PERSONAL FINANCE / KATHY M. KRISTOF : Cushioning Clinton Plan Pitfalls
The ink is barely dry on President Clinton’s tax package, and already accountants are coming up with a myriad of strategies to help clients work around some of the more onerous tax hikes or take advantage of new entitlement programs included in the bill.
What can you do? Here’s a look:
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Q: What should I do if I’m part of a low-income family?
A: Although the bill technically won’t affect you until 1994, if your family earns less than $28,000 and you have children, get familiar with the earned income tax credit.
The credit, a special entitlement program for working parents with dependent children, has been simplified, bolstered and made more widely available in the Clinton plan.
The credit currently has three tiers, giving you some money for just having kids, some for paying for their health insurance and a bit more if you have an infant.
Under the new law, there will be just one tier. But it should be more generous and made available to families earning a bit more--up to $28,000 for those with two children in 1994, compared to about $22,000 now. Eligibility and the amount of the credit will rise with inflation in future years.
It’s important to note that you don’t have to pay federal income tax to qualify for the credit. You simply have to fill out the forms, and--if you qualify--Uncle Sam will send you a check.
For the 1993 tax year, the credit will follow current rules. But in 1994, it will be restructured according to the new law. For more information about the credit, ask the Internal Revenue Service to send you a copy of their publication No. 596. It can be ordered through the IRS’s toll-free hot line by calling (800) 829-3676.
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Q: What should I do if I’m middle-class, earning less than $100,000?
A: You’re definitely affected, but some of the impact is indirect and difficult to quantify.
The one direct impact is gasoline taxes, which rise by 4.3 cents per gallon. That would probably cost between $20 and $30 annually for someone driving an economy car an average of 10,000 miles a year. It may also cause modest increases in the cost of bus rides and the cost of consumer goods trucked or shipped to market from far away.
But aside from carpooling--which can make sense under any circumstances--the tax hike isn’t big enough to go to great lengths to avoid it.
However, if you are a middle-income retiree or someone who falls into the onerous alternative minimum tax, the effect could be much greater.
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Q: How does it affect middle-class retirees?
A: If you’re collecting Social Security payments, more of your Social Security income may be taxable.
Currently, those earning more than $25,000 individually or $32,000 as a couple pay tax on 50% of their Social Security income. Under the new law, there will be a second Social Security tax bracket for those earning more than $34,000 individually or $44,000 as a couple. These people will find 85% of their Social Security income taxed to the extent that it exceeds the new thresholds.
In other words, only 50% of the amount between $25,000 and $34,000 is taxed for single filers, but any amount above that is 85% taxable.
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Q: What does that mean in dollars and cents?
A: A couple earning $90,000--$70,000 from pensions and investments and $20,000 from Social Security--currently pays $2,800 tax on their Social Security benefits. Under the new law, that would rise to $4,760, says Stephen R. Corrick, partner with the accounting firm of Arthur Andersen & Co. in Washington.
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Q: What can retirees in this income bracket do?
A: You may want to shift money out of municipal bonds--a favorite tax-favored investment--because interest earned on these bonds could make more of your Social Security income taxable. How so? No matter what your age, municipal bond income is not federally taxable. But, when you’re trying to figure out how much of your Social Security benefits are taxable, you have to add municipal bond income into your adjusted gross income.
If your total “modified adjusted gross income”--that’s taxable income plus normally non-taxable interest earnings--adds to more than the threshold amount, it makes a portion of your Social Security income taxable.
Better investment vehicles, from a tax standpoint, are growth stocks that don’t generate dividends, and savings bonds, which don’t generate taxable income until they mature.
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Q: What’s the alternative minimum tax and am I really at risk of falling into it if I’m simply middle-class?
