Plan Would Reduce Bills for 63%; Varies for Others

For almost two-thirds of the nation’s 100 million taxpayers--the 63% who file a basic return without itemizing deductions--President Reagan’s tax reform proposal looks like a winner. By offering big cuts in tax rates, plus a near-doubling in the personal exemption, Reagan’s plan would reduce their federal income tax bills.

For the substantial minority of taxpayers who do itemize their deductions, on the other hand, the impact of the plan would vary dramatically, depending on how much use an individual taxpayer now makes of the myriad credits and deductions scattered through the 10,000 pages of the federal tax code.

Most individual taxpayers at all earnings levels would enjoy some savings, and 2 million low-income Americans would have their federal income tax obligation entirely eliminated under Reagan’s proposal.

For example, a family of four now pays no federal income taxes unless its income exceeds $9,575 a year. If the Administration’s plan is enacted by Congress, such a family would not pay taxes next year unless its income reached $12,798.

Moreover, all families with children would be given a financial boost through the dramatic expansion of the personal exemption to $2,000 a person, up from $1,040. And the personal exemption, along with the standard deduction and the tax brackets, would continue to be adjusted to take account of inflation.

In addition, the current credit for child care expenses would be converted into a tax deduction of $2,400 per child, or $4,800 for two or more children. That would increase the provision’s benefits for upper-income families but could represent a slight erosion of benefits for some less affluent families.

And the elderly, blind and disabled, who already enjoy special tax advantages, would be given additional savings.

Although all taxpayers would gain from lower rates and larger exemptions, those who itemize could lose a number of potentially valuable deductions--perhaps the most important being the right to deduct state and local income, sales and property taxes. Particularly hard hit would be residents of states that impose high taxes, including California, New York, Michigan, Minnesota, New Jersey, Oregon and the District of Columbia.

In measuring the impact of this deduction, “the big variable is the price of the home,” said Stephen R. Corrick, tax partner at the Washington office of Arthur Andersen & Co., a major accounting firm. The more valuable the home, the higher the property tax bill--and the bigger the deduction.

Vacation Property

Taxpayers who itemize also would lose much of the financial benefits from buying vacation homes, transferring stocks and savings accounts to their children and participating in real estate tax shelters under Reagan’s proposal. But the mortgage deduction on an owner-occupied home would remain intact, and taxpayers who itemize deductions would continue to fully deduct charitable contributions.

In addition, the special deduction for a married couple when both spouses work, worth up to $3,000 now, would be abolished.

Those who are unable to work and receive disability income would be taxed on that income for the first time, although the proposal would raise the threshold at which they would begin paying taxes on total income. And the unemployed, whose benefits now are partly taxed, would be required to count all of their benefits as income.

Why does the President propose these restrictions on deductions and credits? He is committed not only to simplifying the current tax code but also to revising it without lowering--or raising--federal revenues, and the curtailment of present deductions is necessary to help offset the impact of lower individual tax rates. (In addition, the Reagan plan calls for a partial shifting of the tax burden from individuals to businesses.)

Some Would Expand

But not all of Reagan’s tax proposals are designed to cut back on tax benefits; some would expand them.

For example, the current capital gains exclusion would be narrowed slightly, but because of lower rates, the effective top rate of taxation on profits from the sale of stocks, bonds and other assets would be cut from the current 20% to 17.5%

The earned income credit for low-income families would be expanded, and it would be indexed to rise with inflation.

In addition, even though the disabled would be required to pay taxes on their disability income, they would receive an expanded tax credit that also would be targeted at the elderly and blind.

The credit would boost the point at which an elderly couple with average Social Security income would begin paying federal taxes from the current $18,990 to $19,500. It would raise the tax-free level of income for a disabled single person from $9,383 to $10,400 and would mean that a blind person who is married and has no Social Security income would not have to pay taxes until he has earned more than $17,667, compared with the current threshold of $7,990.

Social Security Tax

The plan also makes no changes in the current taxation of Social Security for relatively affluent beneficiaries, who are required to pay tax on half of their Social Security if their income is above $25,000.

Under Reagan’s plan, the current complex system of 15 tax brackets, ranging from 11% to 50%, would be collapsed into just three levels, 15%, 25% and 35%. As with the present tax system, these rates would be “progressive.”

That is, for families filing joint returns, the 15% rate would apply on the first $29,000 of taxable income, the 25% rate would apply to additional income up to $70,000, and the 35% rate would apply to income above $70,000.

The lowering of rates, along with the increased personal exemption, would wipe out income taxes for the 2 million poorest taxpayers, Administration officials said Wednesday. For a single person, the first $4,900 in earnings would be tax-free, compared with the current $3,560, while the tax-free cutoff for a couple would be raised to $8,000 from $5,830.

No one with earnings below the official poverty line, now $11,400 for a family of four, would pay any federal income tax under the reform plan. “That’s a downright liberal idea,” said Lawrence M. Axelrod, tax manager at the Washington office of a major accounting firm, Touche Ross & Co.

