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Tactics For The New Tax Hikes


Personal Business: Taxes

TACTICS FOR THE NEW TAX HIKES

If you haven't yet figured out whether you will owe more income taxes under President Clinton's new budget, try looking at it this way: If you and your spouse do not make at least $180,000 a year, you don't have to worry about higher rates. The new 36% levy kicks in at $140,000 of "taxable income" for couples--that's minus about $40,000 in deductions and exemptions that folks at these levels can usually subtract. To reach the top stated marginal rate of 39.6% at $250,000 in taxable income, you would probably have to earn over $300,000 a year.

Many tax professionals do not subscribe to the dire predictions of some Republicans. Except for high-income individuals and high-income corporations, the consequences aren't that severe, says Eileen O'Connor, senior tax manager at Grant Thornton's office of federal tax services. You can no longer deduct private club dues, your medical payroll tax might go up, and business meals will be only 50%--instead of 80%--deductible. But this doesn't come close to the havoc the loophole-closing 1986 Tax Reform Bill wreaked on many upper-income taxpayers.

Of course, there is one group--not necessarily classified as affluent--that will feel a bigger bite. Married retirees who earn more than $44,000 a year ($34,000 for single filers) will have to pay taxes on 85% of their Social Security benefits in 1994. The old law taxed only 50% of Social Security for couples and individuals with income above $32,000 and $25,000, respectively.

LOST CHANCE. For those of you who will pay more taxes next year, there is not a lot you can do to minimize the additional burden. Most of the long-term strategies suggested by financial planners and tax advisers are things you should have been doing anyway: investing in tax-free bonds and making use of tax-deferred retirement programs. Take advantage of flexible spending accounts offered by some employers to pay for child care and medical expenses in pretax dollars. Consider purchasing tax-favored insurance products, such as annuities. As for short-term strategies, since the tax is retro- active to Jan. 1, 1993, the opportunity to save big by shifting income into this year--on the theory it will be taxed at lower rates--is gone.

But tax experts have been scrambling to come up with ways to shave at least a few dollars off their clients' bills. One promising area could provide some respite to taxpayers earning in the range of $100,000 to $300,000, the levels at which many of the new taxes kick in. Traditional financial planning wisdom has it that one should defer income and deduct as much as possible to pay as little as you can in taxes each year. Now, for some taxpayers, it may be smarter to bring on income and defer the deductions, says George E.L. Barbee, executive director of client services at Price Waterhouse. A new era in tax preparation has begun that he calls "threshold planning."

The first step is to figure out how much you owe and try out a few maneuvers. "Without running the numbers, you can't tell whether moving money around between thresholds makes sense," says Barbee. For example, if you are self-employed and earn more than $135,000 from your business, you will have to pay 2.9% of your entire earnings for the medical payroll tax in 1994. The old law only required tax on the first $135,000 of earnings. So instead of deferring income until 1994, you might want to move income into this year. "If you are self-employed, collect on bills sooner, get more orders in this year," says Steve Corrick, a tax partner at Arthur Andersen. "Save deductions until 1994." But if you are right on the $135,000 threshold, you might still be better off deferring income--despite the additional medical payroll tax--so you're not subject to the 36% rate.

One reason it is important to make the calculations is that many of the thresholds come into play on different lines on your tax forms. For example, couples with children begin to lose some of the benefit of deductions once "adjusted gross income" (before deductions and exemptions) gets above $108,450. But exemptions don't begin to phase out until "taxable income" (after deductions and exemptions) gets above $162,700. Both these pieces have been in place for a while, but the new legislation makes them permanent. Comparing the phaseouts "is like comparing apples and oranges and bananas," says Barbee.

STAY CLEAR. Families may be able to avoid losing the benefits of deductions and exemptions by shifting some income into another year, at least putting off the tax bite for next year. But the most important tax to avoid is the alternative minimum tax (AMT), says Barbee. This tax disallows many itemized deductions so the wealthy can't avoid paying their fair share in taxes. It is determined by a complicated formula rather than an income threshold. Under the new laws, it rises to 26% or 28% from 24% now. "It is truly a calculation that someone has to make," Barbee says. "If you are close to it, you might be able to work your way out of it with good tax planning."

Tax experts are also scrutinizing new laws intended to stimulate business by giving consumers and investors a tax break. The applications are not clear yet, but don't be surprised if your adviser suggests you do the following:

n Seek out capital gains. When the top marginal rate was 31%, high earners could save 3% by shifting income into accounts that produced capital gains taxed at 28%. Under the new laws, the spread between capital gains and ordinary income taxes is much wider. Now, you could be taxed 39.6% on income, but only 28% on capital gains. "A 3% spread is not terribly interesting," says Barbee. "But an 11.6% spread is."

If you can tolerate additional risk in your portfolio, you may want to transfer money from cash and bonds (which generate income) into stocks and real estate (which produce capital gains). Also, even if you're worried about a correction in the stock market, consider holding on to stocks for a full year so they will be taxed as long-term capital gains when you sell.

-- Get a luxury tax refund. The three-year-old 10% surtax on yachts, furs, jewelry, and private aircraft above a certain price was repealed, effective Jan. 1, 1993. If you made such a purchase in the past eight months, you are due a refund on the extra tax.

-- Donate to charity such assets as stocks, bonds, artworks, collectibles, real estate, and other property that has appreciated. The new law makes permanent a provision allowing you to deduct the fair market value of appreciated property, without having to worry about triggering the AMT. This provision is retroactive to June 30, 1992, for "tangible personal property," such as artwork and collectibles. If you made a generous gift in the last year, consider filing an amended return.

-- Qualify for a 50% capital-gains exclusion if you buy newly issued stock in a business with less than $50 million in total capitalization and hold it for at least five years. The applications for this new tax break are unclear, but tax pros will probably figure out a way to take advantage of it. Some tax pros question whether individuals will ever want to take on so much risk just to save on capital gains. "We kind of suspect that this is not going to catch fire real quickly," says Corrick.

How far will you go to reduce your tax burden? If you rent, buying a house would qualify you for a big mortgage interest deduction. Or, by forgoing marriage, you could avoid the "marriage penalty" that kicks you into a higher tax bracket.

But tax experts warn clients against running their lives simply to avoid taxes. "When tax rates drive decision-making, we tend to get people who make a lot of foolish short-term decisions," observes Joel Isaacson, a New York financial planner. Still, he says, if you are planning on getting married, you might want to wait until 1994 to tie the knot. It could save you some cash for your honeymoon. Amey Stone EDITED BY AMY DUNKIN


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