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Summarizing the changes of RRA '93.

On August 10, 1993, President Clinton signed into law the 1993 Revenue Reconciliation Act. A summary of the more critical changes is provided here, along with a few suggested techniques for minimizing clients' tax liability.

Tax Changes for Individuals

* The top marginal rate for personal taxes increases from the current 31% to 36% at the following taxable income thresholds:

--Single individuals: $115,000; --Married filing jointly and surviving spouse: $140,000; --Married filing separately: $70,000; and --Heads of households: $127,500 (effective January 1, 1993)

* There is a 10% surtax on taxable incomes over $250,000 other than net capital gains. This is actually a fifth tax bracket of 39.6%. However, when combined with the elimination of the $135,000 ceiling for the Medicare tax (effective January 1, 1994) and the limitations of itemized deductions and personal exemptions, the effective tax rate for upper income taxpayers will exceed 43% (effective January 1, 1993).

* Effective January 1, 1994, all salaries and wages (no longer just the first $135,000), will be subject to the 1.45% Medicare tax, levied on both employee and employer. For self-employeds, the rate is 2.9%.

* The current limits on itemized deductions and personal exemptions have been made permanent. Itemized deductions will be reduced by 3% of adjusted gross income in excess of $108,450. Personal exemptions for 1993 will be $2,350 and will be reduced by 2% for each $2,500 or fraction by which adjusted gross income exceeds $162,700 (joint returns) and $108,450 (single filers) (effective January 1, 1993).

* Effective January 1, 1994, 85% of the Social Security benefits of couples with provisional incomes over $44,000 and individuals with provisional incomes over $34,000 will be taxed. Those couples with income of $32,000- $44,000 and individuals earning $25,000-$34,000 will continue to have 50% of their benefits taxed.

* The alternative minimum tax rate will increase from 24% to 26% on AMT income up to $175,000 and to 28% for income over that amount. The AMT exemption is now $45,000 for joint returns, $33,750 for singles and heads of households and $22,500 for married filing separately. It is phased out for higher income taxpayers. Contributions of appreciated property are eliminated as a preference item. The deductible amount is the fair market value of the property for both the regular tax and the AMT (effective January 1, 1993).

* Effective January 1, 1994, for moving expenses to be deductible, the move must be at least 50 miles (increased from 35 miles) from home. Meals, temporary lodging and the other indirect expenses are disallowed as moving expenses. The new law will also allow these expenses above the line in calculating adjusted gross income.

* The capital gains rate will remain at 28%. However, effective the day of signing the tax bill, August 10, 1993, there is a 50% exclusion of capital gains from the sale of stock of small capitalization start-up companies acquired in initial public offerings and held at least five years. A small corporation is defined as a C corporation in an active trade or business with under $50 million in gross assets. Banking, real estate, leasing, minerals, hospitality and farming are not included in the definition. 50% of the excluded gain is a preference item for alternative minimum tax. The 50% exclusion is an important stimulant for a narrow part of the economy.

* The amount of the earned income credit will be increased for low income families, and will be expanded to include childless couples between the ages of 25 and 65. This is effective January 1, 1994.

Business Tax Changes

* The top corporate tax rate (taxable income over $10 million) was increased from 34% to 35%, effective January 1, 1993. Deferred tax liabilities established at 34% will have to be written up to 35% with a corresponding increase in income tax expense. Likewise, deferred tax assets will have to be written up with a corresponding increase in income.

* A very complicated, two-tier investment tax credit was proposed in the original tax bill. Corporations urged that it be eliminated in exchange for halving the proposed increase in the tax rate, which was 36% in the original proposal.

* Small businesses have a new incentive for growth. RRA '93 expanded 179 expensing, allowing them to write off equipment purchases of up to $17,500, up from $10,000, for tax years beginning after 1992.

* A major new tax benefit is the allowance of amortization for intangible assets acquired in mergers and takeovers, such as customer lists and goodwill, over 15 years. Amortization of goodwill has always been non-deductible. Shorter amortization periods are provided for other types of intangibles, such as sports franchises, book and movie rights, and some software.

* Effective January 1, 1994, the new law will expedite and simplify quarterly estimated tax payments by both individuals and corporations.

* The 10% luxury tax on yachts, private airplanes, furs and expensive jewelry has been repealed, effective January 1, 1993. The tax still applies to luxury automobiles costing $30,000 or more. This price level will continue to rise in $2,000 increments based on inflation.

* Salaries of the top five executives in excess of $1,000,000 are no longer deductible. Certain types of payments, such as commissions and incentive bonuses, are not included in the calculation of executive compensation for the purposes of this provision. This applies to publicly traded companies.

* Effective January 1, 1994, only 50% of meals and entertainment expenses will be deductible. Previously the maximum was 80%. Also, club dues and lobbying expenses will no longer be deductible.

