What Did the Taxpayer Relief Act of 1997 Do?

The Taxpayer Relief Act of 1997, signed into law by President Bill Clinton, was a major bipartisan tax-reduction act. Its primary objective was to deliver widespread tax relief, with a particular focus on middle-income American families. The act aimed to stimulate the economy by encouraging long-term investment and making education more affordable. It was passed alongside the Balanced Budget Act of 1997, with both pieces of legislation designed to work in tandem to achieve a balanced federal budget. The Taxpayer Relief Act was projected to provide approximately $95 billion in net tax cuts over five years.

Capital Gains Tax Reductions

A central feature of the Taxpayer Relief Act of 1997 was the reduction in tax rates applied to long-term capital gains. A capital gain is the profit from the sale of an asset, like stocks or bonds, held for more than one year. Prior to the 1997 Act, long-term capital gains were subject to a maximum rate of 28 percent.

The Act reduced the top rate on long-term gains to 20 percent and created a new 10 percent rate for individuals in the lowest tax bracket. For the 2025 tax year, long-term capital gains are taxed at 0%, 15%, or 20%, depending on the taxpayer’s income and filing status. High-income earners may also be subject to an additional 3.8% Net Investment Income Tax.

New Home Sale Exclusion Rules

The Taxpayer Relief Act of 1997 fundamentally changed how capital gains from the sale of a personal home were taxed. A single individual can exclude up to $250,000 of capital gain from the sale of their principal residence, and this amount doubles to $500,000 for married couples filing jointly. This benefit can be claimed multiple times, as long as the taxpayer has not used it within the previous two years.

To qualify, a homeowner must meet both ownership and use tests. They must have owned the property for at least two years and lived in it as their primary residence for at least two years within the five-year period ending on the sale date. These two-year periods do not have to be continuous.

This new framework replaced a system that required homeowners to roll over proceeds into a more expensive home to defer tax. It also eliminated a previous one-time exclusion of $125,000 that was only available to taxpayers over age 55.

Creation of Education and Child Tax Credits

A major focus of the Taxpayer Relief Act of 1997 was providing tax relief to families through new tax credits, with benefits targeted primarily at middle and low-income taxpayers. The Act introduced the Child Tax Credit, initially set at $400 per child and increasing to $500 in 1999. For the 2025 tax year, the credit is worth up to $2,000 per qualifying child under age 17, with up to $1,700 being refundable for some families. The credit begins to phase out for single filers with a modified adjusted gross income over $200,000 and for joint filers over $400,000.

The legislation also established two new education tax credits. The Hope Scholarship Credit was later replaced by the American Opportunity Tax Credit (AOTC) in 2009, which provides a maximum credit of $2,500 per student and is partially refundable. The Lifetime Learning Credit offered a broader benefit, calculated as 20 percent of the first $10,000 in educational expenses for a maximum of $2,000 per return. For 2025, this credit begins to phase out for single filers with a modified adjusted gross income between $80,000 and $90,000, and for joint filers with income between $160,000 and $180,000.

Introduction of the Roth IRA

The Taxpayer Relief Act of 1997 introduced a new retirement savings vehicle: the Roth Individual Retirement Account (IRA). Named after its chief legislative sponsor, Senator William Roth, this account offered a different tax structure compared to the traditional IRA. The defining feature of the Roth IRA is its tax treatment. Contributions are made with after-tax dollars, so there is no upfront tax deduction, but qualified withdrawals of both contributions and earnings are completely tax-free. This is the reverse of a traditional IRA, where contributions may be tax-deductible, but withdrawals are taxed as ordinary income.

To make a qualified, tax-free withdrawal of earnings, the account must be open for at least five years, and the owner must be at least 59½ years old, disabled, or using the funds for a first-time home purchase. Contributions can be withdrawn at any time without tax or penalty. Another advantage is that Roth IRAs are not subject to required minimum distributions (RMDs) for the original owner, allowing funds to grow tax-free for life.

For 2025, the ability to contribute is phased out for single filers with a modified adjusted gross income between $150,000 and $165,000 and for joint filers with income between $236,000 and $246,000. The maximum contribution for 2025 is $7,000, or $8,000 for those age 50 and over.

Changes to Estate and Gift Taxes

The Taxpayer Relief Act of 1997 also brought notable changes to the federal estate and gift tax system, designed to reduce the tax burden on the transfer of wealth. The central mechanism for this relief was a modification of the unified credit. The unified credit allows an individual to transfer a certain amount of assets without paying federal gift or estate tax. Before the 1997 Act, the credit shielded $600,000 worth of assets from these taxes.

While the 1997 Act scheduled a gradual increase in this exemption, subsequent legislation has changed it dramatically. For 2025, the federal estate tax exemption is $13.99 million per individual, though this amount is scheduled to be cut by about half at the end of 2025 unless Congress acts. The Act also indexed the annual gift tax exclusion for inflation. For 2025, this exclusion allows an individual to give up to $19,000 to any number of people without filing a gift tax return.