Second in a series No matter how wealthy you are, new tax tactics in 1991 will play a big role in determining how much of your money remains your money after taxes.
To help you find ways to turn the new government rulings to your financial advantage, tax attorney Eli J. Warach, chief consulting tax editor of Maxwell Macmillan/Prentice Hall, has analyzed the tax laws. How do the new law, new cases and new IRS rulings affect you?
Start with the new law, generally effective starting Jan. 1, 1990. What can you do about it now -- and in 1991 -- for your benefit?
In the area of travel and entertainment, each year seems to bring another change, mostly to the taxpayer's detriment. The new law adds something harsher than ever.
When you, as an employee, use your own car and pay for food and entertainment, you can't deduct the full amount on your tax return. These costs are deemed employee business expenses. As such, they are lumped together with "miscellaneous deductions."
This category of itemized deductions is limited to the excess of deductions over 2 percent of adjusted gross income. Even worse, before lumping the food and entertainment portion with the travel expense category, the food and entertainment amounts must be reduced by 20 percent. The remainder is then lumped in with the miscellaneous deductions and reduced by 2 percent of adjusted gross.
That's bad enough. Now, the new tax bill adds another category of itemized deduction disallowance. Starting in 1991, when a taxpayer has adjusted gross income of more than $100,000, 3 percent of the excess knocks out that amount of itemized deductions. So if you have $200,000 of adjusted gross, you lose $3,000 of deductions. And that's true whether you have $40,000 of deductions or $4,000 worth.
You can't lose all your deductions under this new provision. Here's why: there is a built-in safety net of 20 percent of itemized deductions. So the worst you can lose is 80 percent. But even that can be a killer. Even if you somehow reduce your itemized deductions in 1991 by, say, paying some state taxes in advance (where permitted), you still lose the same amount of itemized deductions. And this includes deductions such as mortgage interest, real estate taxes and state income taxes.
Is there anything you can do about it? Here are some examples.
The wrong way: Rachel and Dan own and work for K.T. Corp., a Texas corporation. In 1990, Dan and Rachel have a combined adjusted gross income of $200,000. Dan spends $3,000 a year on food and entertainment, $5,000 on other travel expenses. They have no other miscellaneous expenses. Their other itemized deductions come to $16,000.
Result: Dan reduces the $3,000 by 20 percent. That leaves $2,400. He adds that to the $5,000 for a total of $7,400. That figure is now reduced to $3,400. Why? Because Dan and Rachel must reduce the $7,400 by the 2 percent miscellaneous deduction (2 percent of $200,000 is $4,000). So the net result for 1990 is itemized deductions of $19,400 ($3,400 in miscellaneous deductions plus $16,000 in other itemized deductions).
In 1991, on the same facts, they would add the $3,400 to the other itemized deductions of $16,000 and subtract another $3,000 (that's 3 percent of the excess of $100,000). So their total itemized deductions would be only $16,400. But remember, their actual expenses were $24,000. So they lose a total of $7,600 -- about 32 percent of their total itemized deductions.
A winning way: Sarah and Seth have the same kind of set-up. However, in 1991, Seth fully accounts to the employer (the company) for every dollar of T & E expenses and gets reimbursed for those expenses.
This serves a double purpose. First, the $8,000 he gets -- $3,000 for food and entertainment and $5,000 for other travel expenses -- reduces his adjusted gross income by that amount. Then, the money is tax-free to him.
The company deducts only 80 percent of the $3,000, but it deducts the $5,000 in full.
Result: The remaining $16,000 in itemized deductions will be reduced by $2,760 -- instead of $3,000 -- which is 3 percent of $92,000.
NEXT: Tips on claiming dependency deductions.