TAX CUTS: HOW THEY MIGHT AFFECT YOU : Q & A : Parents and Seniors to Get Best Breaks
The tax bill passed by the House Wednesday would provide a windfall to parents and senior citizens, while granting more modest breaks to investors, savers, owners of troubled real estate and to married couples.
But advisers warn against making any swift moves that bank on the changes. The bill is likely to be amended several times and many of the most generous tax breaks scaled back before the plan becomes law.
“I can’t stress enough that this is much further from being enacted than it sounds,” says Gillian Spooner, partner at KPMG Peat Marwick in Washington, D.C.
Nevertheless, many experts believe the bones of the bill will remain intact. Who is slated for the biggest breaks? Which tax changes are most likely to succeed? How would the bill affect your taxes? A look.
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Q: How does this bill benefit senior citizens?
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A: There are six provisions to watch:
* It would gradually eliminate the 1993 tax hike on Social Security benefits that makes up to 85% of these government stipends taxable.
* It would raise the amount seniors--age 65 to 69--could earn before their Social Security benefits are scaled back. (Currently, you lose $1 in Social Security benefits for every $3 in wages you earn over $11,280. That would be increased gradually to $30,000 by 2000.)
* It would provide a $500 tax credit for taxpayers who take in parents or grandparents who are “physically or mentally incapable of self-care.”
* Those who bought long-term care insurance could include the cost of premiums as health expenses, which are deductible once they exceed 7.5% of income.
* Those who are terminally or chronically ill don’t have to pay tax on income received under their life insurance contract or for the sale or assignment of a life insurance contract. This affects the terminally ill at any age.
* The bill also would boost the amount of money and property you could leave to your heirs tax free to $750,000 from the current $600,000, over three years.
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Q: How would the bill provide a windfall to parents?
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A: First it would provide a $500 tax credit for each dependent child under the age of 18, without reducing any other current tax breaks for parents, including personal exemptions, the earned income tax credit, the child-care credit and dependent-care accounts, according to the House Ways and Means Committee.
Second, if you adopt a child, the House bill would allow you to reduce your tax dollar for dollar until you recoup up to $5,000 in legal adoption expenses. The adoption credit would not apply to those adopting stepchildren or those involved in a surrogate childbirth, however.
The adoption credits would be phased out for parents with combined income of $60,000 and eliminated for those earning $100,000 or more. The $500 “family tax credit” would be reduced for those earning more than $200,000 and eliminated for parents earning $250,000 plus.
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Q: What’s the difference between a credit and a deduction?
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A: A credit is far more generous than a deduction because it’s a dollar-for-dollar reduction in the tax you owe. On the other hand, a deduction reduces your taxable income. So, for someone in the 28% bracket, a $1 deduction saves only 28 cents in tax, while a $1 credit reduces their tax by $1.
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Q: What about capital gains? Is the rate coming down?
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A: Technically, separate capital gains rates will be eliminated and replaced by a complicated computation, says Nancy Anderson, manager of technical services at H&R; Block and co-author of the H&R; Block Tax Guide. The good news is no matter what your tax bracket, the computation will result in paying less in capital gains taxes.
The 28% capital gains rate would be replaced by a new rule that says you figure your total capital gain, cut it in half, and then pay ordinary income taxes on the result.
In other words, if you had $10,000 in capital gains and $3,000 in capital losses, you would net them out to find you had a total gain of $7,000. Divide that in half. You pay income tax on the $3,500 result.
If your income tax rate is 28%, your tax would amount to $980 (14% of the $7,000 gain) vs. $1,960 (28%) under current law. For taxpayers in the 39.6% bracket, the effective capital gains rate would be 19.8%, Anderson says.
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Q: What about indexing capital gains for inflation?
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A: According to the bill, property acquired after Dec. 31, 1994, would be indexed to inflation. You’d only pay capital gains if the investment returned more than the inflation rate. However, indexing is given a poor chance for survival because its cost could soar over time.
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Q: How does the bill help owners of troubled real estate?
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A: It would make a loss on your personal residence deductible. The bill proposes to treat a real estate loss just like a capital loss. You could subtract the loss from capital gains. If you had no capital gains, or your real estate loss exceeded your gains, you could use up to $3,000 in real estate losses each year to reduce your ordinary income.
However, losses recognized after 1995 would be reduced by 50%, just like capital gains.
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Q: I heard the bill would eliminate the marriage penalty. How would that work?
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A: Under current law, two-income married couples pay more tax than two singles with identical income. The House proposal would reduce the difference by a maximum of $145 annually by creating a new tax credit. You’d get the credit by computing your tax twice--once as a married couple filing jointly and once by filling out separate returns for each spouse, claiming just the standard deduction and one personal exemption on each return. If the second calculation results in a lower tax bill, you get to claim a credit of up to $145. If not, there’s no reduction. Unaffected would be the marriage benefit of the current law, which gives a married couple a lower effective tax rate than an unmarried couple if one spouse has much less income than the other.
However, “The people who are really hurt by the marriage penalty are paying several thousand dollars more per year,” says Philip J. Holthouse, partner at Holthouse Carlin & Van Trigt in Los Angeles. “They are not even going to notice the $145.”
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Q: How are savers helped by the bill?
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A: It would allow qualifying married couples to deduct up to $4,000 in contributions to Individual Retirement Accounts, even if one spouse wasn’t working. Currently, single-income married couples are only able to deduct $2,250 in IRA contributions annually.
Second, it would create a new type of IRA, called an “American Dream Savings Account.” Contributions to this account would not be deductible, but income earned on your savings would not be taxable if you left the money in for five years or more and used the proceeds for a variety of allowable activities, such as education, a first-time home purchase, medical expenses, long-term care insurance and, of course, retirement.
