Complicated, Unnerving Job Lies Ahead : How to Figure Out Your New Tax Form
If you thought the new tax code was supposed to be simple, think again.
For a great many taxpayers, adjusting to the new rules will be a complicated and unnerving process. Tax accountants and H&R; Block will not have to worry about running out of business.
To begin with, all those who prepare tax forms--whether individuals or professional tax accountants--will have to learn the rocks and rills of a new landscape. And on top of that, tax rates will be a hybrid of the old and the new in the transition year of 1987. In 1988, the new rate structure will be in effect.
Apart from the new rate structure, virtually all the new tax provisions will take effect as of 1987. But a few--such as the higher standard deduction and personal exemption and limits on the consumer interest deduction--will be phased in.
The work sheet and instructions that follow on Page 16 are designed to help individuals figure out how the new tax code in effect for 1987 and 1988 will differ from the old rules, which still determine the 1986 tax burden.
Only by April 15, 1988, when taxpayers file their 1987 tax return, will the new rules begin to kick in. And the all-new rate structure will show up only on the tax form filed by April 15, 1989, for the 1988 tax year.
Figuring out what the tax would be if current law remained in effect is complicated by the fact that the tax code is adjusted for inflation. Because most taxpayers will be consulting last year’s tax forms in calculating their taxes or using estimates of this year’s income and expenses, this work sheet relies on the tax code in effect as of 1986 for purposes of comparison.
But in general, preparing the work sheet should provide a realistic look at whether the new tax code bill will be a boon or a bane for you.
INCOME
Wages, salary: Essentially no change. Include all wages, salary and tip income. If your employer is diverting more than $7,000 of your salary into a tax-deferred 401(k) retirement plan, you must increase your 1987 and 1988 income by the excess over $7,000.
Interest income: Unchanged. Include all interest income, except from tax-exempt bonds.
Dividends: The exclusion of $100 in dividend income ($200 for married couples) will disappear. All dividend income must be included in 1987 and 1988.
Capital gains: For 1986, include 40% of your long-term capital gains--profits from the sale of investments held for at least six months. For 1987 and 1988, include all capital gains. Because there will be a special ceiling on the capital gains tax rate in 1987 only, an adjustment for that year will be made later in the work sheet.
Rents, partnerships: No longer will taxpayers be able to offset other income with losses from limited partnerships and other investments in which the taxpayers do not actively participate. The provision is phased in over five years. In 1987, 65% of such losses may be included, and in 1988, 40% may be included.
An exception is allowed for losses related to rental property in which the taxpayer actively participates. People with adjusted gross incomes of less than $100,000 may take as much as $25,000 in rental real estate losses. The allowance is phased out for taxpayers earning between $100,000 and $150,000. For example, a taxpayer with an adjusted gross income of $125,000 may deduct up to $12,500.
Unemployment compensation: The partial exclusion of unemployment compensation will be repealed. Include all unemployment compensation in both 1987 and 1988.
All other income: Most other types of income will remain unchanged, but business income will be affected by the repeal of the investment tax credit, new depreciation schedules and other changes.
Total income: Add all income categories to get total income.
ADJUSTMENTS
Employee business expenses: This adjustment is eliminated starting in 1987, but such expenses will be partially deductible for taxpayers who itemize their deductions. (See miscellaneous deduction below.)
IRA deduction: Taxpayers not covered by pension plans will be allowed to deduct up to $2,000 for contributions to an individual retirement account, with an additional allowance of $250 for a non-working spouse.
But other rules apply if an unmarried taxpayer or either spouse in a family is covered by a pension plan. In such cases, couples with an adjusted gross income of less than $40,000 ($25,000 for singles) will remain entitled to a deduction of up to $2,000 for each worker. The deduction will be phased out for married couples with adjustable gross incomes between $40,000 and $50,000 (between $25,000 and $35,000 for singles). For example, a married couple with an income of $45,000 will be allowed a $1,000 deduction for each spouse who works ($125 for a non-working spouse).
Above those income levels, workers covered by pensions will be ineligible for an IRA deduction.
Deduction for married couples when both work: The two-earner deduction--10% of the adjusted gross income of the lower-earning spouse up to $3,000--will be repealed.
Other adjustments: There will be no change in Keogh plans and most other adjustments, but moving expenses will become a separate itemized deduction.
Adjusted gross income: Subtract adjustments from total income to get adjusted gross income.
ITEMIZED DEDUCTIONS
Medical and dental expenses: Under current law, medical expenses may be deducted only to the extent they exceed 5% of adjusted gross income. The new plan will raise the threshold to 7.5%.
State and local income and property taxes: Fully deductible, just as under current law.
State and local sales taxes: This deduction will disappear.
Mortgage interest payments: Mortgage interest on first and second homes will remain deductible. For 1987 and 1988, taxpayers may deduct interest on all housing-backed loans, regardless of how the money is used, so long as the total amount of outstanding loans does not exceed the purchase price of the home plus the cost of any home improvements. Loans above those limits used for family educational expenses or medical expenses will also be deductible.
Other interest: Consumer interest deductions--auto loans and credit card charges, for example--will be phased out. Only 65% of such interest charges will be deductible in 1987 and 40% in 1988. Interest paid on loans to finance investments will remain deductible, but only up to the amount of a taxpayer’s dividend and interest income. Deductions for any amount above that level will be trimmed by the same percentages as consumer interest deductions.
Charitable contributions: No change for itemizers.
Casualty and theft losses: No change.
Miscellaneous deductions: Miscellaneous deductions for such things as union dues, tax preparation fees, professional journals--as well as deductions for employee business expenses--will be retained only to the extent that they exceed 2% of adjusted gross income. There will be no deduction for the expenses of employees who do some of their work at home and maintain offices there, although home office expenses for independent businesses will be retained as a miscellaneous deduction.
