The IRS Restructuring and Reform Act of 1998 (the "Act"), signed into law by President Clinton on July 22, 1998, is an attempt to improve taxpayer service by reorganizing the structure of the IRS. In addition, the Act provides for many taxpayer protections and rights and contains Technical Corrections affecting provisions of the Taxpayer Relief Act of 1997(the "TRA") . Some highlights of the Act follow.

Reorganization

Elimination of 3-Tiered System. In an effort to provide taxpayers with better service, the IRS will create operating units to serve taxpayer groups with similar needs. The IRS has identified four such groups, which are individuals, small businesses, large businesses, and tax-exempts. These operating units will replace the traditional National-Regional-District tiered structure.

Creation of Independent Oversight Board. To provide the IRS with input from the private sector, the administration, execution, and application of the internal revenue laws will now be in the hands of a nine person oversight board consisting of six members from the private sector.

Taxpayer Protections & Rights

Burden of Proof. Except for large partnerships, corporations, or trusts with a net worth greater than $7 million, the IRS will now have the burden of proof in court proceedings as to factual issues relating to income, gift, or estate tax if the taxpayer provides credible evidence and meets certain requirements relating to substantiation, record-keeping, and cooperation with reasonable IRS requests. The taxpayer will still have the burden of proof in administrative proceedings , but taxpayers who appeal IRS audit results may still benefit because settlement offers may reflect the "hazards of litigation", which will increase if the IRS has the burden of proof. Nevertheless, this shift in the burden of proof may not have a significant impact, as cases rarely hinge on who has the burden of proof.

Interest and Penalties. The Act suspends interest and certain time related penalties if the IRS does not give the taxpayer notice of his tax liability within 18 months (12 months after 2003) after a timely filed return.

Innocent Spouse Relief. Obtaining "innocent spouse" status for items attributable to a spouse or former spouse on a joint tax return was made easier by the Act. In addition, a taxpayer may elect to be liable only to the extent a deficiency is attributable to items allocable to him or her.

Technical Corrections & New Provisions

Capital Gains

Netting Capital Losses. The Act addresses how capital losses fit in with the new capital gains rate reductions. There is effectively only one long-term capital gains rate (20%) for most long-term held property, making the TRA netting problem disappear for most taxpayers for all years except 1997. There may be some losers in this tax break because most taxpayers with 28% net capital loss carryovers from 1997 will come up short in 1998 by only being allowed to offset them against income taxed at 20% (after being used to offset short-term gain and, in limited amounts, ordinary income).

Sale of Principal Residence. Taxpayers may now exclude a pro-rata portion of the $250,000 ($500,000 for married couples filing jointly) capital gain exclusion for the sale of a residence owned and used for less than two years. Prior to the Act, a taxpayer could only exclude a pro-rata portion of the gain equal to the fraction of the two years for which the ownership requirement was met.

Example: A single taxpayer realizes a gain of $100,000 upon selling a house after living it for only one year. Under the TRA, the taxpayer could exclude one-half of the $100,000 gain (or $50,000), but under the Act, the taxpayer may exclude $125,000 (one-half of the $250,000 exclusion), thus paying no tax on the gain.

Roth IRA. Upon converting an existing IRA into a Roth IRA, taxpayers can choose not to elect the four- year averaging rule available for 1998 and instead take the entire amount into income for the year of conversion. If a taxpayer elects the four-year averaging rule and takes distributions during that period, the withdrawn amount is included in gross income, together with the amount under the four-year averaging rule.

Unified Credit & Family-owned Business Exclusion. The Act coordinates the increase in the unified credit (from $600,000 to $1 million from 1997 to 2006) with a decrease in the family-owned business exclusion (now a deduction) so that there will be neither an increase nor decrease in the total estate tax on estates holding family-owned businesses as increases in the unified credit are phased in. This and several other changes intend to make it less burdensome for the family to continue the business.

Capital Gains Holding Period. The holding period for long-term capital gains entitled to the 20% capital gains tax rate (10% for taxpayers in the 15% ordinary income tax bracket) has been reduced from 18 months to 12 months, effective retroactively to January 1, 1998.