The challenge of mapping your way through '86 tax uncertainties
Trying to map out a financial plan for 1986 is difficult if not impossible, money experts say. The reason: an unprecedented dose of uncertainty surrounding the nation's tax law.
In fact, 1986 is ``the most uncertain period we have ever had with respect to our tax law,'' says David A. Berenson, national director of tax policy and practice at Ernst & Whinney, a major accounting firm.
Nevertheless, experts say there are a few steps individuals can take to cope with this flurry of uncertainty. These include drawing up a projection of their expected financial condition in 1986 and making certain adjustments on their tax returns for 1985, which will be filed by this April.
But most individuals will find their tax planning options limited. ``I would not advise individuals to do much more than hope the [tax overhaul] law passes quickly,'' quips Victor B. Noschese, national director of tax practice at Arthur Young & Co., another large accounting firm.
The main questions hanging over US tax law:
Will the Senate pass a tax overhaul bill this year and if so, how closely will it parallel the bill that emerged from the House of Representatives in December?
If an overhaul bill clears Congress, will it be in a form President Reagan will sign?
Will Congress keep the Jan. 1, 1986, effective dates spelled out in the House version of the overhaul bill, or will it abide by sense-of-the-Congress resolutions passed in December by both the House and Senate and make most provisions effective on Jan. 1, 1987, or thereafter?
Will Congress enact a tax increase to prevent the drastic spending cuts that will otherwise be required under the recently enacted balanced-budget law? Will Congress openly boost individual tax rates?
Or will Congress take what some experts see is the more likely and more politically palatable route of imposing a tax on imported energy or on consumption? One type of consumption tax being discussed is a value-added tax (VAT), in which a tax is imposed at each stage of production.
Will Congress extend, retroactively, a variety of tax law provisions it allowed to expire at the end of 1985?
These included a tax credit to promote efficient energy use and to promote solar power; an exclusion from employees' taxable income of employer-paid educational, legal, and van-pooling expenses; and the exclusion from taxable income of utility company dividends which are reinvested in the utility.
If Congress and the White House are keeping taxpayers guessing about the state of tax laws in 1986, the Internal Revenue Service (IRS) is taking steps to lessen the uncertainty surrounding the processing of tax returns for 1985.
Last year an estimated 100 million phone calls to the IRS went unanswered, and there were long delays in processing some returns. Fred Perdue, director of returns processing, says that ``1986 will be a substantially different processing year -- substantially better, much more like a normal processing year.''
The IRS has beefed up its computer system, hired more workers for its tax-return processing centers, added more phone lines, and augmented the staff of phone answerers.
``In our toll-free operation, we've increased our telephone lines up to roughly 3,400 and increased our staffing by approximately the same amount,'' roughly 26 percent during peak periods, says Phil Russo, assistant IRS director for taxpayer services.
To cope with the uncertainty surrounding the future of the tax code, individuals should make a projection of their likely income, deductions, and taxes under existing law, Ernst & Whinney's Mr. Berenson says. ``Then you have the blueprint for planning,'' when the changes in the law are clear. As a result, ``you are not scurrying in the last month of the year.''
After projecting deductions under current law, a taxpayer is in a position to judge how a new alternative minimum tax (AMT) in the House bill would affect him. The tax is designed to ensure that all individuals pay some tax, even if they have extensive deductions from so-called tax preferences or shelters.
The minimum tax rate under the House bill would climb from 20 to 25 percent, and its provisions have been tightened so that a greater number of preferences are subject to the tax. The tax would apply to AMT income over $40,000 for married couples filing jointly, $30,000 for single individuals, and $20,000 for married individuals filing separately.
Although the Senate may change some provisions of the minimum tax, ``I don't think many of those rules will change substantially,'' says Mr. Noschese of Arthur Young. As a result, individuals should be ``very careful about investing in shelters that are exposed'' to the minimum tax.
Those on the borderline of being subject to the minimum tax should be careful about using the traditional tax planning strategy of trying to take deductions as soon as possible while pushing income into the next tax year, Berenson says. That is especially true because deductions which are often accelerated, like the ones for state and local taxes, medical expenses, and tax preparation fees, are added back into income to determine the alternative minimum tax.
One other planning step open to some individuals is to make the maximum possible contribution to a so-called 401k, or salary deferral plan. In such a plan the employee forgoes a portion of his earnings, which are put into a retirement plan. The income thus escapes taxation until it is paid out at a later date.
The current maximum employee contribution to such a plan is $30,000 per year. Under the House bill, the limit would be reduced to $7,000 and the contribution would also reduce, dollar for dollar, the maximum amount that could be contributed to an individual retirement account (IRA).
But the limits on 401k plans, under the House bill, take effect for plan years beginning Jan. 1, 1986. ``A lot of plans are not on calendar years,'' notes Lawrence Axelrod, a tax partner at Touche Ross & Co., another large accounting firm.
So even if the effective date for these limits is not changed, individuals may still have the option to make one last large contribution to their pension plan. That is ``a very good thing to do,'' Mr. Axelrod says.