Even before any of President Clinton's tax hikes go through, you may find yourself paying more taxes for 1992. Less money withheld from 1992 paychecks and stricter withholding laws, combined with fewer deductions, means that many taxpayers will owe money where they didn't before. More than ever, you'll have to root around in the tax code for deductions and credits to give you some relief.
One unpleasant result of all those 1992 mortgage refinancings is that many homeowners will face bigger tax bills. That's because refinancing cuts the amount of interest you pay and deduct. And you can't claim points on a refinancing upfront, as you can on a new mortgage; they're amortized over the life of the loan.
Former President Bush is responsible for another blow that "could affect over 70 million people," says David Berenson, national director of tax policy for Ernst & Young. To pump up the economy for the election year, Bush reduced withholding by as much as $170 for individuals making up to $53,200 and $345 for married couples earning up to $90,200. As a result, "their refund will be smaller or nonexistent, or possibly they'll get hit with penalties," Berenson notes.
OVERESTIMATE. Withholding could also be a big problem for estimated-tax payers affected by a new ruling that requires them to pay 90% of their current year's tax liability. In the past, you were safe if your quarterly payments equaled 100% of the previous year's. That's no longer good enough if your adjusted gross income--after you subtract such nonitemized deductions as retirement-plan contributions and alimony--rose by more than $40,000 ($20,000 for couples), your AGI is more than $75,000, or you were required to make estimated payments within the past three years. "This will affect the bulk of our clients who accelerated income into 1992" in anticipation of tax hikes, says Ernst & Young partner William Brennan. Affected taxpayers should overestimate to avoid penalties, says Rick Taylor, a senior tax manager at KPMG Peat Marwick in Washington. "If you know you underpaid, pay up as soon as possible to turn off the interest meter."
Another potential surprise lurks in the fact that some tax incentives, which Congress has been renewing for years, expired on June 30, 1992, when Bush vetoed a bill that contained them and some tax hikes. So they're valid only up to July 1. These include a provision allowing self-employed people to deduct 25% of their health-insurance costs. Others allow employees to exclude employer-provided educational assistance and group legal services from taxable income. Also expired is a provision that exempts the donation of appreciated tangible property to charity from the alternative minimum tax (AMT)--a parallel tax that allows fewer deductions. The AMT hits about 400,000 wealthy individuals. This means that any big donation of, say, art to a museum after June 30 could make you liable for the AMT.
The Clinton Administration may well reinstate these incentives for 1993, but because that will cost the government money, they probably won't be retroactive, says Kenton Klaus, a partner at Arthur Andersen & Co. So you're liable for taxes on those items after June 30. You can file an amended return if they do get reinstated retroactively.
GOODBYE OFFICE? Adding to the burden of people who are self-employed is a recent Supreme Court ruling that makes it harder to claim home-office deductions. In the past, you qualified for the deduction if you used the office for any activity, such as billing, that's essential to the business. Now, you must provide the primary goods and services there. And the amount of work time you spend in the office should outweigh that spent outside of it. That could eliminate the home-office deduction for anyone who uses their office for administration and preparation, such as independent consultants, building contractors, and caterers who work at home but deliver the goods elsewhere. Your home office will be more acceptable to the Internal Revenue Service if you meet clients there.
Then, there are "hidden" tax hikes. For every $1,000 over AGI of $105,250 ($52,625 for married couples filing separately), you lose 3%, or $30, worth of itemized deductions. And for every $2,500 over AGI of $105,250 for singles and $157,900 for couples, you lose 2% of the value of personal exemptions for you and your dependents. So if you claim an exemption for yourself, which knocks $2,300 off '92 taxable income, you forfeit $46 for every $2,500 over the trigger point. The limitations effectively raise the marginal rate for a family of four making $157,000 or more to 34.1%, says Coopers & Lybrand.
