It just didn't seem right when the federal government hit the nation's highest earners with a dramatic tax increase last August--and made it retroactive to the first of the year. To soften the blow, the Internal Revenue Service is allowing most taxpayers in the new top marginal rates to pay the difference due to the rate change in equal portions over three years. This amounts to an interest-free loan from the government.
But deferring your taxes is not the no-brainer it seems, despite the simple formula: You calculate your tax liability using both the new and old rates and divide the difference by three. On your 1993 returns, you use the new rates but subtract out two-thirds of the increase. The following years, you add the remaining thirds of the '93 increase back in.
The more complex your returns, the less likely you are to qualify for the installment plan. You can't use it, for example, if your taxes increased due to changes in the alternative minimum tax, which ensures that wealthy people don't deduct their way out of paying taxes. Also, if you usually get an extension because you own sophisticated investments, you must pay 100% of the taxes you owe by Apr. 15 to be able to defer part of your increase. "That can be tricky," says tax attorney Peter Berkery, author of The 1993 Tax Act: How the New Legislation Can Pay Off For You ($10.00; Irwin Professional Publishing). If it turns out that you underestimated, you forfeit the chance to defer.
LOST CAUSE. While the particulars should not be too daunting for your tax preparer, they might be for the IRS: In 1981, the last time the IRS let people pay the initial year of tax hikes in installments, it bungled the job, says tax adviser Stuart Becker, president of Becker & Co. in New York. "We found we spent more time and professional fees straightening out clients' problems than the interest they would have earned" on payments that they held back, he says.
If you have the funds to cover the increase, Becker says, you should just pay up and get it over with--unless you can defer as much as $50,000. You have to pay the tax anyway, so the most you should do with that money is earn some interest in a bank or money-market account--investments currently yielding less than 3%.
But James Velten, senior tax manager at Coopers & Lybrand, says deferring taxes is a personal decision and the IRS has cleaned up its act since 1981. Some of his clients don't want 1993 taxes hanging over their heads for two more years, while others would never hand money over to the government sooner than they had to. The only other factor to consider, Berkery says, is whether the amount you can save will cover the cost of having your tax preparer fill out and keep track of all the forms.