The Many Complications of Being Rich

Last year’s tax legislation promised to give poor families a tax break at the expense of the rich. And that had some wealthy folk fretting about their upcoming tax bills.

But despite all the hoopla, the wealthy--those who earn between $100,000 and $250,000--are not likely to see a significant difference in their 1991 tax liability. However, very rich families could end up paying several thousand dollars more than in prior years, as their tax rates are likely to rise by less than 2 percentage points overall.

To illustrate, consider a hypothetical couple earning $215,000 in wages and investment earnings. This couple reported itemized deductions of $71,000 and had no dependents. In 1990, this couple would have paid roughly $38,028.50 in federal tax. For the 1991 tax year, their tax will jump by all of $157 to just over $38,185.

A similar couple earning $515,000, who had $201,000 in itemized deductions, would have paid $87,920 in federal tax during 1990. Their 1991 tax bill will rise to $94,315--an increase of $6,395.

High-income filers also face increasing complexity of the tax system. Many more will be forced to hire professional tax preparers this year to cope with altered rules and the additional forms. Those who opt to fill out returns on their own are likely to spend additional hours at the job.

Some of the changes that have introduced this grander level of complication:

* Individuals earning more than $100,000 and couples earning more than $150,000 will have to fill out a separate eight-line work sheet to determine the deduction for their personal exemptions. For everyone else the personal exemption deduction is standard--$2,150 per person.

But high-income filers lose 2% of the personal exemption deduction for every $2,500 their income exceeds the threshold. So a couple with $175,000 in income would be $25,000 over the threshold, which means they would lose 20% of the value of their personal exemptions ($25,000 divided by $2,500 equals 10, times 2 percentage points).

* Those who earn more than $100,000--regardless of whether they are single or married filing jointly--will need to fill out another 10-line work sheet to determine how much their itemized deductions are worth. For everyone else, the value of itemized deductions are also standard: For every dollar you spend on mortgage interest, charitable contributions and state taxes, you can deduct a dollar.

High-income filers, however, will have to reduce these itemized deductions by 3% of their adjusted gross income above $100,000. So someone who earned $300,000, would lose $6,000 of the deductions for these items--3% of the amount over $100,000. Deductions for medical expenses and casualty losses are exempt from the reduction.

* The alternative minimum tax rate rose in 1991 to 24% from 21%, which means far more individuals will need to calculate whether they fall into the AMT trap. The alternative minimum tax is a parallel but separate tax system that kicks in when individuals have high amounts of certain types of writeoffs, such as unusually large deductions for state and local taxes or miscellaneous expenses.

If taxpayers believe that they are at risk of paying the AMT, they need to calculate their tax both under the normal system and under the AMT system, which allows full credits for certain deductions and little or no credit for others. Then they pay the higher tax.

In essence, calculating the AMT is like doing your tax return twice.

In addition, if high-income families report any capital gains, that income will be taxed at a different rate than their ordinary income. In 1991, the top capital gains rate is 28%, while the top income tax rate is 31%.

Then too these new changes are added to alterations made during the past five years that have made taxpaying more ponderous.

For example, since 1987, taxpayers have had to categorize their interest expenses to determine the deductible amount. For the 1991 tax year, the only interest expense that is deductible against ordinary income is mortgage and home equity interest charges.

Investment interest expenses can only offset investment gains. Interest from “passive” activities can only offset passive gains. These too are minor changes from the previous tax year. In 1990, individuals could generally deduct 10% of their personal interest, investment interest and passive activity interest against ordinary income.