Just when most taxpayers had finally adjusted to the tax reforms passed in 1986--along come more changes, wrought by the Omnibus Budget Reconciliation Act of 1990. While the act has little effect on the 1040 Form you'll be filing for 1990 income, it requires a rethinking of strategies for 1991 and beyond.
In one sense, the new provisions simplify life: There's no more 33% "bubble" covering income between two 28% brackets. For 1991 income, the lowest rate is still 15%. The next is 28%, and once the top rate of 31% starts, it never stops (table).
COMPLEXITIES. But in other ways, things become more complex for the six-figure-income set. If you're likely to make in the neighborhood of $100,000 in 1991, "tax planning becomes a matter of trying to reduce adjusted gross income if you can," says Michael Borsuk of accountants Coopers & Lybrand in New York.
Next year, when doing the return for 1991, you'll figure your itemized deductions, such as mortgage interest and state and local taxes, as usual. But then you'll reduce their total by 3% for every dollar of adjusted gross income (AGI) above $100,000 (both for married couples filing jointly and singles). The deductions can't be reduced to zero--the law lets you keep at least 20% of them. Medical, investment interest, and casualty-and-theft deductions aren't touched but are still subject to their own limits.
Many people think they can avoid the extra tax bite by shrinking their deductions, notably by skimping on gifts to charities. Not so, says Borsuk. Because the loss of deductibility is based on AGI, "once you fall victim to it, it doesn't matter how high or low your deductions are." For instance, with AGI of $150,000, affected deductions of $10,000 would become $8,500 (3% of $50,000 being $1,500). Say you boosted your total contributions to $20,000. You'd deduct $18,500, because you'd still lose only that same $1,500.
The attack on personal exemptions (each is $2,150 in 1991) is similar, but you have to be especially alert due to the step-like way in which it climbs, cautions Eli Warach, a senior vice-president at tax-book publishers Maxwell Macmillan. The exemption amount is nicked by 2% of each $2,500 chunk of AGI "or fraction thereof" over the thresholds ($100,000 for singles, $150,000 for joint filers). So a single with AGI of $102,500 would suffer a 2% exemption loss, while moving up a dollar, to $102,501, triggers a 4% loss.
MORE DEBATE. Already, there's talk in Congress of simplifying the new law, perhaps by replacing its deduction and exemption limits with a straightforward increase--such as raising the 31% top rate by a point or so. Whether Congress will actually do much this year is unclear, however: The recession has lawmakers wary of raising taxes, while White House ideas for expanding IRAs and cutting the capital-gains tax further remain controversial.
Nevertheless, changes in the law continue to be proposed and debated. So the taxpayer should assume it's use-it-or-lose-it time for tax breaks: The current tax law "may be as good as it's going to get," declares John Regan, a Hofstra University professor and Bender's Federal Tax Service specialist.
Now, interest on home-equity loans is deductible, and home-sellers over 55 have a one-time ability to exclude a gain of up to $125,000 without buying another house. Both breaks are at risk, some Washington-watchers add, along with bargain "special averaging" rates on lump-sum pension payouts. There's no assurance that the new 28% rate on the capital-gains tax will remain, either, so don't postpone taking a capital gain without good reason.
To come out best under current law, "think of increasing your tax-exempt income," says Bob Coplan of accountants Ernst & Young. That may mean selling some taxable corporate and Treasury bonds and replacing them with municipal bonds that pay tax-free interest.
Often, limiting AGI involves deferring income--and thus the tax on it. If a yearend bonus is customary, "ask your employer now to defer it until Jan. 2," suggests Coopers & Lybrand's Borsuk; the IRS can disallow a deferral if it's agreed upon after the work is done. Also, you can limit AGI by buying a one-year Treasury bill or a certificate of deposit designed to delay paying out interest until 1992.
LATE RENT. Owners of rental property might let a tenant know that they'd cheerfully wait until January to get the December rent check. If you're not a landlord, this may be the year to become one. Lose money on the place, and if you're managing to keep AGI under $100,000 anyhow, you get to deduct in full losses of up to $25,000 a year.
Salary you shelter in retirement plans comes out of your AGI stream, too. So if you aren't already doing so, consider feeding your company's 401(k) plan to the max; that's $8,475 this year, according to the Research Institute of America. The money in a 401(k), a Keogh, or similar defined-benefits plan grows without taxes until you take it out after age 59 1/2.
If you have incentive stock options, think about exercising them now instead of waiting to make a bigger killing, suggests John Erb, an executive financial counselor at De Teffe Capital Management in Alexandria, Va. The difference between the option price you pay and the market price isn't subject to regular tax now. But this "bargain element" is subject to the alternative minimum tax. The AMT works by adding back tax-favored income such as that "bargain element" as well as certain deductions. Then, if the total is greater than your regular rate, it is taxed at 24%. "A small bargain element is less likely to trigger the AMT," Erb notes.
Because Congress increased the AMT proportionately more than regular rates, more people are vulnerable to the AMT. So it's more important than ever to "do your tax planning in two-year chunks," urges Erb. If it's already clear that you'll be in the AMT this year and not next, you might take capital gains while they can be taxed at the relative bargain rate of 24%.
Whatever other strategies you explore, don't try the most common money-waster--being overwithheld. While it's nice to have a fat refund coming, "the IRS isn't going to pay you interest" on that money, says Eileen O'Connor at accountants Grant Thornton. As long as Uncle Sam lets you keep a dollar, you may as well do something more rewarding with it in the meantime.