesses
have the option, under the Act, of claiming an additional exemption equal to the
difference between $1,300,000 and the exemption afforded by the unified credit. (The
total exemption from the family business provision and the unified credit cannot, in
other words, exceed $1,300,000.) The unanticipated interaction arises because the
exemption afforded by the unified credit comes “off the bottom” while the family
business exemption comes “off the top.” That is, the unified credit’s exemption is
calculated so that it effectively offsets the first taxable dollars of an estate that are
subject to relatively low tax rates under the estate tax’s graduated rate structure. In
contrast, the family business exemption offsets the last taxable dollars of an estate that
are subject to the highest estate tax rates. As a consequence, as the unified credit
increase is phased in and the family business exemption consequently declines (because
of the $1,300,000 cap), taxes on estates comprised of family businesses can gradually
increase: an “off the top” exemption amount is exchanged for an “off the bottom”
one. HR 2645 would rectify this by providing that the family business exemption
would be reduced by the dollar amount of the unified credit — not by the increase in
the credit’s effective exemption. Thus, the maximum total tax savings from the credit
and family exemption combined would remain constant as the credit’s increase is
phased in.
Revenue Effects
The following estimates of the revenue effects of the Taxpayer Relief Act and the
Balanced Budget Act are by the Joint Committee on Taxation and were published in
the conference report of the Taxpayer Relief Act (Taxpayer Relief Act of 1997.
Conference Report to Accompany H.Rept. 105-220. pp. 776-808.)
The provisions in the technical corrections bill follow the rules proposed in a letter from6
conressional leaders to the Treasury Department on September 29. BNA Daily Tax Report,
October 10, 1997. P. GG-1.
Table 1. Revenue Effects of the Taxpayer Relief Act
REVENUE LOSING PROVISIONS:Effective1997-021997-07
$500 tax credit for children under 17 ($400 in 1998),
$75,000/110,000 AGI phaseout. 1/1/98-$85.0-$183.4
Tax credits for education expenses1/1/98-31.6-76.0
Expansion of State-sponsored tuition and savings
programs to include room and board1/1/98-0.5-1.5
Student loan interest deduction1/1/98-0.7-2.4
Education IRAs1/1/98-3.9-14.2
Penalty-free withdrawals from IRAs for education
expenses 1/1/98 -0.8 -1.7
Extension of exclusion for undergraduate employer-
provided education assistance (through 5/31/00)12/31/96-1.2-1.2
Other Education-related Tax Incentivesvaries-0.7-1.8
Education tax incentives subtotal:-39.4-98.8
Expanded IRAs1/1/98-1.8-20.2
Capital gains tax changes: 20/10% rate for assets held
18 month; 18%/8% rate for assets held 5 years after
various other provisions.varies+.1-21.2
Savings incentives subtotal:-1.7-41.4
Alternative minimum tax provisions: eliminate AMT
for small corporations; conform AMT depreciation
class lives to regular tax; reverse IRS position on
installment sales by farmers.varies-8.2-20.0
Estate and gift tax reductions, including increase of
unified tax credit to $1 million over 10 years; $1.3
million exclusion for family-owned businesses.varies-6.4-34.5
Expiring tax provisions: extend research tax credit,
contributions of appreciated stocks, work opportunityGenerally
tax credit through 6/30/98; make orphan drug tax6/1/97, but
credit permanent. See also extension of employer10/1/97 for
education assistance listed above.WOTC-2.9-3.1
District of Columbia tax incentivesVaries -0.7-1.2
Welfare to work tax credits1/1/98-0.1-0.1
Miscellaneous revenue losing tax provisionsvaries-4.9-12.3
REVENUE RAISING PROVISIONS
Extend and modify Airport Trust Fund excise taxesvaries+33.4+80.2
Other excise tax provisionsvaries+1.5+3.2
Provisions related to financial productsvaries+2.2+3.8
Provisions related to corporate reorganizations and
other corporate provisionsvaries+1.7+2.8
Administrative provisionsvaries+2.3+4.8
Provisions Relating to Tax-Exempt Organizationsvaries+0.5+1.2
Foreign Provisionsvaries+0.4+1.0
Pension and Employee Benefit Provisionsvaries+0.0+0.3
Other revenue raising provisionsvaries+9.2+12.1
Revenue raising provisions subtotal:+51.2+109.4
Simplification and Other Foreign Provisionsvaries-1.1-4.1
OTHER SIMPLIFICATION PROVISIONS:
Individual and business simplificationvaries-0.5-1.2
Estate and gift tax simplificationvariesa/a/
Excise tax simplificationvaries-0.1-0.3
Pension simplificationvaries-0.3-0.8
Other simplification provisions subtotal:-0.9-2.3
Trade: GSP extension through 6/20/986/1/97-0.4-0.4
Net revenue effect of tax reconciliation bill (HR 2014)—-100.4-292.0
Revenue provisions in spending reconciliation bill
(HR 2015), including tobacco excise tax increase—+5.2+16.7
Total revenue effect of reconciliation bills—-95.3-275.4
a/ Revenue loss of less than $50 million.
