Your Taxes : Changes in Law: Study Them Well

Last summer’s tax law ushered in a host of changes for American taxpayers--from higher rates for the wealthy to little-known breaks for small-business owners and philanthropists. Knowing how the law changed could pay off by providing you with increased deductions and, in some cases, retroactive tax refunds. Here’s a look at some of the changes and how they could affect you.

* New top rate. The top marginal tax rate is now 36% on taxable income above $140,000 for married couples and $110,000 for singles. There’s also a 10% surtax on income over $250,000 for both individuals and joint filers. However, if you must pay more tax because of these new rates, you can elect to pay it in three annual installments. But beware. There are tricks to calculating the installments and to paying the tax, notes Gregg Ritchie, a partner in the personal financial planning group of KPMG Peat Marwick in Los Angeles.

To use the three-year payment plan, you must calculate what your 1993 tax would have been under the old rates and then calculate it using the new rates. The difference, with a few exceptions, is the amount you can elect to pay over the next three years. But if you miscalculate and underpay by even a dollar, you could lose the ability to defer payment of the additional tax, Ritchie says. If in doubt, pay too much and file for a refund later, he says.

* Retroactive break. Self-employed individuals got a retroactive tax break that allows them to write off 25% of the cost of health insurance premiums for all of 1993 and part of 1992. For instance, if you paid $2,000 to buy medical insurance for yourself and your family last year, you would subtract 25% or that cost, or $500, from your income. (You report the cost on Line 26 of Form 1040.) For someone in the 31% tax bracket, that would save $155 in tax.

You can amend last year’s tax return to claim a credit for the last half of 1992 as well. Assuming that your premiums and tax rate were the same, that would net you about $77.50.

* Expenses. Self-employed individuals and small-business owners can now claim up to $17,500 in office equipment purchases, compared to $10,000 under the previous law, says Philip J. Holthouse, a partner at Holthouse Carlin & Van Trigt in Los Angeles. If you spent more than $17,500, the remainder must be depreciated according to a set schedule--usually over five to seven years.

The change provides a substantial break for anyone who bought a lot of equipment in 1993 to start a business and then had taxable income.

* Trust income. Taxes on trust income also soared under the 1993 tax act. But people who have put money into trust accounts can opt to “distribute”--take some of the income out of the trust--if they do it quickly. That would cause the trust income to be taxed at ordinary income tax rates, which could result in substantial savings.

Consider someone who has a trust account for the benefit of a 15-year-old child. If the trust earned $10,000, the earnings would be taxed at the newly created 39.6% rate. But if this person distributed the income to the child before March 6, it would be taxed at the child’s ordinary income tax rate, which is probably 15%, Ritchie says.

(If the child is under age 14, the income would be taxed at the parents’ marginal rates. But unless the parents are exceptionally wealthy, that rate is still likely to be less than the trust tax rates.)

* Alternative minimum tax. More people will fall into the onerous alternative minimum tax system for 1993. The AMT is primarily a concern to high-income Americans who pay high state income taxes and high property taxes. You’re particularly at risk if you recognized a big capital gain during 1993 and live in a state that doesn’t have a separate capital gains tax, such as California, notes Holthouse.

The way the AMT works is you have to calculate your tax liability twice--once under the ordinary income tax system and once under the AMT system, which offers lower overall rates but allows fewer deductions. You then pay whichever amount is higher.

* Appreciated donations. People who make large charitable contributions should also know that the tax law allows them to donate appreciated property without triggering the AMT.

Let’s say you have stock you purchased in 1969 for $100 and it’s now worth $10,000. If you give the stock to charity, you get a $10,000 deduction, which saves you about $2,800 in tax. And neither you nor the charity pays capital gains tax on the $9,900 gain.

* Home office. It wasn’t part of the 1993 tax act, but the rules on home office deductions also tightened last year because of a Supreme Court decision. Now you can deduct home office expenses only if you meet several strict tests. The home office must be your primary place of business, you generally must meet clients there, and you must not use the office for any other purpose.

* Mutual funds. Middle- and high-income filers need to be more careful about how they report mutual fund income this year because of the widened difference between ordinary income tax rates and capital gains rates.

Mutual funds typically distribute both dividend and capital gains income. The dividend income is taxed at your ordinary income rates, which may be 31% or more in 1993. The capital gains are taxed at 28%. But you must fill out a separate form (Schedule D) to get the lower rate.