Lower at All Levels

Even when tax obligations begin, the rates paid would be much lower for all income levels than under current law. Only when family income exceeds $70,000 would the maximum rate of 35% be applied. In contrast, the tax code now levies a 33% rate when family income reaches $35,200.

But the price paid for these lower rates would be the shrinking or outright elimination of some cherished benefits:

--Today, workers whose employers provide them with medical insurance pay no taxes on this fringe benefit, which economists regard as a form of income. Under the Reagan plan, the first $120 a year of health insurance premiums paid by an employer would be counted as part of the worker’s taxable income, and for families the first $300 a year in employer-paid health insurance premiums would be taxable.

However, the current deduction for medical expenses that exceed 5% of a taxpayer’s income would remain unchanged.

--At present, taxpayers can deduct any and all interest payments that they make for any purpose, from financing vacation homes, boats or new cars to paying off credit cards. Under the President’s plan, the mortgage interest deduction for a taxpayer’s primary residence would remain untouched--a recognition of the political reality that two-thirds of Americans are homeowners. But deductions for other interest payments would be limited to $5,000 more than investment income.

Rental Deduction

For rental property that is directly owned, the interest deduction would be continued, but houses and apartments could become less attractive as investments under Reagan’s plan because the cost would have to be written off in smaller, inflation-adjusted annual deductions--spread over 28 years instead of the current 19 years.

--Tax shelters, notably those in which an investor buys a share in a real estate project, also would lose some of their luster. A participant now is allowed to take deductions even larger than the actual number of dollars he puts into the deal, while the Administration proposal would limit deductions to the amount of money “at risk.” Other provisions would also reduce the attractions of tax shelters, but they would continue to flourish because several proposals offered under the original Treasury plan were dropped.

--The present exclusion on the first $100 of dividend income ($200 for a joint return) would be repealed.

--Income averaging, which provides a break for taxpayers whose income abruptly increases, would be repealed.

--In another category, many upper-income taxpayers with funds to spare now reduce their tax burden by giving cash or stocks to their minor children, who obviously are in a much lower tax bracket. Reagan’s reform plan would wipe out the advantage of such a move by requiring that any earnings in the children’s account of more than $2,000 a year be taxed at the parents’ rate.

Set-Aside Plans

--Restrictions would be placed on salary set-aside plans, in which employees can put aside up to $30,000 a year tax-free for their retirement years and the employer is permitted to make matching donations. Keogh retirement plans for self-employed individuals would be unchanged from current law.

These popular retirement plans would be limited to an $8,000 a year tax-free contribution by the worker. And the size of the contribution would be reduced by the amount of an employee’s contribution to an Individual Retirement Account. For affluent one-earner families, the Administration offers a boost in the amount that can be deposited in an Individual Retirement Account. The limit for a non-working spouse, now $250, would be raised to $2,000--the same as for a working spouse.

“This is a bone to the country-club set,” Axelrod said. “Most people can’t afford IRAs--they need the cash.” HOW THREE FAMILIES WOULD FARE Using the Reagan Administration’s description of President Reagan’s tax reform package, The Times calculated that a hypothetical single taxpayer earning $15,000 in 1986 and a hypothetical family of four earning $25,000 would pay less in federal income taxes than if current tax law remains in effect next year. But a $40,000 couple with no children would pay more. SINGLE TAXPAYER The hypothetical $15,000 single taxpayer receives employer-financed health insurance and contributes $200 to charity but does not itemize deductions.

Reagan Current law package Wages $15,000 $15,000 Taxable health insurance 0 300 Adjusted gross income 15,000 15,300 Charitable contribution deduction -50 0 Personal exemption -1,080 -2,000 Taxable income 13,870 13,300 Tax 1,697 1,560

FAMILY OF FOUR In the hypothetical $25,000 family of four, there are two wage earners, one earning $20,000 and the other $5,000. The family contributes $500 to charity, and the larger wage earner has employer-provided health insurance. The family does not itemize deductions.

Reagan Current law package Wages $25,000 $25,000 Taxable health insurance 0 300 Two-earner deduction -500 0 Adjusted gross income 24,500 25,300 Charitable contribution deduction -75 0 Personal exemption -4,320 -8,000 Taxable income 20,105 17,300 Tax 2,390 1,995

$40,000 FAMILY The hypothetical $40,000 family has two wage earners, one at $30,000 and the other at $10,000, but no children.

Reagan Current law package Wages $40,000 $40,000 Taxable health insurance 0 300 Two-earner deduction -1,000 0 Individual Retirement Account -2,000 -2,000 Adjusted gross income 37,000 38,300 Itemized deductions: State and local taxes -3,500 0 Mortgage and other interest -8,000 -8,000 Charitable contributions -800 -800 Zero-bracket amount 3,670 4,000 Total itemized deductions -8,630 -4,800 Personal exemption -2,160 -4,000 Taxable income 26,210 29,500 Tax 3,665 3,875