Taxpayer Relief Act of 1997 Definition

What Is the Taxpayer Relief Act of 1997?

The Taxpayer Relief Act of 1997 was one of the largest tax-reduction acts in U.S. history. The legislation reduced tax rates and introduced some new tax credits that remain in place today. Now-familiar concepts such as the child tax credit and the Roth IRA were introduced with this act.

The measure comprehensively reformed the Internal Revenue Code, making more than 800 changes. At the time of its passage, the act was estimated to constitute a $95.3 billion tax cut over the ensuing five years.

Understanding the Taxpayer Relief Act of 1997

The benefits of the Taxpayer Relief Act were directed mainly to middle- and low-income taxpayers. Many of its provisions, such as the child tax credit and the education credit, were phased out at higher income levels.

President Bill Clinton signed the Taxpayer Relief Act of 1997 on Aug. 5, 1997. The new tax policy has since provided billions of dollars in tax relief for individuals and small business owners.

Some Benefits of the Taxpayer Relief Act of 1997

Overall, the act offered substantial tax relief for parents, college students, investors, homeowners, small business people, and retirees. A number of now-familiar tax benefits were introduced with the 1997 act, including the child tax credit and the Roth retirement account option.

Parents of minor children benefited from the new child tax credit introduced by the act. The credit was introduced in 1998 at $400 per child under age 17 and increased to $500 in 1999.

The American Rescue Plan raised the child tax credit in 2021 from $2,000 to $3,000 per child for children between the ages of 6 and 17, and $3,600 per child for children under the age of six. The credit is available for married couples filing jointly who earn up to $150,000, or $112,500 for a family with a single parent (or Head of Household).

Most recently, the credit returned to $2,000 in 2022, though the refundable portion has undergone changes. In 2022, the refundable portion was $1,500; beginning tax year 2023, up to $1,600 of the credit may be refundable.

Education Credits Introduced

The act established the legal basis for education savings accounts, which allow parents to save for future college expenses with tax-free gains and withdrawals for educational purposes.

In addition, the act created the Hope Tax Credit and the Lifetime Learning Credit for college students. The Hope Credit is now known as the American Opportunity Tax Credit, which provides tax credits up to $2,500 each year per eligible student. The 1997 act also established a deduction for the first $2,500 of student loan interest paid each year for federal loans.

Capital Gains Tax Lowered

The act significantly reduced capital gains taxes for investors in several ways. The top marginal long-term capital gains rate fell from 28% to 20%, and the 15% bracket was lowered to 10%. It also extended the time frame that a taxpayer would need to hold an asset to qualify for the lower long-term capital gains tax rates from 12 to 18 months. 

Since the act, these rates have changed. For 2022 and 2023, the long-term capital gains tax rate is 0%, 15%, or 20% depending on the income bracket of the taxpayer as well as their filing status. Short-term capital gains are now taxed at the filer's ordinary income tax level. Short-term is again defined as less than a year.)

The 1997 act exempted from taxation any capital gains on the sale of a personal residence up to $500,000 for married couples filing jointly and $250,000 for single individuals. This exemption applies only to residences taxpayers have occupied for at least two of the last five years. It can be claimed only once every two years.

The Roth IRA and More

Other big changes introduced in the 1997 act:

• The Roth individual retirement account was created. This variation on the IRA allows taxpayers to pay into a retirement account using after-tax dollars but withdraw the money after retirement with no additional taxes owed on the contributions or the profits earned on them.
• The estate tax exemption was raised to $600,000 and was set to increase to $1 million by 2006. For 2022, the exemption was $12.06 million. For 2023, the exempt has increased to $12.92 million.
• The annual gift tax exclusion of $10,000 was required to be adjusted annually for inflation. For 2022, the gift tax exclusion limit is $16,000. For 2023, the gift tax exclusion limit is $17,000.

The Bottom Line

The Taxpayer Relief Act of 1997 brought about major changes to the tax code. Through education credits, relief for homeowners selling their house, and extra incentives to save for retirement, taxpayers received a number of tax reduction opportunities. Many of these opportunities, though adjusted for inflation over the years, still remain in place.