Time to Get Organized

Regardless of whether you do your own taxes or have them done, getting your records together and putting down your deductible expenses can save you time and money.

Convinced? Here are checklists and a work sheet to help you get organized.

CHECKLIST: What you’ll need to establish your income...and expenses

* W-2s, indicating the wages, salaries and tips you earned in 1993 and the federal, state and local taxes you’ve already paid through employee withholding.

* 1099s, which show earnings from jobs as an independent contractor or that can indicate the proceeds from stock or bond sales. If your 1099 is for securities sales, you’ll also need documentation indicating how much you paid for the security. The difference between what you paid and the amount you sold it for--shown on the 1099--is your capital gain.

* 1099-DIVs, which are provided by mutual fund companies to report your dividend and long-term capital gains or losses.

* 1099-INTs, for interest income you’ve earned in bank and brokerage accounts.

* K-1 forms. If you invest in partnerships, you’ll get a K-1 form, which indicates partnership income and losses.

* SSA-1099s, which report your Social Security income, if any.

* Social Security numbers for you, your spouse and dependents.

* 1098s, showing the mortgage interest expenses you paid during the year. If you refinanced, you may have two or more of these forms. Refinancers will also need loan papers that show how much they paid in “points,” which are deductible over the life of the loan.

* Canceled checks and receipts for charitable contributions.

* Deposit receipts for IRA and Keogh contributions.

* Bills, canceled checks, receipts and-or bank records to calculate self-employment income or losses.

* Insurance papers, appraisals and loss reports to substantiate casualty losses.

* Medical bills, canceled checks and pay stubs (showing health insurance premiums paid through employee withholding) for medical expense deductions.

* Social Security number or employer identification number for your baby-sitter or child care provider, if you paid for child care so that both spouses could work for income.

* Canceled checks for any estimated tax payments you may have made during the year.

WORKSHEET: Fill in the blanks that apply INCOME: Wages (worker No. 1): (worker No. 2): Interest earnings: Dividend earnings: Alimony received: Disability insurance payments: IRA/pension distributions: Annuity income: Lump-sum pension payments: Social Security income: Compensation: State tax refund (received in 1993): Long-term capital gains*: Short-term capital gains: * Gains on securities held for more than a year. Indicate only the net gain, which is the sales price minus the amount you paid for the security.

REAL ESTATE: Mortgage interest paid: Refinancing “points”: --- divided by --- (months of the loan), multiplied by --- (number of months you had the loan in 1993) = --- (1993 “points” deduction.) Interest paid, home equity loan of $100,000 or less: Rental property mortgage expense: Rental property repairs: Depreciation: Rental income: Do you actively manage your rental property, finding and approving renters and arranging property maintenance and repair, yes or no?

Do you earn less than $100,000? (If husband and wife, this indicates combined earnings.), yes or no? If the answer to both of the above questions is yes, you can subtract rental losses of up to $25,000 against ordinary income.

TAXES: Taxes paid: State and local taxes paid in 1993: DMV tax: Disability tax payments: Personal property taxes:

MEDICAL EXPENSES: Health insurance premiums: Unreimbursed portion of doctor/dentist/hospital bills: Medicare-Part B, premiums: Unreimbursed cost of prescription drugs:

OTHER: (Write on a separate sheet figures for all that apply) Casualty losses (minus $100 in insurance proceeds) You can deduct the portion that exceeds 10% of your adjusted gross income. * Investment losses and interest expense * Charitable contributions * Non-cash contributions (clothes, shoes, furniture, food, etc.) List charity name and approximate value of goods donated. If the value exceeds $500, you will have to provide a detailed list. * Union dues * Membership fees and dues * Unreimbursed cost of work-related education * Tax preparation fees (paid in 1993) * Investment counsel fees * Unreimbursed work-related automobile expenses * Unreimbursed cost of business publications * Contributions to deductible IRA, SEP-IRA or Keogh plan * Child care expenses. (Fill in only if you are a single, employed parent or a married couple paying child care expenses for children younger than 13 in order for both parents to work) Name and Social Security/employer ID number of child care provider * Moving expenses (Fill in only if you moved more than 30 miles to your present location)

About This Report

Today’s “Your Taxes” report, Pages D6 through D11, is a guide to preparing 1993 income tax returns. All stories were written by Kathy M. Kristof, The Times’ personal finance columnist.