How Tax Changes Affect Middle Class
U.S. legislators are weighing plans to significantly reduce the tax bite for middle-income families. But their discussions provide little help to middle-class families about to file their 1991 returns.
Although some relatively minor details have changed over the past year--some deductions have been lost while other tax breaks were slightly enhanced--those earning between $30,000 and $100,000 are likely to find their tax liability similar to 1990’s.
The specific changes that are likely to affect middle-income families:
* Standard deductions were hiked for the 1991 tax year--to $3,400 for singles from $3,250 in 1990 and to $5,700 for married couples filing jointly, from $5,450. The head-of-household deduction was boosted to $5,000 from $4,750.
* Personal exemptions rose to $2,150 from $2,050.
* Tax tables were indexed for inflation, so if your income stayed constant, you’ll pay slightly less tax. For example, a single person with $30,000 in taxable income will pay $5,762 in federal tax for 1991 versus $5,879 for 1990.
* Some tax breaks were also indexed for inflation. For example, allowable contributions to 401(k) retirement plans rose to $8,475 for the 1991 tax year compared to $7,979 in 1990. This amount can be taken out of a participant’s paycheck before tax and is not considered taxable income.
On the other hand, certain deductions have been eliminated.
* Consumers can no longer deduct any interest expenses for personal loans--on cars, boats, credit cards, etc. For the 1990 tax year, they could still deduct 10% of these interest expenses.
* Investment interest expenses--such as the amount you pay to buy stocks on margin--are now only deductible to the extent of investment income. For 1990, you could deduct 10% of such expenses, up to $10,000, against ordinary income as well.
* Similarly, passive activity writeoffs--such as losses on tax shelters and rental properties--can now be deducted only to the extent that you have passive activity gains.
Most other tax rules affecting middle-income families have remained fairly constant.
As a result, those whose circumstances have changed little over the past year might choose to fill out their own tax returns this year. If they use last year’s as a guide, it should be fairly simple.
However, changes in the economic environment may have spurred some taxpayers to change their finances and thus their taxes.
For example, those who refinanced mortgages last year should be aware of some rules relating to the deductibility of mortgage interest and “points”--the upfront fees you pay to get the loan.
Usually deductible when you first take out a mortgage, points aren’t generally fully deductible when you refinance.
The only exception: If you borrow more than your mortgage balance to make home improvements, the points associated with the additional loan amount are immediately deductible. But the points on the portion of the loan that was simply refinanced are not, and must instead be amortized over the life of the loan. (In the case of a 30-year loan, 1/30 of the points related to the refinance are deductible each year.)
Consider a family with a $100,000 mortgage. They get a new 30-year loan for $200,000 and use the extra $100,000 to add a second story. Of the $4,000 they pay in points, $2,067--$2,000 plus 1/30 of the remaining amount--is deductible on their 1991 return.
All their mortgage interest expenses are also deductible, but any other miscellaneous fees--such as appraisal and application charges--are not.
Individuals who closed savings accounts to buy into mutual funds during the year may also need to grapple with complex tax issues.
Near year-end, mutual funds often distribute dividends: Some of the amount may be a return of long-term capital gains, some a return of invested capital and some dividend income.
Investors need to know which category these distributions fall into before reporting them on their tax returns because some could be tax-exempt and others subject to capital gains taxes.
