“Simple” and “Not-So-Simple” Changes

The Small Business Job Protection Act of 1996 provides a number of new planning opportunities. Beginning in 1997, a married couple will be able to contribute $2,000 to each of their IRA accounts, even if one spouse doesn’t work. Previously, the total contributions to a husband and wife’s IRA accounts were limited to $2,250 when one spouse had no earned income.

The 10% early withdrawal penalty has been waived in situations where the taxpayers are using withdrawals of IRA money to pay for deductible medical expenses. This applies to the medical expenses that exceed the 7.5% exclusion amount currently in place.

The Small Business Job Protection Act also created a new type of retirement plan called the Savings Incentive Match Plan for Employees, or SIMPLE. There are two types of SIMPLE’s: a SIMPLE 401(k) and a SIMPLE IRA. The maximum contribution to the SIMPLE is $6,000 in 1997. This amount will be indexed to inflation. If you are an employer and are interested in more information on this topic please call us.

Medical Savings Accounts will be a new trial program for companies with fewer than 50 employees. The program is open only to the first 750,000 companies that apply. The program allows employees to put pre-tax dollars into a savings account to pay for health care expenses and high-deductible medical insurance. The first dollars spent on health care expenses for the year will come from the medical savings account until the applicable deductible is met.Then the insurance company will begin to pay. If the taxpayer participates in any other employer-sponsored health insurance coverage, the Medical Savings Account will not be available. Medical Savings Accounts are only available through a limited number of insurance companies.

Other features of the new tax law allow medical deductions for long-term health care insurance beginning in 1997. The allowable deduction for your long-term health care premium will be based on your age. Unreimbursed long-term care expenses are deductible as medical expenses except where services are provided by family members (unless those family members are licensed health care providers). As with all other medical deductions, the deductible medical expenses will still be limited to the amount that exceeds 7.5% of your adjusted gross income.

The IRS and Congress continue to debate the definition of an independent contractor. One thing seems clear, however: for the independent contractor status to be upheld, there must be some evidence that the independent contractor holds himself/herself out to the public as a business person. This means that the independent contractor might do such things as advertise, solicit business from customers, send out invoices for services performed, and execute sales agreements. It the status of an independent contractor is changed to that of an employee by the IRS, there will be grave consequences for the payer.

The likelihood that your income tax return will be audited has increased by two thirds. Audits of individual tax returns rose to 1.67% of all income tax returns filed. The IRS also is increasing their audits of taxpayers who are self-employed. The percentage of audits for this group is now close to 3%.