Dreading the annual hassle of tackling taxes?
For many taxpayers, there is good news about 1988 taxes: They represent the lowest rates in more than 40 years. Tax returns for the year will reflect, for the first time, the full benefits of the new tax rates mandated by the Tax Reform Act of 1986.
That means a 15% rate for four out of every five taxpayers, who use the simple tax forms and can take advantage of 1988's higher standard deductions and personal exemptions. High-income individuals face a maximum effective rate of 28%, but that is down from 38.5% a year ago.
But, despite the lower rates, some taxpayers may find themselves actually paying more in taxes than in years past. The downside of tax reform is the sharp cutbacks in deductions on interest paid on consumer debt. In another change, long-term capital gains are now counted as ordinary income and could be taxed at a higher rate than previously.
"The amount of taxes that taxpayers will pay in 1988, in many instances, will be higher than before the 1986 tax act, even though the tax rates are lower," explained Mark S. Granich, tax partner at the Long Beach office of Deloitte Haskins & Sells. "The reason is they are losing more in deductions than they are gaining in tax rate reductions."
In addition, high-income taxpayers may be subject to the more restrictive and costly alternative minimum tax. Others who began receiving substantial retirement benefits in 1988 will have to make major decisions this year on receiving payouts from these nest eggs.
In figuring 1988 taxes, be aware of these major changes that determine how you compute your taxes:
Tax rates: The basic rate structure in 1988 is three-tiered, compared to five in 1987 (see chart on page 10). For example, a married couple filing jointly pays a 15% marginal rate on taxable income of up to $29,750. The rate rises to 28% on income between $29,750 and $71,900. It increases again to 33% on taxable earnings between $71,900 to $149,250.
Confused? Remember that your effective tax rate is not the same as the marginal rates indicated by the three tax brackets of 15%, 28% and 33%. To calculate your effective tax rate--the actual percentage that you pay--divide your total taxes by your taxable income.
"The net result is that income from dollar 1 to 149,250 is at a flat 28%," explained Robert Gowing, tax partner in charge of the Los Angeles office of Touche Ross.
Personal Exemptions: $1,950 each for taxpayer, spouse and each dependent, up from $1,900 in 1987. However, for high-income taxpayers the benefits of these exemptions are eliminated because of a 5% surcharge if taxable income exceeds $149,250 for joint returns, $123,790 for heads of households, $89,560 for single individuals and $113,300 for married individuals filing separately.
Standard Deductions: "Those taxpayers who don't have a lot of itemized deductions will benefit from the higher standard deductions in 1988 versus 1987," Granich said.
The deductions for 1988 are: $2,500 for each spouse of a married couple filing separately, $3,000 for single taxpayers, $4,400 for heads of households and $5,000 for married taxpayers filing jointly. Single taxpayers 65 years or older can take an additional standard deduction of $750. For married taxpayers 65 or older the deduction is $600 each.
Itemized (Schedule A) Deductions: An alternative to using the simple standard deductions is to use itemized individual deductions allowed by the IRS. Among the changes in 1988 requirements are:
- Personal interest paid on consumer loans, such as credit cards and car loans, is now only 40% deductible, down from 65% in 1987. The deduction will drop to 20% in 1989.
- The deduction for mileage is 24 cents a mile in 1988, up from 22.5 cents the year before.
- State and local income taxes, real estate and certain personal property taxes are deductible, but sales taxes have not been deductible since 1986.
- Trade or business interest is fully deductible.
- Deductions for medical and dental expenses, personal casualty and theft losses, charitable gifts and miscellaneous items remain unchanged at 1987 levels, when they were dramatically cut back. Deductions for investment interest and passive activities interest are also unchanged. There also have been no changes in children's taxes, estate taxes or individual retirement accounts.
- Under a 1987 change in the Tax Reform Act, interest deductions on mortgages or loans secured by personal residences are now limited to loans of $1 million on first and second homes. Gowing explained, "For people who already had mortgages (of more than $1 million) in place before Oct. 13, 1987, the interest on the full amount is still deductible." Interest on any mortgage after that date is subject to the new rule. "It is the government's insidious attempt to chip away and broaden the (tax) base and to get at the wealthy taxpayers," he said. Under the new rules, interest is deductible on home equity loans of up to $100,000.