Yearend Planning for Individuals and Small Businesses; How to Make the Most of This Year's Limited Opportunities (1990)

The law changes of recent years succeeded in eliminating aggressive noneconomic advantages and shifting the burden to those individuals government believes are most able to afford it. At the same time, the tax simplification that was the main selling point of both the Tax Reform Act of 1986 and subsequent modifications to it has not really been achieved. Although these changes created challenges for CPAs, there are still yearend planning opportunities available. This year is notable because it marks the final phaseout of several opportunities the TRA sought to end and because it seems clear taxes will increase in the future. This article, which went to press before any budget accord was reached, tells what's ahead in the coming season. CPAs should monitor legislative activities to see what effect they'll have on clients. PLANNING FOR INDIVIDUALS While some new items are really variations on and old theme, planners must keep them in mind. The rates remain at 15%, 28% and 33%. Inflation indexing, however, has caused the amount covered in each bracket to rise. High-income taxpayers will continue to lose their personal exemptions as their incomes increase. The 33% bracket was created to eliminate the benefit of the 15% bracket for people earning above certain amounts so all their income would be taxed at a flat 28%. However, when their income level eliminates their exemptions, the rate goes highger. A main goal of yearend planning should be to soften the effect of the 33% bracket (see exhibit 1 on page 64 to understand this bracket's impact). The personal exemption has increased to $2,050. The standard deduction is now Married, filing jointly $5,450 Married, filing separately 2,725 Single 3,250 Unmarried head of household 4,750 Additional standard deductions are available for taxpayers over 65 and fr the blind. In addition, new rules limit the usefulness of like-kind exchanges between related people that are made after July 19, 1989. (For further information, see Finally, Guidance on Like-Kind Exchanges, by Philip J. Wiesner and David G. Meulmester, part 1, JofA, Oct.90., pages 50-59, part 2, Nov.90, pages 76-84.) SPECIAL CONCERNS A few areas deserve special attention this season: Interest deductions. Tax planners must remember the key to deductibility is not necessarily where the borrowed money comes from but how the funds are used. There are several different kinds of deductible interest: * Interest on residential mortgages is deductible up to $1 million of acquisition debt, plus $100,000 of home equity debt. Planners should remember that an acquisition debt can be refinanced but the interest expense is deductible only on the balance existing on refinancing, plus the home equity debt (if available). Clients should take care when financing the purchase of a second home with money borrowed against their principal residence--some or all of the interest may not be deductible. Exhibit 2 on page 66 summarizes the rules on vacation homes. Planners also must be familiar with the grandfather rules for residential debt acquired before October 13, 1987. * Investment interest is deductible up to net investment income plus 10% of remaining investment interest up to $10,000. It must be emphasized that one of the biggest planning mistakes is using money borrowed from security margin accounts for personal purposes. This interest expense would be considered personal and subject to the personal interest limitation. It is possible to structure transactions to guarantee an interest deduction. For example, a client has a money market mutual fund, which is considered an investment income source. She also has a brokerage security account. She needs $5,000 for personal purposes. By transferring $5,000 from the margin account to the mutual fund, she turns the interest on the margin account into investment interest expense. …