15 of 18 Studied Would Benefit : Most Californians Seen Gaining in Tax Reform
Most taxpayers would gain from the tax reform proposal that President Reagan submitted to Congress last week, even in relatively high-tax states such as California, where the loss of the deduction for state and local tax payments is expected to hit particularly hard.
An analysis of actual tax returns by a Southern California-based income tax and financial planning firm shows that the impact of Reagan’s proposal, if enacted by Congress, would vary considerably, depending on California taxpayers’ income and mix of tax breaks under current law.
But 15 of the 18 taxpayers analyzed would come out ahead despite the loss of the substantial state and local tax deduction in California. And Reagan’s plan would help narrow the differences in income tax payments among taxpayers with similar incomes, although some disparity would persist.
Some Categories Ahead
The survey by Torrance-based Cal State Associates shows that some categories of taxpayers are most likely to come out ahead under the Reagan program. These include:
--Taxpayers who do not itemize their deductions; they would benefit from the tax rate cuts without losing any of the deductions Reagan would abolish.
--Families with large numbers of children; they would benefit most from the increase in the personal exemption next year from $1,080 under current law to $2,000.
--Taxpayers with more than $100,000 in income; they would benefit the most from the reduction of the top tax rate from 50% to 35%.
--Families whose income comes from only one wage earner; they would lose nothing from the elimination of the special deduction for two-earner families.
Most of the losers under Reagan’s plan can be found in one of these categories:
--Middle-income families with two approximately equal wage earners; the elimination of the two-earner deduction would hit them hardest.
--Couples without children.
--Taxpayers with substantial tax shelters; they would be the big losers from the weeding out of tax breaks.
A separate analysis by the accounting firm of Touche Ross & Co. confirms that a typical two-earner family making about $50,000 could face a modest tax hike under the proposed new tax system. At the same time, it found, the nearly two-thirds of taxpayers who do not itemize deductions would receive a substantial percentage cut in their taxes.
But for taxpayers who itemize, forecasts are more difficult. With many taxpayers having some characteristics that would help them under the Reagan plan but others that would hurt them, the actual outcome would depend on individual circumstances.
The White House plan, moreover, contains several features that make it all but impossible to determine the exact impact on taxpayers next year, when the package would begin to take effect if it managed to clear Congress this year.
For one, the lower tax rates would not become effective until next July 1, but many tax breaks would be eliminated at the beginning of the year. For another, the plan, instead of immediately eliminating certain tax shelters, would get rid of them only gradually.
For purposes of simplicity, the analysis performed by Harry Hudson of Cal State Associates assumed that the full effect of the Reagan tax package would begin on Jan. 1, 1986. In fact, unless Congress changes the plan, the gains would be less next year--and the losses would be greater--because the rate cuts would not go into effect until six months after several deductions were eliminated and the personal exemption and zero-bracket amount were boosted.
Hudson also adjusted current tax law to the rates that are expected in 1986 so that the figures would be comparable to the proposed tax plan. Because the tax code has been adjusted for inflation starting this year, those who examine their 1984 tax returns would find that their tax payments last year were somewhat higher than they would be with the same income in 1986.
Tax Shelter Investor
Among the 18 taxpayers analyzed by Hudson, one of the three who would lose under the Reagan plan is a middle-income family with one child that has invested heavily in a tax shelter. The family would have to pay 14% more in taxes--unless, of course, it switched its investments to other forms of tax shelters that would be preserved under the Reagan plan.
A more typical loser is a family with three children whose father made about $32,000 last year and whose mother earned about $28,000. (See chart on Page 16.) Under current law, this family would pay $6,344 in 1986; the Reagan tax package would require it to pay $307 more.
The third loser is a two-income family in the middle-income range with two children that, under the Reagan plan, would no longer benefit by itemizing its deductions. But it would lose only $69 or 2.5% of its tax payment under current law.
Touche Ross also found two-earner families to be the likeliest losers. A four-member family with one spouse earning about $33,000 and the other $17,000, it found, would lose $105, or about 3%, under the White House plan.
But most taxpayers would benefit from Reagan’s changes. Even for many families whose taxable income rose, actual tax payments would fall because of the tax rate cuts.
Consider a single taxpayer with $33,500 in income and itemized deductions of $8,280 more than the “zero-bracket amount” (the amount of taxable income, $2,480 in this case under current law, whose tax rate is zero). Under current law, her taxable income would be $24,250 and she would pay $4,153 in taxes. Under the Reagan plan, her taxable income would rise to $26,636, but her taxes would drop by 11% to $3,699.
A childless family in which one spouse earned about $38,000 and the other earned about $15,000 (see chart) would also save money, but only a relatively small amount. Even though the couple would no longer have enough tax deductions to itemize, it would save $219, or 2.5%.
High-income families who have not sheltered a large portion of their income from taxes would generally do well under the Reagan proposal.
A one-earner couple with one child and a total income of about $123,000 would pay income tax of $27,714 under current law on taxable income of $91,760. But under the Administration plan, the family’s taxable income would rise to $101,377, but its federal tax obligation would fall to $24,981, a 10% savings. The main reason: Its top tax rate would fall from 42% to 35%.
