Business Glossary

Individual:adjusted gross income (AGI) less itemized deductions and personal exemption. After taxable income is derived, the tax to be paid can be determined by looking at the tax rate schedules.Corporation:gross income less allowable business deductions.

legislation that redefined life insurance and raised taxes on life insurance companies. Among the provisions were new rules for some life insurance products, including a definition of flexible premium life insurance, and an increase in life insurance company taxes. Congress was concerned that a policyholder could take a substantial amount, say $1 million, and, after putting a few dollars toward a life insurance premium, put the remainder into a tax-free investment vehicle. One of two tests had to be satisfied for a policy to qualify as life insurance: (1) the cash surrender value policy could not exceed a net single premium, and (2) the death benefit had to represent a certain percentage of the cash value, which declined as the policyholder got older. For example, at age 40, the death benefit must be 140% of cash value. The second rule closed a loophole on tax-free withdrawals from annuities. Prior to 1982 annuity holders could withdraw their initial premium tax free at any time. The 1982 code decreed that any money withdrawn from an annuity would be considered income first and would therefore be taxable.

The older 1959 tax code devised a shorthand formula for determining taxes paid by insurers. The formula worked when interest rates were low, but as they soared, insurers found ways to reduce the increased tax bite. The 1982 code introduced a stopgap measure designed to raise taxes on life insurers by $3 billion.

postponement of taxes on investment or other earnings until the investor begins to consume them and anticipates being in a lower tax bracket. One example of a tax-deferred investment is an Individual Retirement Account (IRA). Earnings accumulate tax free until the account holder retires after age 59½. At that time, taxes must be paid on the earnings as money is withdrawn from the account. Other examples of tax deferred investments are insurance products such as annuities and various types of whole life insurance such as variable life and universal life. The tax reform act of 1986 limited the use of IRAs, making insurance products one of the few taxdeferred investments still available.

interest earned on dividends from a participating life insurance policy left on deposit with the insurance company and subject to taxation.

legislation enacted by Congress as part of the Deficit Reduction Act of 1984 to reduce the federal budget deficit. The following are highlights from the more than 100 provisions in the Act:

1. shortened the minimum holding period for assets to qualify for long-term capital gains treatment from one year to six months.
2. allowed contributions to be made to an Individual Retirement Account no later than April 15 after the tax year for which an IRA benefit is sought; previously the cut-off was the following October 15th.
3. allowed the Internal Revenue Service to tax the benefits of loans made on below-market, interest-free, or "gift" terms.
4. tightened income averaging requirements.
5. set a $150 per capita limit on the amount of Industrial Development Bonds that a state could issue in a year, and permitted interest to be tax-exempt only for certain "small issues."
6. retained the 15% minimum tax on corporate tax preference items as in the tax reform act of 1976, but increased from 15% to 20% the deduction allowed for a tax preference item.
7. restricted golden parachute payments to executives by eliminating the corporate tax deductibility of these payments and subjecting them to a nondeductible 20% excise tax.
8. required registration of tax shelters with the Internal Revenue Service and set penalties for failure to comply. Also set penalties for overvaluing assets used for depreciation in a tax shelter.
9. expanded rules in ERTA to cover additional types of stock and options transactions that make up tax straddles.
10. repealed the 30% withholding tax on interest, dividends, rents, and royalties paid to foreign investors by U.S. corporations and government agencies.
11. raised the liquor tax, reduced the cigarette tax, and extended the 3% telephone excise tax.
12. delayed to 1987 the scheduled decline in estate and gift taxes.
13. granted a specific tax exemption for many fringe benefits.
14. extended mortgage subsidy bonds through 1988.
15. required Alternative Minimum Tax quarterly estimated payments.
16. changed the rules affecting taxation of life insurance companies.
17. disqualified from eligibility for long-term capital gains tax the appreciation of market discounts on newly issued Original Issue Discount bonds.
18. real estate depreciation was lengthened from 15 to 18 years.
19. delayed implementation of new finance leasing rules until 1988.
20. restricted the sale of unused depreciation tax deductions by tax exempt entities to companies that can use the deductions.
21. phased out the graduated corporate income tax on the first $100,000 of income for corporations with income over $1 million.
22. created Foreign Sales Corporations (FSCs) to provide American companies with tax deferral advantages to encourage exports.
23. limited tax breaks for luxury automobiles to a maximum writeoff of $16,000 in the first three years of ownership.
24. increased the earned income tax credit for lower-income taxpayers from 10% to a maximum of 11% of the first $5,000 of income.
25. eliminated the tax on property transfers in a divorce.
26. increased the standard automobile mileage rate from 9 cents a mile to 12 cents a mile for expenses incurred in volunteer charity work.
27. tightened rules and increased penalties for those who try to inflate deductions by overvaluing property donated to charity.

dividends of a participating life insurance policy deemed by the Internal Revenue Service to be a return of a portion of premiums and thus not subject to taxation.

retirement vehicle permitted under section 403 (b) plan of the U.S. Internal Revenue Code for employees of a public school system or a qualified charitable organization. Under such an agreement, the maximum annual contribution is $4500. Cash values and dividends accrue but are not taxed until the annuitant actually receives benefits. At that time, the annuitant is taxed only on the amount that exceeds the investment in the annuity. Should the annuitant receive a monthly benefit under one of the various annuities, the percentage of each payment that would not be subject to taxation is determined by the exclusion ratio:

where the expected return under the annuity equals the life expectancy of the annuitant × the annual income payment.