Source: Joint Committee on Taxation.
Additional CRS Reports and Issue Briefs
CRS Report 97-657 E. Aviation taxes and the Airport and Airway Trust Fund, by
John W. Fischer.
CRS Issue Brief 97024. The Budget for fiscal year 1998, by Philip D. Winters.
CRS Report 96-769 E. Capital gains issues and proposals: an overview, by Jane G.
Gravelle.
CRS Report 97-860 E. The Child Tax Credit, by Gregg Esenwein.
CRS Report 97-687 E. Child tax credits: comparison of proposals for low-income
taxpayers, by Gregg A. Esenwein and Jack H. Taylor.
CRS Report 97-773 GOV. Citations to provisions in 1997 reconciliation acts
cancelled under the Line Item Veto Act, by Robert Keith.
CRS Report 96-311 E. The corporate alternative minimum tax: likely effects of
repealing it, by Gary Guenther.
CRS Report 97-308 E. Corporate “tax welfare,” by Jane G. Gravelle.
CRS Report 97-628 E. Corporate-owned life insurance: tax issues, by Jack Taylor.
CRS Report 95-455 S. Distributional effects of tax provisions in the Contract with
America as reported by the Ways and Means Committee, by Jane G. Gravelle.
CRS Report 97-766 GOV. District of Columbia revitalization: legislation enacted
by the 105th Congress, coordinated by Eugene P. Boyd.
CRS Report 97-609 E. Depreciation recapture and the taxation of capital gains
income, by Gregg A. Esenwein.
CRS Report 97-669 E. Distributional effects of the proposed tax cut, by Jane G.
Gravelle
CRS Report 97-546 E. The Electronic federal tax payments system: background and
proposals, by Jack Taylor.
CRS Report 97-610 E. Estate tax issues and proposals: an overview, by Salvatore
Lazzari.
CRS Issue Brief 95064. Expiring tax provisions, by Sylvia Morrison.
CRS Report 97-333 E. Family tax credit proposals in the 105th Congress, by Gregg
A. Esenwein.
CRS Report 97-929 E. Farm tax issues in the 105 Congress, by Jack Taylor.th
CRS Report 97-128 E. Farmer’s tax accounting methods and deferred payment
contracts, by Jack H. Taylor.
CRS Report 97-501 E. Gifts of appreciated stock to private nonoperating
foundations, by Louis Alan Talley.
CRS Report 96-199 E. The Home office deduction, by Sylvia Morrison.
CRS Report 97-629 E. Individual retirement accounts (IRAs): 1997 Revisions and
Policy Issues, by Jane G. Gravelle.
CRS Report 96-20 EPW. Individual retirement accounts (IRAs): legislative issues
in the 105th Congress, by James R. Storey.
CRS Issue Brief 89148. Item veto and expanded impoundment proposals, by Virginia
McMurtry.
CRS Report 97-472 E. Leaking Underground Storage Tank Trust Fund (LUST), by
Nonna A. Noto and Louis Alan Talley.
CRS Report 97-603 E. Like-kind exchanges: current tax treatment and proposed
reforms, by Jack Taylor.
CRS Issue Brief 96040. Major tax issues in the 105th Congress, by Taxation and
Government Finance Section, Economics Division. Updated regularly.
CRS Report 97-796 EPW. Pension plans: changes made by the Taxpayer Relief Act
of 1997, by James R. Storey.
CRS Report 97-452 E. President Clinton’s FY1998 capital gains tax proposals, by
Gregg A. Esenwein.
CRS Report 97-559 E. The Revenue cost of capital gains tax cuts, by Jane G.
Gravelle.
CRS Report 97-650 EPW. Tax benefits for education in the budget reconciliation
legislation, by Bob Lyke.
CRS Report 97-581 E. Tax subsidies for higher education: an analysis of the
administration’s proposal, by Jane Gravelle and Dennis Zimmerman.
CRS Report 96-757 E. Tax treatment of health insurance for the self-employed, by
Gary L. Guenther.
CRS Report 97-828 E. Tax-Exempt Bond Provisions of the Taxpayer Relief Act of
CRS Report 97-614 E. Taxes and FY1998 Budget Reconciliation: Highlights of the
House, Senate, and Conference Bills, by David L. Brumbaugh and Gregg
Esenwein.
CRS Report 96-607 EPW. Tuition tax credit and deduction: issues raised by the
President’s proposals, by Bob Lyke.
CRS Report 97-540 E. The Work Opportunity Tax Credit and the 105th Congress,
by Linda Levine.