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Planning for today and tomorrow: the Revenue Reconciliation Act of 1990.

PLANNING FOR TODAY AND TOMORROW: THE REVENUE RECONCILIATION ACT OF 1990

After months of negotiation with the Bush administration, Congress passed the Revenue Reconciliation Act of 1990 on October 27, 1990. President Bush signed it into law on November 5. The act makes significant changes in individual tax rates (top rate 31%), freezes the maximum rate on capital gains (it remains at 28%) and includes a limitation on itemized deductions and a phase-out of the personal exemption above certain income levels. Other important changes include increased FICA payroll taxes and excise taxes on certain luxury items. The act also changes estate freeze rules as well as some corporate provisions. Certain expiring provisions, including the health insurance premium deduction for self-employeds, targeted jobs credit and credit for research expenses are extended through 1991.

Which provisions do accounting practitioners who advise individual, corporate or small business clients need to know about? What planning opportunities, if any, do the changes create? And what should accountants and their clients be looking for in the future - are more changes on the horizon? To help practitioners gain a perspective on the current tax climate, the Journal spoke to three experts, one each in the areas of individual, corporate and small business taxation, to ask about the most important provisions of the new legislation, what can be done to reduce tax exposure and the outlook for the future.

INDIVIDUAL TAXPAYERS

HIT HARD

There's little doubt individuals were the group hit hardest by the new tax law. Tom Ochsenschlager, a partner in Grant Thornton's federal tax services office in Washington, D.C., says the politics of this bill were "particularly strident." It was difficult to get the president to agree to tax rate increases, and lawmakers were reluctant to cut entitlements in an election year, he says. Despite these difficulties, Ochsenschlager points out this is the first bill in recent memory to make real spending cuts.

In Ochsenschlager's view, the new legislation is a "masterpiece" because it picked up revenue from three different tax systems. "Some came from the income tax system, some from the payroll tax system and some from excise taxes. Yet none of the changes to any of the three systems was so dramatic that taxpayers are inclined to get very excited about them."

IMPACT OF INDIVIDUAL PROVISIONS

The most unexpected individual tax provisions in the new legislation, in Ochsenschlager's opinion, were the limitation on itemized deductions and the phase-out of personal exemptions. These changes were unexpected not only because they created another so-called bubble but also because that bubble is now based on adjusted gross income instead of taxable income. Ochsenschlager doesn't think these changes represent a change in policy; Congress included them for the revenue effect.

The preferential 28% capital gains rate is, Ochsenschlager says, "interesting to talk about, but in terms of the economic effect, it's one big yawn. I'm sure the president is not happy with it - it certainly doesn't satisfy his campaign promise." Only a few taxpayers are likely to benefit. In fact, most of the clients Ochsenschlager advises who incur capital gains typically have large gains from the sale of real estate or a business. For these taxpayers, he says, the amount of the gain has been so large that it "blew them right through the old 33% bubble and out the other side where the gain was taxed at only 28% anyway."

Ochsenschlager says under the new law these clients still will be taxed at 28% and possibly higher, with the limitation on itemized deductions and the phase-out of exemptions both based on AGI. "Capital gains will increase AGI and for most taxpayers decrease the amount of itemized deductions the taxpayer can take. That means capital gains will be taxed at an effective rate of 28.93%." Further, if the capital gain drives the taxpayer's AGI over $150,000 (but less than $272,500) Ochsenschlager says the effective rate on long-term capital gains will be even higher because this is what he calls the "phase-out zone" for exemptions.

INCREASE IN MEDICARE TAX The new law increases the Medicare component of FICA and self-employment taxes by raising the income ceiling on which the 1.45% tax is imposed to $125,000. The 6.2% Social Security tax will be collected only on the first $53,400 of income in 1991. (The rates are doubled for self-employed taxpayers.) This provision in particular, Ochsenschlager points out, is likely to affect CPAs themselves, many of whom are self-employed.

PRIOR PROVISIONS

The 1990 act isn't the only tax legislation that will have an impact on individual tax planning for 1991. Some deductions, such as personal interest and passive losses, have now been phased out fully. Ochsenschlager thinks this may make things easier since many of the complaints about the 1986 tax changes involved the complexity of the phase-outs. "We had two tax systems running parallel - one being phased out and the other being phased in. Now that most of the phase-outs are complete, people will find the tax rules easier to understand."

LOOKING TO THE FUTURE

Ochsenschlager doesn't think future budget and tax negotiations will be as drawn out as they were in 1990. Congress has, he believes, gotten over their "fear of failure." Ochsenschlager says they now "realize they can come up with a pretty tough bill that actually raises taxes, cuts spending and even cuts entitlements - and still be re-elected."

For Ochsenschlager, the big story about the 1990 act is what's missing. Corporate tax revenues, he says, are below projections for the 1986 act, which could mean a future increase in corporate rates. He also sees a possible energy tax on all forms of energy. Although it is likely to be marketed as a conservation measure, it could generate considerable revenue. And for individuals, there is nothing, he says, to prevent Congress from "fine-tuning the dials" on the itemized deduction limitation percentage. "There's nothing magic about 3%."

A stock transfer tax is also a possibility. Ochsenschlager says the rate probably would be nominal, but it would allow Congress to tax pension plans for the first time. Individuals who participate in defined contribution retirement plans would be affected most; they would see their plan account balances shrink. Mutual funds also would be affected by this "hidden tax." Few individuals pay attention to the volume of transactions in either qualified plans or mutual funds.

Looking further into the future, Ochsenschlager thinks Congress will increasingly look to consumption taxes - possibly even a value-added tax - for revenue. While this would represent a fundamental change in our tax system, consumption taxes may be the way to go because they "raise revenue, decrease the propensity of people to consume and may even increase savings in the process." And while Ochsenschlager is uncertain if the 1990 act is "a watershed or a water hole," he believes with its increased reliance on excise taxes it may be a watershed and an indication of what's coming.

PETER D. FLEMING is a senior editor with the Journal.

Mr. Fleming is an employee of the American Institute of CPAs, and his views, as expressed in this article, do not necessarily reflect the views of the AICPA. Official positions are determined through certain specific committee procedures, due process and deliberation.
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No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1991, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Author:Fleming, Peter D.
Publication:Journal of Accountancy
Date:Jan 1, 1991
Words:1207
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