For example, if an annuitant invested $40,000 in an annuity, and at age 60 has a 14-year life expectancy, and receives an annual income of $5000, then 57.14% of each income payment would not be subject to taxation.

means of ending a pension plan only for reasons of business necessity, following IRS regulations. If the IRS determines that the plan was terminated for other reasons, employee and employer contributions become taxable. Reasons acceptable to the IRS include bankruptcy, insolvency, and the inability of a business to continue to make its contributions because of adverse financial conditions.

landmark federal legislation enacted that made comprehensive changes in the system of U.S. taxation. Among the law's major provisions:
Provisions Affecting Individuals

1. lowered maximum marginal tax rates from 50% to 28% beginning in 1988 and reduced the number of basic tax bracket from 15 to 2-28% and 15%. Also instituted a 5% rate surcharge for highincome taxpayers.
2. eliminated the preferential tax treatment of capital gain. Starting in 1988, all gains realized on asset sales were taxed at ordinary income rates, no matter how long the asset was held.
3. increased the personal exemption to $1,900 in 1987, $1,950 in 1988, and $2,000 in 1989. Phased out exemption for high-income taxpayers.
4. increased the standard deduction, and indexed it to inflation starting in 1989.
5. repealed the deduction for two-earner married couples.
6. repealed income averaging for all taxpayers.
7. repealed the $100 ($200 for couples) dividend exclusion.
8. restricted the deductibility of IRA contributions.
9. mandated the phaseout of consumer interest deductibility by 1991.
10. allowed investment interest expense to be offset against investment income, dollar-for-dollar, without limitation.
11. limited unreimbursed medical expenses that could be deducted to amounts in excess of 7.5% of adjusted gross income.
12. limited the tax deductibility of interest on a first or second home mortgage to the purchase price of the house plus the cost of improvements and amounts used for medical or educational purposes.
13. repealed the deductibility of state and local sales taxes.
14. limited miscellaneous deductions to expenses exceeding 2% of adjusted gross income.
15. limited the deductibility of itemized charitable contributions.
16. strengthened the Alternative Minimum Tax (AMT), and raised the rate to 21%.
17. tightened home office deductions.
18. lowered the deductibility of business entertainment and meal expenses from 100% to 80%.
19. eliminated the benefits of clifford trust and other incomeshifting devices by taxing unearned income over $1,000 on gifts to children under 14 years old at the grantor's tax rate.
20. repealed the tax credit for political contributions.
21. limited the use of losses from passive activity to offsetting income from passive activity.
22. lowered the top rehabilitation tax credit from 25% to 20%.
23. made all unemployment compensation benefits taxable.
24. repealed the deduction for attending investment seminars.
25. eased the rules for exercise of Incentive Stock Option (ISO).
26. imposed new limitations on salary reduction plan and Simplified Employee Pension (SEP) Plans.

Provisions Affecting Business
27. lowered the top corporate tax rate to 34% from 46%, and lowered the number of corporate tax brackets from five to three.
28. applied the Alternative Minimum Tax (AMT) to corporations, and set a 20% rate.
29. repealed the investment tax credit for property placed in service after 1985.
30. altered the method of calculating depreciation.
31. limited the deductibility of charges to bad debt reserves to financial institutions with less than $500 million in assets.
32. extended the research and development tax credit, but lowered the rate from 25% to 20%.
33. eliminated the deductibility of interest that banks pay to finance tax-exempt securities holdings.
34. eliminated the deductibility of greenmail payments by companies warding off hostile takeover attempts.
35. restricted completed contract method accounting for tax purposes.
36. limited the ability of a company acquiring more than 50% of another firm to use Net Operating Losses to offset taxes.
37. reduced the corporate dividend exclusion from 85% to 80%.
38. restricted tax-exemption on municipal bond to public purpose bond and specified private purpose bond. Imposed caps on the dollar amount of permitted private purpose bonds. Limitedprerefunding. Made interest on certain private purpose bonds subject to the AMT.
39. amended the rules for qualifying as a Real Estate Investment Trust (REIT) and the taxation of REITs.
40. set up tax rules for real estate mortgage investment conduits (REMICs).
41. changed many rules relating to taxation of foreign operations of U.S. multinational companies.
42. liberalized the requirements for employee vesting rules in a company's qualified pension plan, and changed other rules affecting employee benefit plans.
43. enhanced benefit of Subchapter S corporation status.

tax levied on the transfer of property or money made without adequate legal consideration. This tax is imposed on the donor of a gift and is based upon the fair market value of the property as of the date of transfer. Under the law, each parent may give each recipient $11,000 a year ($22,000 for parents electing gift-splitting) without gift tax consequences. Also, gifts between spouses are untaxed.