A: The AMT is a separate tax system that is designed to sock rich people who have a lot of deductions. Theoretically, though, everybody is supposed to calculate it. In fact, you’re supposed to calculate your tax liability twice--once based on the ordinary 1040 system, the other time based on the AMT system. The AMT system takes away many of your itemized deductions, but calculates your tax at a lower income tax rate. In the end, you’re supposed to pay whichever amount is higher--your tax based on the regular system or the tax you’d owe under the AMT system. But, since so few people have traditionally fallen into AMT, most people just ignore it.
But because the AMT rate jumps significantly with the Clinton plan--moving it to 26% from 24% for income under $175,000, closer to ordinary tax rates--more middle-income families are likely to fall into it, particularly if they live in high-tax states such as California, New York, Oregon and Massachusetts. That’s because state taxes are deductible under the ordinary income tax system, but they aren’t under AMT. You’re also at risk if a good portion of your income comes from capital gains or if you’ve got a substantial home equity loan that wasn’t used for home improvements.
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Q: What do I do if I fall into the AMT?
A: If you’re at risk, you’d be wise to talk to a tax adviser about how you can restructure your income or deductions to avoid the AMT. You may want, for instance, to defer some capital gain income. Or, you might want to time your deductions to come in a year when more of your income comes from wages than capital gains.
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Q: What can I do if I’m in a high-income household?
A: Your planning options are probably the best of all. Under the Clinton plan, households with taxable income of $115,000 individually or $140,000 filing jointly will get hit with higher taxes right away. But you can reduce the bite by contributing the maximum amounts possible to tax-deferred retirement plans, such as 401(k)s, Keoghs and Individual Retirement Accounts. You can also invest in municipal bonds, which pay tax-free interest earnings.
If you have kids, consider shifting more income to them. If the children are over the age of 14, they’ll get taxed at their own rates--probably 15% versus your 36% to 44% effective rate.
Many companies are also expected to make deferred-pay plans available to high-ranking executives. Additionally, income from incentive stock options would be taxed at lower capital gains rates, so some companies may stress this form of compensation over higher salaries in the future.
And, finally, when it comes to charitable giving, you’d be wise to give appreciated property rather than cash. That’s because you can get a deduction for the market value of the contribution but you won’t have to pay capital gains taxes on the appreciation.
Business and the Tax Bill Winners Small companies buying equipment: Can write off in one year up to $17,500 for purchases;current limit is $10,000.
* Investors in small firms: Company with assets of less than $50 million sells stock. Investor who buys and holds it for five years pays tax on just 50% of profits.
* Commercial airlines: Exempt for two years from the fuel tax increase.
* Buyers and sellers of luxury gifts: The 10% tax is repealed on jewelry and furs costing more than $10,000, boats over $100,000, and private aircraft over $250,000. Tax remains on cars costing more than $30,000, but will be adjusted for inflation.
* Big spenders for research: Tax credit, which had expired, is made retroactive to July 1, 1992 and forward to June 30, 1995. Company gets credit of 20% of its research and development spending in excess of average outlays for the base period 1984-1988.
* Real estate agents, brokers, developers: Professionals in real estate, working at it more than 750 hours a year, can get a tax deductions for their losses in real estate investments they don’t personally manage. Deduction can be offset against all income.
* Companies hiring people in poor neighborhoods: Empowerment Zones created in areas where poverty rate is 20%. Company gets a tax credit of 20% of worker’s salary, up to a maximum credit of $3,000 (for a salary of $15,000).
* Losers Big corporations: Top tax rate for profits over $10 million goes to 35% from 34%.
* High-income individuals and richest small business owners (sole proprietors, partnerships, S corporations, where profits become personal income of the owner): Top personal tax rate goes to 36% for incomes above $115,000 for individuals and $140,000 for couples. Hits top 4% of business owners.
* Those who “Do Lunch”: Business tax deduction for meals, tickets to sporting events, and shows, and other entertainment, cut to 50% from current level of 80%. Club dues no longer deductible at all.
* Gasoline users: Tax on gasoline and diesel fuel increases by 4.3 cents a gallon.
