Up until now, saving money on your taxes was a lot like trying to save money on your groceries. The goal in either game was to collect as many discounts as you could to lower how much you ended up spending.
Uncle Sam historically has charged high prices--the maximum tax rate in 1986 was 50%--but the Internal Revenue Service helped you lessen the burden with its own version of the double coupon: myriad deductions. You could fully deduct interest expenses, charitable donations, individual retirement accounts and a good chunk of your losses, among other things.
But with the Tax Reform Act of 1986, the provisions of which affect how you file for 1987, the IRS has changed the way it does business. It has lowered prices, but it has also extinguished the days of the double coupon. The maximum tax rate now is 38.5%, the lowest maximum rate since 1931, and the rate will drop to 28% for most taxpayers this year. However, several deductions are gone and many others are being phased out.
"What Congress was trying to do was to start limiting deductions in 1987," explains Ellis Balsam, a tax partner with the accounting firm of Peat Marwick Main & Co. in Los Angeles. "But they also gave you some benefits of lower tax rates this year, too."
So far, however, it appears that many taxpayers will lose more in the way of deductions than they will gain in terms of savings from lower rates. "I'm finding in my practice that people are paying more in taxes overall," said Barbara Raskin, a Miami accountant.
"They aren't quite the low-price leader just yet," Balsam said.
Personal exemptions are up significantly this year. You are entitled to deduct $1,900 for yourself, your spouse and anybody else who qualifies as a dependent. The exemption last year was just $1,080.
There is more good news for those taxpayers who don't itemize their returns. The standard deduction has gone up slightly. Single individuals can deduct $2,540, and married couples can deduct $3,760. Those taxpayers who are blind or 65 and older get even bigger deductions.
Of course, if you itemize, things get a lot more complicated.
The interest on a mortgage for a first or second home is fully deductible as long as the amount you have borrowed doesn't exceed what you paid for the house plus the cost of improvements. There are exceptions to this rule. If your debt exceeds that amount but you're using the excess for educational or medical purposes, it still is fully deductible. Also, if you took out your mortgage before Aug. 17, 1986, the interest is fully deductible if the debt doesn't exceed the fair market value of the home on that date.
The interest you pay on money borrowed for investments is still deductible, but this is being phased out in some categories. For example, there are new deduction limitations on the interest paid on debt you have used to acquire investment property. You can deduct interest equal to your net investment income (income minus expenses) plus an additional $6,500.
The area where many taxpayers will feel the pinch of reform is in personal interest--the interest paid on credit cards, car loans, and educational and other personal loans. Only 65% of personal interest expense is deductible for tax year 1987, and it drops to 40% in 1988, 20% in 1989 and 10% in 1990. After 1990, personal interest cannot be deducted.
Both Balsam and Raskin recommend repaying as much personal debt as soon as you can to take advantage of the deductions that are left. If you can't quickly pay off your credit cards and other personal debt, you may want to refinance your home and use the proceeds to pay off your personal debt. By doing so, you would be converting non-deductible personal interest to mortgage interest, which generally is deductible as described above.
Charitable contributions are deductible up to 50% of your adjusted gross income (total income minus IRA contributions and other adjustments).
A smaller portion of medical expenses not reimbursed by your health-care plan can be deducted this tax season. The expenses--including those for eyeglasses, contact lenses and even hair transplants in addition to regular examinations, treatment and medicine--are fully deductible but only to the extent that they exceed 7.5% of your adjusted gross income.
Subscriptions to professional journals, job-hunting costs and other miscellaneous expenses are deductible after they exceed 2% of your adjusted gross income.
The deductibility of business-related meal and entertainment expenses has also been cut back--to 80% from 100%.
Moving expenses continue to be fully deductible as long as you can meet one requirement--your new job site must be far enough away to have added at least 70 miles to your daily round-trip commute had you stayed in your old home.
Educational expenses are fully deductible if you meet two criteria. First, the courses you are enrolled in must improve your job skills or enable you to hold on to your current job. Second, your total miscellaneous expenses must exceed 2% of your adjusted gross income before you can deduct the educational expenses. Balsam said some taxpayers will lose this deduction because they can't meet the 2% requirement.
State and local sales taxes can no longer be taken as a writeoff. However, state and local income taxes, as well as real estate taxes, still are fully deductible.
Finally, if you took a bath during last October's stock market crash or lost money on other investments, the IRS will award you a booby prize--$3,000 of net capital losses from investments can be deducted this year. Should you have gambled your money away in Las Vegas rather than on Wall Street, you had better hope you won as much as you lost, because gambling losses that exceed gambling winnings are not deductible.