The Tax Law Changes For 2000 Tax Returns?

Unlike the extensive changes of the previous two years, there was no major tax legislation signed into law during 2000. As a result, the rules for 2000 are pretty much the same as 1999, with the exception of changes that had already been scheduled under the previous tax law revisions. The changes more likely to apply to our readers are covered in the subsequent sections below, which are separated by topic.

Of course, there are the usual changes in tax brackets, standard deductions and personal exemptions, which increase annually based on inflation. There are also increases in amounts linked to previous law changes, such as the Child Tax Credit (now $500), the above-the-line deduction for Educational Loan Interest (now maximum of $1,500) and the Adjusted Gross Income level at which IRA contribution deductions phase out for those who are participants in an employer retirement plan (up $1,000 from last year, for each status except Married Filing Separately.)

As to when we are likely to see another major tax law change, most experts don't see a large likelihood of that happening in the year 2001, at least given an almost equally divided Congress.

B. Capital Gains

The rules and rates for capital gains essentially remain unchanged from 1999: Long term (sale of property held more than a year) gains are taxed at no more than 20% (10%, to the extent that your total income keeps you in the 15% marginal rate), with the exception of collectibles, recapture of depreciation, and otherwise tax-favored gains on certain (Sec. 1202) stock.

However, keep in mind that the 1997 act contained capital gain provisions that won't become effective until 2001 (or 2006, depending on your tax bracket). Specifically: Unless Congress makes changes beforehand (which is entirely possible, see leadoff story in this issue), there will be a third category of holding period, for sales after 12/31/2000. Investments ACQUIRED after a QUALIFYING DATE (see next paragraph), held no less than FIVE years from that date, and sold no earlier than January 2001, would be subject to a maximum rate of 18% (if 20% would otherwise apply) or 8% (if 10% would otherwise apply, because all income falls within the 15% marginal tax bracket.)

The "qualifying date" will be 1/1/2001 for someone who is in a marginal tax rate HIGHER than 15%. Therefore, in practice, such people would have to wait until 1/1/2006 to achieve the 18% rate. To further add complications to this, someone who acquires property before 1/1/2001 may ELECT to treat it as property acquired ON 1/1/2001, providing they recognize any appreciation in value (i.e., pay tax on any gain, as if they had sold it) as of 1/1/2001. They then wait another five years to sell, for any subsequent gain to get the lower 18% rate.

Thankfully, the rules are a bit easier for those who are in a 15% marginal rate, including the gain on the sale. There is no "qualifying date" for them, so any property sold January 2001 or after AND which was held for five years or more, would qualify.

C. Deduction for Business Use of Your Home

One provision of the 1997 tax act, which was delayed to be effective for years AFTER 1998, greatly relaxes the rules that must be met in order to deduct business use of your home.

The major change is the elimination of the rule that required the office be the "principal place of business" ... the place where you meet with customers OR the place where you generate most of your income. That is NO LONGER required.

In place of that rule, a simple test requires that the use of the office be an "ordinary and necessary" expense for the business and, unless this is the only fixed location of the business, it must be the only place available where you can perform the necessary "administrative or managerial" functions of the business.

Note that this does not change the requirement that the office must be used "totally and exclusively" for the business, and have NO other use whatsoever. This is very strictly interpreted, and ANY degree of non-business use will disqualify the office. (Theoretically, if you have your computer in your home office, and sometimes use the computer to track personal investments, surf the web, or play an occasional game of Solitaire, ANY of those activities can cause you to lose ALL deductions for use of the home office for the year.)

Also, if the use of the office is as an employee, that use must clearly be for your EMPLOYER'S CONVENIENCE, not yours. If you are provided a suitable place to work by your employer (even if that means a 25 mile drive to the office in the middle of the night, when you are on-call to return customer emergency calls), that precludes you from claiming deductions for use of your home.

Note that, if your office in home qualifies for a deduction under the revised laws, it can be considered a "place of business" for determining your deductible business mileage. It would NOT be non-deductible commuting.

D. Roth IRAs

If you convert an existing IRA to a Roth IRA after 1998, the taxable portion of the transaction is included in your income IN FULL in the year of conversion. (The election to "spread it over four years" only applied for conversions completed by 1998.)

And, under a recent ruling by the IRS, a 1998 conversion may be "recharacterized" (i.e., reversed, as if it never happened) anytime up to 12/31/99.

For 1999 and future years, a conversion to a Roth IRA may be recharacterized anytime up to October 15 of the following year. (Your return does NOT have to be on extension, but an amended return will likely be necessary, if it is not.)

"Stop Smoking" clinic fees are now deductible as medical expenses, under guidance released during 1999 by the IRS. Unlike in the past, it is no longer necessary that the smoking be "aggravating" any other condition. Also included are deductions for prescription medications used to stop smoking, but not "over the counter" items such as normal-strength nicotine gum or "the patch." The new guidance is retroactive to all open years, so, if this would have provided a significant saving, you can file amended returns (1996 can be amended until 4/15/2000.)

The only other change is an increase in the percentage of qualified medical insurance premiums that may be deducted "above the line" by self-employed individuals. That increases to 60% for 1999 as well as, based on current schedules, 2000 and 2001.

E. "Points" On New Home Mortgage

Under previous guidance, qualifying "points" paid by you (or the seller) on the purchase of your home were considered current year deductions, on Schedule A. If, along with all of your other itemized deductions, you did not have enough on Schedule A to itemize, and instead claimed the standard deduction, you lose any tax benefit that the points would ever provide.

In a ruling during 1999, effective for all open years, the IRS clarified that the current year deduction of those points is not mandatory. The taxpayer can make an ELECTION (which must be attached to the return for the year the points were paid) to amortize the points over the life of the loan. That would allow the taxpayer to get a small benefit (better than nothing) for the points over future years.

Example: Fred and Wilma buy a home together in November 1999, paying $6,000 in points. However, their total itemized deductions don't come to more than the $7,200 standard deduction they would be entitled to receive for 1999, so they do not file Schedule A. Their accountant files an election on that return to amortize the points over the 30 year life of the loan, at the rate of 1/360 per month. Since two months passed in 1999, 2/360ths of the points are deemed to have been claimed, even though they did not itemize in 1999. They can deduct 12/360ths of the points ($200) each year, for the next 29 years, and the final 10/360ths in the final year.

Keep in mind that any unamortized points can be claimed in full, in the year you sell the house or refinance the original mortgage.

F. Standard Mileage Rate

For mileage driven in 2000 the rate allowed is 32.5 cents. For mileage driven in 2001 the rate is 34.5 You are required to keep documentation that can show your mileage for each of those periods.