In addition to the 3% deduction phase-out, you can't claim miscellaneous deductions for expenses such as union dues or investment-management fees unless they exceed 2% of AGI. That's after you take into account the 80% cap on deductions for business meals. Medical writeoffs and casualty deductions are exempted from the 3% phase-out but must exceed 7.5% and 10% of AGI, respectively.
With such limits eating into your deductions, it's important to zero in on every little break. Here are a few tips:
-- A change in filing status could put some extra change in your pocket. If you're recently divorced or widowed, you can file as a head of household or surviving spouse. Both get you a better standard deduction and tax rate than filing as single. You can file as a surviving spouse for three years if you have a dependent child. Married couples might want to file separately if one partner has sizable medical bills or job-hunting expenses, or you have similar incomes. It might also help you avoid the AMT. "You should prepare your returns both ways," advises Steven Pennachio, a tax partner at KPMG Peat Marwick.
-- You should also prepare your taxes normally and as if you were liable for the AMT. You owe whichever is higher. If you were subject to the AMT last year but not this year, you may be able to apply a credit to this year or future tax bills. This is a bonus "that's easy to forget and hard to figure out," says Grant Thornton's Tom Ochsenschlager. "But it can be worth a lot of money."
-- You can use investment losses to offset capital gains and ordinary income up to $3,000. Losses that can't be used this year can be carried over to next year. You can also carry over excess interest payments on loans for investment purposes since you can claim those loans only to the extent that you have investment income.
-- It's not too late to shelter money in retirement accounts. Indeed, you can set up individual retirement accounts and simplified employee pensions (SEPs) to cut 1992 income as late as Apr. 15. You get to deduct your IRA contribution only if you or your spouse don't have an employer-sponsored plan or you make less than $40,000. If you have a small business, you can fund a SEP with the lesser of $30,000 or 15% of your compensation.
-- Another way to pare down your income is with tax credits. Although uncommon, these are worth $1 per tax dollar--whereas deductions are worth only 31 if you're in the top federal bracket. You may be entitled to a child-care credit if you need someone to watch your kids so you and your spouse can work. If your AGI is under $10,000, your credit is 30% of your expenses up to $2,400 for one child, $4,800 for two. That figure decreases gradually to 20% if your AGI is above $28,000. Then, the most you get is $480, or $960 for two kids. If you are at least 65, you get a $900 credit ($700 if married). The same applies if you are legally blind. If you're over 65 and blind, double the credit. You also get a credit for any foreign taxes you might have paid on global securities.
Many of these deductions are nickel-and-dime stuff compared with the lucrative tax shelters of yesteryear. These days, says Arthur Anderson tax partner Steven Weinstein, you "have to look for the small victories."
DEDUCTIONS YOU MAY HAVE MISSED BUSINESS -- Business gifts of $25 in value or less per recipient -- Cleaning and laundering services while you are traveling for business -- All expenses related to moving, if a new job is at least 35 miles further from your home than your current job -- One-half of your paid self-employment tax -- Subscriptions to professional journals and trade publications -- Tax preparation fees CASUALTY -- Damage from Hurricane Andrew can be deducted by amending 1991 return to get the refund more quickly, or by including it in your 1992 return -- Damages from flooding caused by the big storm in January, when parts of the Northeast aere declared disaster areas, can be claimed on your 1992 return INTEREST -- On business-related loans -- On home-improvement loans -- On loans for investments -- Full points from a first refinancing if you refinance your mortgage a second time INVESTMENT -- Books, magazines, and newsletters that you buy for investment advice -- Cost of travel to see your broker -- Foreign real estate taxes and income taxes, on international securities, for example -- Rent on safe-deposit boxes to hold stock and bond certificates -- Separate fees paid to the trustee of your individual retirement account -- Worthless securities or debts that have become uncollectible MEDICAL -- Alcoholism and drug abuse treatment expenses -- Contact lenses and eyeglasses -- Hearing devices -- Legal abortions and sterilization procedures -- Transportation, meals, and lodging related to medical treatments -- Wigs essential to your mental health DATA: BUSINESS week