How next year's tinkering could change this year's tax planning. New reasons for shifting income to '89 and taking more deductions in '88
Now that most members of Congress have gone home to perform one of their more important tasks - getting themselves reelected - the public must live with the tax laws they left behind. Most Americans are still trying to absorb the effects of the 1986 tax law. Now, in their year-end tax planning, they will be looking for ways to soften the tax bite while they wonder how much deeper it will be in the future.
Although both presidential candidates promise either to veto any tax increases (Vice-President George Bush) or to raise taxes only as a ``last resort'' (Gov. Michael Dukakis), there are ways Congress can increase revenues and cut the deficit without changing tax rates, say tax professionals who follow the process in Washington. The possibility of some of these becoming law could affect this year's tax planning.
``There are ways Congress can tweak the dials,'' says Thomas Ochsenschlager, a tax partner with Grant Thornton International, an accounting firm. Some people have said Congress might, for example, start the 28 percent tax bracket at a lower level. But Mr. Ochsenschlager thinks lawmakers will be more subtle than that.
They might, for example, raise the ``floor'' for employee business expenses and miscellaneous itemized deductions from its current level of 2 percent. As it stands, only the expenses or deductions that exceed 2 percent of adjusted gross income can be deducted. So a person with an income of $50,000 cannot deduct the first $1,000 of these expenses.
If the floor were raised to 4 percent, Ochsenschlager says, that would push another $1,000 into nondeductible territory. This possibility argues for taking as many deductions this year as you can, since they might not be of any use next year.
Congress could also delay indexing of several items, including the personal exemption, says Pamela Pecharich, director of tax policy at Coopers & Lybrand, another accounting firm. In the 1986 tax act, the personal exemption gradually increases from $1,080 in that year to $1,950 in 1988 and $2,000 in 1989. After that, it is to be increased each year at a rate indexed to inflation. Keeping the $2,000 permanent would ``add up to quite a lot of money down the road,'' Ms. Pecharich says.
If there is no change in indexing, many people will be paying lower taxes next year and in future years because of the larger personal exemption. For this reason, Pecharich says, ``in counseling our clients, we find that in most cases it's probably OK to defer income into '89.''
``The pension area is another one that's ripe for more tinkering,'' says C. Clinton Stretch, director of tax legislative affairs at Deloitte, Haskins & Sells, accountants. ``Retirement savings might be harder to save next year, so you should put as much as possible into these programs this year.'' This includes 401(k) employer-sponsored savings plans and individual retirement accounts (IRAs), but it does not include single-premium deferred annuities.
The tax advantages of these annuities, Mr. Stretch says, are almost certain to be eliminated in the next Congress, so people would be well advised to stay away from them.
The rules on 401(k) plans have been changed once, Stretch says, so they could be changed again. When the plans were started, employees could put as much as they wanted into them; now, there's a $7,000 annual limit. Next year, Congress may decide that lowering it further would add more revenue, so see if you can put more money in one of these plans before the end of this year.
``The IRAs look safe where they are,'' Stretch says.
The tax experts do not think Congress will lower the income at which people move up into the 28 percent bracket from its present level of $29,750 for married couples. There are just too many moderate-income voters who would be affected by that to make it politically safe.
There may be some sentiment, however, to increase the number of taxpayers who pay the 33 percent surcharge. That surcharge now only covers the portion of married-couple income between $71,900 and $192,930. People earning more than that pay just 28 percent on everything.
``It doesn't make sense that the rich people pay 33 percent on some of their money while the filthy rich pay 28 percent,'' Stretch says.
Taxing all income over $71,900 - and over $192,930 - would add about $18 billion in federal revenues over three years, Ochsenschlager says, reading from a 1987 report by the congressional Joint Committee on Taxation.
Year-end tax planning won't be of any help in one possible change, unless you can pack in a lot of business lunches between now and New Year's Eve. ``There's nothing magic about an 80 percent limit'' on the amount of business meals and entertainment that can be deducted, Stretch says. Congress lowered the limit from 100 to 80 percent in 1986, and it could easily be scaled down again, he suggests.
Lowering the business-meal deduction to 50 percent would raise about $6.6 billion over three years, or $2.2 billion a year, Ochsenschlager says.
Current and possible future tax considerations are also important to investors, particularly those who took big losses in last year's stock market plunge. If they sold their stocks after Oct. 19, 1987, they might not have been able to take all their losses on that year's tax returns.
But they can use those losses this year and in future years, if necessary. Capital losses can be used to offset capital gains dollar for dollar. Additional losses can then can offset as much as $3,000 of current income. And any losses beyond can be carried forward to offset gains in future years.
Many investors, figuring that 1988 tax rates are as low as they're ever going to be, may be trying to push income and capital gains into this year, and in most cases that's probably a good idea.
``We have been saying to a number of clients that they might consider trying to pull income into this year,'' Ochsenschlager says. ``But if you think rates are going to go up, do the reverse: Try to accelerate income into this year and defer deductions.''
Most experts, however, believe tax rates will not be raised for 1989 income, though 1990 could be another matter.
But some investments, such as real estate, fare better over the long term, regardless of tax considerations.
``You have to figure out the math on both sides of the equation'' before deciding whether to sell out now or keep your money in an investment, says Pecharich at Coopers & Lybrand.
Whether or not revenues are increased will not have much to do with who wins the White House next month, Stretch says.
``I think the president is irrelevant to this process,'' he says. ``We're going to raise revenues and cut spending, not in response to the president, but in response to the financial process,'' including the international money markets. But ``the president will have some influence on the choices of taxing mechanisms.''