Andrea Markesin, an accountant and divorced mother of one, will file her return this year as a single head of household. That allows her to claim up to $127,500 in income taxed at the old 31% top rate. If she were to marry her boyfriend, who makes at least as much as she does, she would run right through the new 36% bracket and go several thousand into the 39.6% range. "It would be stupid to get married," she says, adding that her beau plans to hold her to that statement when the subject of marriage comes up.
The "marriage penalty" is nothing new. But for high-income earners, the old ball and chain is going to be a lot heavier. They're just one of the groups likely to feel some pain from the '93 tax hikes. And affected taxpayers may owe more than they thought, since the withholding tables weren't adjusted to account for the hikes. Also, complying with requirements to defer payment of the additional taxes may be tricky. The good news: The bulk of taxpayers won't fork over much more than they did last year. You may even get a break, especially if you are self-employed, gave a gift of appreciated property, or live in a federally declared disaster area. But lots of first-time investors may have to crunch some numbers to figure out what they owe on mutual-fund gains.
WEDDED BLUES. The marriage penalty is particularly pernicious in that it traps people who may not individually make all that much but whose combined income drives them over the limits. It only takes two people earning $80,000 apiece to move from the 31% to the 36% bracket. Yet two single people living together can earn up to $230,000 before they hit 36%. The difference is more dramatic when you add a 10% surcharge--for an effective rate of 39.6%--for anyone making over $250,000. An unmarried couple can earn twice that before facing the maximum hit.
The tax tables turn against unmarried wage earners at lower income levels. This is the seldom-noticed singles penalty, which gives an advantage to married couples when one spouse makes little or no money. Such a married person making $80,000 would pay only 28% in taxes, while a single person making the same amount would pay 31%, says Markesin.
The good news for those on both ends of the income spectrum is that you may be entitled to a refund if you paid taxes on certain items that lost their deductible status for the second half of 1992 when Congress failed to renew them. These items are now retroactively deductible, and if this pertains to you, you'll want to amend your 1992 taxes for a refund. You are eligible if: you're self-employed and paid full taxes on the cost of your health-care coverage in '92; you paid taxes on special training or educational assistance provided by your boss; you paid excise taxes on luxury items such as boats, furs, and jewelry; or you paid alternative-minimum taxes on a charitable contribution of appreciated property.
There's also good news for those who really need it: People whose homes were destroyed in federally declared disaster areas, such as the flooded plains of the Midwest, hurricane-ravaged communities in the Southeast, and the West's earthquake-stricken sections. The rules relating to insurance reimbursement have been greatly eased. You now have four years instead of two to replace your home, and you no longer need to distinguish between reimbursements for the house and those for its contents. As long as you spend all your insurance proceeds, you won't be taxed on them, according to How the New Tax Law Can Pay Off For You by Peter Berkery ($10; Irwin Professional Publishing).
For those subject to the new increases, the bad news pretty much dominates. Although you have the option of paying the additional tax burden in equal installments over three years, the strategy is more complicated than it seems. You have to pay the higher of the regular tax computed at the old rates or the alternative-minimum tax calculated at new rates. What makes this calculation tricky is that if the AMT is higher, you defer the difference between both it and your regular tax under the new rates. If the regular tax is higher, you can defer the difference between the tax under the old and new rates. Thus, everyone electing the deferral will have to calculate their AMT liability.
You may need to start planning early because if you want the deferral, you have to elect it by Apr. 15. So taxpayers who usually get extensions "should file on time this year," says Stuart Kessler, tax partner at Goldstein, Golub, Kessler & Co. "You can get an extension and make the deferral election based on estimated income, but if you're one dollar off, you lose it."
HASSLES. Regardless of your tax bracket, if you're among those who poured taxable savings into mutual funds, you owe tax on your gains. New investors may not have considered this. "So many people are throwing their money into funds and not realizing they're taking on record-keeping responsibilities they never contemplated," says Kevin Roach, a tax partner at Price Waterhouse.
Figuring out what you owe can be a daunting task, since in addition to knowing the share price when you initially invested, you have to account for income from reinvested proceeds and capital gains earned but not paid out, which both add to your basis. Other factors, such as tax-free payouts or principal returned, lower your basis. Sometimes, managers will keep track of your tax liability, but no-load funds usually do not provide such records. So, you must piece together the various moves of your fund shares from your statements.
Once you've figured out your basis, you can use a formula to determine what your gains are. You take the total basis in all the shares and divide it by the number of shares you hold to get the basis-per-share for shares sold. Then, you compare that with your sales proceeds to determine your profit or loss. The Internal Revenue Service prescribes a rule that says the first shares acquired are the first sold. That tends to favor obtaining long-term capital gains if you've held shares for more than one year.
Looking ahead to the coming year, there are a few significant changes to keep in mind. Retirees may have to pay more taxes on their Social Security income. If your income, including 50% of your Social Security benefits, exceeds $44,000 for married couples filing jointly or $34,000 for singles, the taxable portion of your Social Security income goes up from 50% to 85%. You might want to reconsider your tax-exempt investments because the interest from these is counted as income for tax purposes. "Anyone making $44,000, or close, should never look at the municipal-bond rate and say that's an aftertax rate for me because that isn't for retirees," says Rick Taylor, a senior tax manager at KPGM Peat Marwick.
GET A RECEIPT. High-income earners will pay more Social Security taxes, too. All earned income is subject to the 2.9% Medicare tax. Last year, income above $135,000 was exempt. Employees only pay half the bite, or 1.45%, employers pay the other half, but the self-employed are responsible for the whole thing.
To deduct charitable contributions for 1994, you need a written receipt--not just a canceled check--from the recipient of gifts of more than $250. Charities should be happy to provide receipts, but if you don't want to bother, give a few separate gifts of less than $250. Where you receive something for your contribution, such as a benefit dinner, your receipt should include a good-faith estimate of the value. To deduct a noncash gift of property--say, gardening tools or clothes--the charity must give you a receipt describing the property. Finally, gifts of appreciated property, such as securities, are now deductible for the AMT as well as regular taxes. This means you get to write off the full value of a stock that has risen, even though your basis may have been quite small.
This is just a taste of the changes to come. But there is a bright side: The tax increases will pass most people by. And if you are affected, that means you're doing very well.
FOR WHOM THE TAX-CHANGES TOLL MARRIED COUPLES
A combined income of $140,000 or $250,000 will put them at the 36% and 39.6% levels. Unmarried couples can make $230,000 and $500,000 before hitting those upper brackets. Couples with only one working spouse fare better than singles at lower income levels.
Long-term capital gains are now much more desirable for high-income taxpayers. Capital gains are no longer considered investment income to offset against investment interest expense. You get a tax break even on capital gains from long-term investments in small companies.
Starting this year, those making more than $44,000 (married) and $34,000 (single) must pay taxes on 85% of their Social Security income, up from from 50%. Since tax-exempt gains are considered income determining your threshold, municipal bonds may work against you.
Starting this year, there's no longer a limit on the amount of earned income that is subject to the Medicare tax of 2.9%. Usually, this burden is split between employer and employee, so people who are self-employed will be hit the hardest.