Business Band-Aid The 1997 Taxpayer Relief Act offered small doses of relief.

Hailed as a major tax-reform package by both Congress andPresident Clinton, the Taxpayer Relief Act of 1997 promised to makelong-overdue improvements to an ailing tax system. But three yearslater, it's clear the law made only a minor difference forbusinesses.

At least that's the consensus shared by most BIZ Experiencessand tax experts. Perhaps it's because the law is actuallyintended to provide more relief to middle-income parents with kidsthan to BIZ Experiencess running businesses. It created a special taxcredit for each child parents have under age 16 and currentlyoffers a number of education credits and deductions forcollege-bound kids.

Another major cornerstone of the law is a reduction in the toptax rate on capital gains for individuals, from 28 percent to 20percent. (The reduction went to 10 percent for taxpayers in thelowest income bracket.) While it was the first time in 16 yearsthat a new tax law provided some tax relief for both individualsand businesses, the size of that relief-some $95 billion incuts-was relatively small compared to the 1981 tax law thatprovided $750 billion in tax reductions.

"Given the revenue constraints of a tax package that size,there's only so much that can be done," says Phil Wiesner,a partner in the Washington, DC, national tax office of KPMG. Evenso, a handful of tax changes in the '97 law turned out to besteps in the right direction for businesses, he adds.

Joan Szabo is a writer in Great Falls, Virginia, who hasreported on tax issues for more than 13 years.

Bigger Deductions

One provision in the law especially beneficial to self-employedindividuals increased the deduction they can take for the cost ofhealth insurance for themselves, their spouses and theirdependents. Under the change, the deductible amount graduallyincreases over a number of years, so that 100 percent of the costis deductible by 2003. This year, self-employed individuals areallowed to deduct 60 percent of the amount paid for thesepremiums.

Although the change is helpful, it doesn't address aninequity in the tax code faced by the self-employed, saysaccountant Debbi-Jo Horton of DJ Horton & Associates inWarwick, Rhode Island. Namely, the fact that this group ofentrepreneurs must still pay a hefty self-employment tax on theamount they pay for health coverage as compared to incorporatedbusiness owners not subject to the self-employment tax. (Theself-employment tax of 15.3 percent consists of 12.4 percent forSocial Security and 2.9 percent for Medicare.)

Horton explains how this works: The self-employed must deductthe cost of health insurance premiums on the front of their 1040tax return, which in effect reduces the income tax they owe. Butthis deduction doesn't affect the self-employment tax they mustpay, which is computed on Schedule SE. "If a self-employedindividual is paying $10,000 annually for health insurance, he orshe is paying the self-employment tax of 15.3 percent on the costof the insurance," Horton explains.

Another important change for BIZ Experiencess with home offices isthe liberalization in the deduction for those offices, says Horton.Under the '97 law, business owners who keep records, scheduleappointments and perform other administrative or managementactivities from their home offices qualify for deductions as longas they don't have other fixed places of business where theyperform a large amount of administrative or management work.However, the other requirements of the home-office deductioncontinue to apply, including the requirement for exclusive andregular use of the home office for business.

According to Horton, this change was especially beneficial.Before the change, many BIZ Experiencess thought that even though theyhad a home office, they didn't qualify for the deduction. Withthe liberalization, there is a clear definition of what constitutesa home office, making it possible for more business owners toqualify for deductions, she contends.

Stocking Up

Another helpful change for small-business owners was an increasein the Section 179 expensing provision for equipment purchases. Asa result of the '97 law, BIZ Experiencess can now take a largerdeduction for the equipment they purchase. For property placed inserv--ice during 2000, the '97 law allows for a deduction of upto $20,000 in purchases of qualifying property. The expensing limitis scheduled to increase to $24,000 for 2001 and 2002, and to$25,000 for 2003.

This provision was especially beneficial for Cheryl WatkinsSnead, president, founder and CEO of Banneker Industries inLincoln, Rhode Island. Founded in September 1991, the companyprovides supply chain management services to manufacturers.Watkins-Snead, 41, says she took advantage of the provision topurchase material- handling equipment (like forklifts).

The expensing provision also benefited Terri Bowersock, owner ofTerri's Consign & Design Furnishings in Mesa, Arizona. Herfurniture business has grown into a franchised and corporate-ownedchain with 16 superstores nationwide and sales of $26 million in1999. Sales are expected to hit $30 million in 2000. Bowersock, 43,says she took advantage of the provision to purchase a fewadditional trucks.

Although the changes in the expensing provision were helpful,additional work needs to be done to improve the existing limit,says Horton. Under the expensing provision, if the total cost ofqualifying property placed in service during a taxable year exceeds$200,000, the $20,000 limit is reduced dollar for dollar by thecost of qualifying property exceeding $200,000. For smallmanufacturing companies that spend hundreds of thousands of dollarson equipment annually, the $200,000 limit is a problem, Hortonsays, because it effectively scales back the deduction. Theexisting limit should be increased at least to take into accountthe rate of inflation.

Retire Right

The '97 law also expanded the availability of IRAs andestablished the Roth IRA. With a Roth IRA, contributions made tothe accounts are nondeductible, but withdrawals are tax-free aslong as certain conditions are met. Although Horton says the RothIRA is attractive to many taxpayers, only time will tell whetherthese new retirement accounts are as beneficial as they appear tobe.

The jury may be out on their effectiveness, but Roth IRAs havesucceeded in causing confusion among taxpayers, says Horton."Some taxpayers were trying to take their $2,000 contributionfor a traditional IRA and then make another $2,000 contribution toa Roth IRA, which simply isn't allowed," she explains.

Nevertheless, Watkins-Snead says she recently established a RothIRA for herself. This type of account is good for her, becauseshe's not yet offering her 12 employees a retirement plan, onthe other hand, Bower-sock provides her employees with a 401(k)plan, because unlike they would with a Roth IRA, her employees areable to make pretax contributions, which reduces taxableincome.

Next Up

All in all, the '97 law seems to have brought about"further complexity to a tax code that is already verycomplex," says Wiesner. Lawmakers have indicated they want tocreate a simpler tax code, but still haven't delivered. Soalthough liberalization of the home-office deduction is beneficial,"It still created a new set of rules that have to bemet," Wiesner continues. "As a result, the cost ofgetting limited relief is more complexity."

Looking to the future, both tax experts and business ownersbelieve additional changes in the tax code are necessary. "Forbusiness owners to receive major relief, there need to be moreacross--the-board cuts," says Wiesner.

Bowersock would like to see serious consideration of tax lawsthat are beneficial for the economy and growing businesses.Proponents of such proposals say that by simplifying the tax systemand cutting top rates, efficiencies would be gained for businessowners. Such proposals seem appealing, but an overhaul of the taxsystem isn't likely to be considered until a new president andCongress are in place in January 2001.

Contact Sources

• Banneker Industries, info@banneker.com, www.banneker.com;

• DJ Horton & Associates, 2008 Warwick Ave., Warwick,RI 02889, (401) 737-9355;

• Klyneld Peat Marwick Goerdler LLP, pwiesner@kpmg.com;

• Terri's Consign & Design Furnishings, (480)969-1121, fax: (480) 969-5052.