The ink isn’t even dry on President Clinton’s tax package, and already accountants are coming up with strategies to help their clients work around some of the more onerous tax hikes-or take advantage of new entitlement programs included in the bill.
What can you do? Here’s a look.
Q-What should I do if I’m part of a low-income family?
A-Although the bill technically won’t affect you until 1994, low-income filers who have children should become familiar with the earned income tax credit (EIC).
This is a special entitlement program for working parents with dependent children. And it’s been simplified, bolstered and made more widely available in the Clinton plan.
The EIC is currently a three-tiered credit, which gives you money for paying for health insurance and having kids-and a bit more if you have an infant.
Under the new law, there is just one credit. But it will be more generous and made available to families earning a bit more-up to $28,000 for those with two children in 1994. Income eligibility and the amount of the credit will rise with inflation in future years.
It’s important to note that you don’t have to pay federal income tax to qualify for the EIC. You simply have to fill out the forms, and, if you qualify, the government will send you a check.
For the 1993 tax year, the EIC will follow current rules. But in 1994, it will be restructured according to the new law. For more information, ask the Internal Revenue Service to send you a copy of publication No. 596. It can be ordered through the IRS’ toll-free hotline at (800) 829-3676.
Q-What if I earn less than $100,000?
A: You’re definitely affected by the new laws, but some of the impact is indirect and difficult to quantify.
The one direct impact comes from gasoline taxes, which rise by 4.3 cents per gallon. That would probably cost between $20 and $30 annually for someone driving an economy car an average of 10,000 miles a year. It may also cause modest increases in bus fares and the cost of consumer goods trucked or shipped to market from far away.
But aside from carpooling-which can make sense under any circumstances-the tax hike isn’t great enough to go to great lengths to avoid it.
However, if you are a middle-income retiree or someone who falls into the onerous alternative minimum tax, the effect could be much greater.
Q-How does it affect middle-class retirees?
A-If you’re collecting Social Security, more of your Social Security income may be taxable.
Currently, those earning more than $25,000 individually or $32,000 as a couple pay tax on 50 percent of their Social Security income. Under the new law, there will be a second Social Security tax bracket for those earning more than $34,000 individually or $44,000 as a couple. These people will find 85 percent of their Social Security income taxed to the extent that it exceeds the new thresholds.
In other words, only 50 percent of the amount between $25,000 and $34,000 is taxed for single filers, but any amount above that is 85 percent taxable.
Q-What does that mean in dollars and cents?
A-A couple earning $90,000-$70,000 from pensions and investments and $20,000 from Social Security-currently pays $2,800 tax on their Social Security benefits. Under the new law, that will rise to $4,760, says Stephen R. Corrick, partner with Arthur Andersen & Co. in Washington, D.C.
Q-What can retirees do?
A-You may want to shift money out of municipal bonds-a favorite tax-favored investment-because interest earned on these bonds could make more of your Social Security income taxable. Better investment vehicles, from a tax standpoint, are growth stocks that don’t generate dividends and savings bonds, which don’t generate taxable income until they mature.
Q-What’s the alternative minimum tax, and am I really at risk of falling into it if I’m middle class?
A-The AMT is a separate tax system designed to trip up rich people who have a lot of deductions. But because the rate jumped significantly with the Clinton plan, more middle-income families are likely to fall into it.
You’re particularly at risk if a good portion of your income comes from capital gains or if your main itemized deductions are state income and property taxes and possibly interest on a home equity loan that was not used for home improvements.
The way it works is you pay the higher of your ordinary income tax or the AMT, which is set at a lower rate-now 26 percent for income under $175,000 and 28 percent for income over that amount-but allows fewer itemized deductions.
Q-What do I do if I fall into the AMT?
A: If you’re at risk, talk to a tax adviser about how you can restructure your income or deductions to avoid the AMT. For instance, you may want to defer some capital gains income. Or you might want to time your deductions to come in a year when more of your income comes from wages than capital gains.