* Effective January 1, 1994, securities brokers will value their inventories at market value rather than lower of cost or market and the unrealized gains will be taxable. However, the initial increase in income will be spread over five years.

* The depreciation period for non-residential real estate is increased from 31.5 to 39 years, effective May 13, 1993, with some exceptions.

* Effective January 1, 1994, the passive loss rules for rental real estate have been modified. Such property will be excluded from passive status if the taxpayer participates, to the extent of at least 50% of professional time, in real estate activities.

* The depreciation component of the ACE adjustment has been eliminated in the calculation of corporate AMT.

* An expired law that allowed self-employed persons to deduct 25% of health insurance costs has been retroactively reinstated. Other provisions which expired June 30, 1992, and have been extended retroactively include:

--Employer Paid Education Expenses (through December 31, 1994); --Research and Experimentation Credit (through June 30, 1995); --Targeted Jobs Credit (through December 31, 1994).

* The standard mileage rate for business use of automobiles remains at 28|cents~ per mile.

Investment

Capital Gains Break for Qualifying Small Business Investment: 50% of capital gains on qualifying small business stock held for five years or more will be excluded when calculating tax on capital gains.

Other Capital Gain Changes

* Income from certain transactions designed to convert ordinary income into capital gains will now be treated as ordinary income.

* Investment interest expense can no longer be used to offset long-term capital gains unless the taxpayer chooses to have the capital gains taxed as ordinary income.

* Original issue discount on all bonds, including U.S. government and tax free municipals, will be taxed as ordinary income.

* Appreciation on stripped preferred stock will be taxed as ordinary income.

Specialized Small Business Investment Companies (SSBIC): Investment in these companies, which are licensed by the Small Business Administration to finance minority-owned businesses, qualifies for two breaks under the new law. First, gain on the sale of stock can be deferred to the extent that the proceeds are invested in to buy common stock or a partnership interest in an SSBIC. Second, stock held in an SSBIC will more easily qualify as small business stock, as discussed above.

Tax Free Bonds: New rules make interest from certain private activity bonds tax exempt.

Pension Plan and Nonprofit Investments: Provisions that previously classified certain leasing and financing arrangements as subject to unrelated business income tax have been repealed.

The Low Income Housing Credit has been made permanent.

Opportunities for Tax Savings

The tax changes of the 1980s made the tax rates flatter and the tax rate structure less progressive. The result was economic growth and increasing tax revenues for the government. The 1993 tax law makes the rates less flat. The new 36% tax bracket, the 10% "millionaire's" surtax, and the phasing out of personal exemptions and itemized deductions make the tax rate structure more progressive. This was done in the name of "fairness," of course, but opinion is divided as to whether the result is "fair." Nevertheless, it is clear that we in public accounting must do all we can to minimize the damage to our clients.

The two new tax brackets are strictly a tax on the wealthier segments of our society, affecting only families with gross incomes of over $180,000. The higher tax rates will have no effect on most of the population. Approximately 98.5% of taxpayers will not see an increase in income taxes. Three-fourths of the tax increases will be borne by those whose incomes are over $200,000. The only additional taxes that most people will have to pay is the 4.3|cents~ per gallon of gasoline that became effective October 1.

With marginal tax rates of 31% and higher, the capital gain rate of 28% is attractive. Tax planning can be quite profitable if we seek opportunities to transfer ordinary income to capital gains. The tax savings would be the difference between 28% and the client's marginal rate of 31%, 36% or 39.6%. Also, if a client is in a position to invest in small, publicly traded start-up companies, the tax savings would be truly significant because of the 50% exclusion.

Those in the higher tax brackets can, of course, take full advantage of the capital gains rates. In addition, investments that earn interest, such as certificates of deposit, money market funds and taxable bonds, could be converted to mutual funds specializing in capital gains or in tax-free municipal bonds. Remember that such interest is a preference item for the alternative minimum tax. Because of the non-deductibility of executive salaries in excess of $1,000,000, stock options should be considered as alternatives to salaries in compensation packages.

Low-income earners should claim the maximum amount of the expanded earned income credit. Previously it was available only to households with children, but it is now available to childless workers with earnings under $9,000. This is a refundable credit which allows the tax liability to be reduced below zero. The government will send the taxpayer a check even when there is no tax liability.

There is not a lot of good news in this tax bill and opportunities for savings are limited. But they are there and we should take full advantage of them in order to serve our clients most profitably.

Arnold Cirtin, Ph.D., CPA, is professor of accounting at Ball State University.
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Title Annotation:Back to School: The Revenue Reconciliation Act of 1993
Author:Cirtin, Arnold
Publication:The National Public Accountant
Date:Nov 1, 1993
Words:1849
Previous Article:A special address by Commissioner of Internal Revenue Margaret Richardson.
Next Article:The effect of RRA '93 on individual taxpayers.
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