The Reagan tax plan would help reduce the wide disparities that current law permits in the tax payments of taxpayers with similar incomes.
Cal State Associates found that, under current law, an actual two-earner couple with two children would pay $6,203 in taxes on an adjusted gross income (before deductions) of $40,282. But a similar actual family with adjusted gross income of $44,886 would pay only $5,013--almost $1,200 less--thanks to its substantial itemized deductions. The Reagan plan would mean a tax payment of $4,847 for the lower-income and $4,825 for the higher-income family.
For many taxpayers, the two key tax breaks that would be eliminated by the White House proposal are the deduction for state and local taxes and the “marriage penalty” deduction of up to $3,000 for families with two wage earners. The Treasury Department estimates that loss of these two deductions would cost taxpayers more than $40 billion in 1987, the first year the entire tax plan would be largely in place.
But in return for the loss of these deductions, taxpayers would save $49.5 billion through lower rates and another $39 billion as a result of the boost in the personal exemption.
The tax plan has some other features that would affect great numbers of taxpayers, but not nearly as substantially. They include:
--A tax on employer-paid health insurance. Under this provision, which would affect more than 80% of all taxpayers, taxpayers would have to pay tax each year on $120 worth of employer contributions to individual health insurance premiums and on $300 in contributions to family insurance plans.
--A limit on miscellaneous deductions. Under current law, tax preparation fees, union dues, safe-deposit box fees and certain employee business-related expenses are fully deductible, but the Reagan plan would allow a deduction only to the extent that they exceeded 1% of adjusted gross income.
And beyond those provisions, the Reagan plan would eliminate some tax breaks that prove highly advantageous to smaller numbers of taxpayers. For example, it would eliminate income averaging, which saves money for taxpayers whose income suddenly spurts, and it would prevent parents from shifting large amounts of income to children under 14 to take advantage of the children’s lower tax bracket. HOW THREE FAMILIES WOULD FARE The Torrance income tax and financial planning firm of Cal State Associates analyzed the impact of President Reagan’s tax reform package on its own clients. It compared what its clients would pay in 1986 under current tax law with what they would pay under the Reagan plan, assuming the entire Reagan plan took effect at the start of the year. (In actuality, under the Reagan plan, the first-year savings would be somewhat less and the loss somewhat more, because the tax rate would not be cut until six months after the deductions were eliminated.) CHILDLESS COUPLE A childless couple with about $53,000 in income, CSA found, would pay 2.5% less under the Reagan tax reform package than current tax law. In this family, the husband earned about $38,000 and the wife, $15,000.
Current Reagan law proposal Wages $52,936 $52,936 Taxable health insurance 0 300 Taxable dividend income 0 8 Two-earner deduction -1,491 0 Adjusted gross income 51,445 53,244 Itemized deductions State and local taxes -4,868 0 Mortgage interest -1,406 -1,406 Charitable contributions -371 -371 Miscellaneous -1,478 -949 Zero-bracket amount 3,670 4,000 Total itemized deductions 4,453 0 Personal exemptions -2,160 -4,000 Taxable income 44,832 49,244 Tax 9,030 8,811 Savings 219 Percent savings 2.5%
$60,000 FAMILY A $60,000 family with three children, by contrast, would experience a 4.8% tax increase. Although its personal exemptions would rise by nearly $5,000, it would lose substantial itemized deductions and its entire two-earner deduction, which would be nearly the maximum $3,000. One parent earned $32,000 and the other, $28,000.
Current Reagan law proposal Wages $60,037 $60,037 Taxable health insurance 0 300 Two-earner deduction -2,803 0 Individual Retirement Account -4,000 -4,000 Partnership loss -700 0 Taxable dividend income 0 136 Adjusted gross income 52,534 56,473 Itemized deductions State and local taxes -3,906 0 Mortgage interest -4,450 -4,450 Other interest -2,693 -2,693 Charitable contributions -1,955 -1,955 Miscellaneous deductions -1,336 -771 Zero-bracket amount 3,670 4,000 Total itemized deductions -10,670 -5,869 Personal exemptions -5,400 -10,000 Taxable income 36,464 40,604 Tax 6,344 6,651 Loss 307 Percentage loss 4.8%
$126,000 FAMILY A four-member family with income of $126,000, all but $7,000 of it earned by the husband, would reap a 6.6% tax cut.
Current Reagan law proposal Wages and interest $126,018 $126,018 Taxable health insurance 0 300 Two-earner deduction -692 0 Individual Retirement Account -4,000 -4,000 Short-term capital loss -1,105 -1,105 Business expenses -1,004 0 Adjusted gross income 119,217 121,213 Itemized deductions State and local taxes -12,530 0 Mortgage interest -15,789 -15,789 Other interest -4,410 -4,410 Charitable contributions -435 -435 Miscellaneous deductions -196 0 Zero-bracket amount 3,670 4,000 Total itemized deductions -29,690 -16,634 Personal exemptions -4,320 -8,000 Taxable income 85,207 96,579 Tax 24,962 23,303 Savings 1,659 Percentage savings 6.6%