Total itemized deductions: In calculating itemized deductions under current law, the standard deduction--now known as the “zero bracket amount”--must first be subtracted from total deductions. Married couples should use a zero bracket amount of $3,670; singles should use $2,480. Under the new tax system, the standard deduction will no longer be built into the tax tables, and so allowable deductions equal total itemized deductions.
Non-itemizer charitable deduction: Repealed; 1986 is the last year for this tax break.
Non-itemizer standard deduction: Under the proposed new tax code, those who do not have enough deductions to itemize will subtract the standard deduction from adjusted gross income. For 1987, use a standard deduction of $3,760 for a married couple and $2,540 for singles. For 1988, the standard deduction will be $5,000 for married couples and $3,000 for singles. In 1988 (but not 1987), elderly and blind people who are single may add $750 to their standard deduction, and those who are married may add $600.
Personal exemptions: For 1986, the personal exemption for each taxpayer and dependent is $1,080. Under the new plan, it will rise to $1,900 in 1987 and $1,950 in 1988. A family of four, for example, would receive exemptions totaling $7,600 in 1987 and $7,800 in 1988. The extra exemption allowed the blind and elderly would be repealed as of 1987.
Adjustment for capital gains: In 1987 only, the maximum long-term capital gains tax rate will be limited to 28%. Taxpayers with capital gains, therefore, will subtract a portion of their long-term gains to arrive at their taxable income. For those in the 35% tax bracket ($45,000 to $90,000 in taxable income for married couples; $27,000 to $54,000 for singles), enter 20% of the dollar amount listed for long-term capital gains. For those in the 38.5% tax bracket (above $90,000 for married couples; $54,000 for singles), enter 27.3% of the gains.
Taxable income: For current law, non-itemizers should subtract their charitable deductions and personal exemptions from adjusted gross income to calculate taxable income. Itemizers should subtract itemized deductions and personal exemptions from adjusted gross income to calculate taxable income.
For 1987, non-itemizers should subtract the standard deduction, personal exemptions and any adjustment for capital gains from their adjusted gross income to calculate taxable income. Itemizers should subtract their total itemized deductions, personal exemptions and any adjustment for capital gains from adjusted gross income.
For 1988, non-itemizers should subtract the standard deduction and personal exemptions to reach their taxable income. Itemizers should subtract their total itemized deductions and personal exemptions from adjusted gross income to calculate their taxable income.
Tax: To compute taxes owed in each year, use the appropriate tax table. In 1988, high-income couples must remember to extend the top of the 33% tax bracket above $171,090 by exactly $10,920 for each additional personal exemption beyond the first two. Thus, a family of four would still be in the 33% tax bracket until its taxable income reached $192,930. Any family with a taxable income above the level at which its 33% tax bracket ends can calculate its tax very simply--it owes exactly 28% of its taxable income and is not entitled to any personal exemptions.
CREDITS
The new plan would retain the current credits for child-care expenses, but the political contributions credit would be ended.
THE BOTTOM LINE
Most taxpayers should be able to generally figure out the potential effect of the proposed new system on their tax burden by using this work sheet. But heads of household are subject to a different rate structure, and some affluent taxpayers with more complex tax situations could find this work sheet incomplete if they are subject to the new 21% minimum tax.
TAX TABLES
COUPLES FILING JOINTLY
Plus this percent of amount by which income Taxable exceeds lower Year income Pay tax of end of bracket 1986 $0 - 3,670 $0 0% 3,670 - 5,940 0 11 5,940 - 8,200 250 12 8,200 - 12,840 521 14 12,840 - 17,270 1,170 16 17,270 - 21,800 1,879 18 21,880 - 26,550 2,695 22 26,550 - 32,270 3,740 25 32,270 - 37,980 5,170 28 37,980 - 49,420 6,768 33 49,420 - 64,750 10,544 38 64,750 - 92,370 16,369 42 92,370 - 118,050 27,969 45 118,050 - 172,250 39,525 49 172,250 plus 67,553 50 1987 $0 - 3,000 $0 11% New 3,000 - 28,000 330 15 Tax 28,000 - 45,000 4,080 28 Tables 45,000 - 90,000 8,840 35 90,000 plus 24,590 38.5 1988 $0 - 29,750 $0 15% 29,750 - 71,900 4,462 28 71,900 - 171,090* 16,264 33 171,090 plus 48,997 28
SINGLE TAXPAYERS
Plus this percent of amount by which income Taxable exceeds lower Year income Pay tax of end of bracket 1986 0 - 2,480 0 0% 2,480 - 3,670 0 11 3,670 - 4,750 131 12 4,750 - 7,010 260 14 7,010 - 9,170 577 15 9,170 - 11,650 901 16 11,650 - 13,920 1,298 18 13,920 - 16,190 1,706 20 16,190 - 19,640 2,160 23 19,640 - 25,360 2,954 26 25,360 - 31,080 4,441 30 31,080 - 36,800 6,157 34 36,800 - 44,780 8,102 38 44,780 - 59,670 11,134 42 59,670 - 88,270 17,388 48 88,270 plus 31,116 50 1987 $0 - 1,800 $0 11% New 1,800 - 16,800 198 15 Tax 16,800 - 27,000 2,448 28 Tables 27,000 - 54,000 5,304 35 54,000 plus 14,754 38.5 1988 $0 - 17,850 $0 15% 17,850 - 43,140 2,677 28 43,140 - 100,470 9,759 33 100,470 plus 28,678 28
*The 33% bracket is extended by $10,920 for every personal exemption beyond the first two.
Source: congressional Joint Tax Committee, Touche Ross & Co.
