HOW TAX REFORM AFFECTS YOU

Stephanie Manderville (Mandy to her friends, Stephie to her parents) is twenty-eight years old. She’s a loan officer at a large bank holding company where she makes $27,000 a year.

Mandy’s expenses include: $500 a month for the condo she rents off of Skillman Street; $378 for the car payment on her 1985 silver Honda Accord (the “Hon” was pur-chased for $12,500 with a $1,000 downpay-ment; $11,500 was borrowed at 11 percent for three years); at least $100 on her Neiman’s charge; about $100 for utilities; about $30 for dog food for her cocker spaniel. Raymond; and $17.50 a month for her membership at the YMCA. Mandy gives $40 a month to Holy Trinity Catholic Church, and she donates $75 each year to her alma mater, North Texas State University.

With food and entertainment expenses for herself, Mandy doesn’t have much left over at the end of the month. But she has saved a little bit each of the last three years and she put it all in an Individual Retirement Account that now totals about $2,400. Mandy is also covered by a pension plan at work.

Mandy will see immediate benefits from the tax law changes. Her tax liability will be reduced in 1987, with another marginal decrease in 1988. See the accompanying chart of tax projections for details. But Mandy will lose some of her write-offs under the new laws. The accountants at Arthur Young have offered the following observations:

● Since IRAs will be fully deductible only for individuals not covered by a pension plan at work, and only if an individual’s adjusted gross income is under $25,000 ($40,000 for those who file jointly), an IRA will not be as beneficial for Mandy as it was before (he law change. The IRA deduction is scaled down tor taxpayers who are in a qualified plan and make lots of money. However, individuals will be allowed to make nondeductible contributions of up to $2,000 to an IRA. the earnings on which would be tax free until withdrawn. In this situation, if Mandy contributed $2,000 to an IRA in 1987. she could only deduct $1,600. She can still contribute to an IRA in 1986 and take the full deduction. Additionally. Yuppies need to remember that IRAs carry substantial penalties for early withdrawal (10 percent of the amount contributed) and are liable for income tax after withdrawal. Since most Yuppies don’t have lots of extra cash, they may find they need that money now locked in an IRA. so they should consider putting those dollars into tax-free bonds instead that can be cashed in without penalty.

● In the past. Mandy had filed the “simple” tax return and did not itemize herdeductions. On the short form, she coulddeduct half of her total contributions tochurch and her alma mater No more. Mandy will only be able to deduct her charitablecontributions in the future if she uses thelong form and itemizes.

● For Yuppies who itemize, major consumer loans and credit cards should be paidoff as soon as possible because the consumerinterest deduction will be phased out withthe new law. In 1987, 65 percent of the interest will be deductible, in 1988.40 percent,in 1989. 20 percent, and in 1990. 10 percent.

● If Yuppies who itemize have any majorpurchases in mind, they should buy in 1986while they can still deduct the sales tax,which will not be deductible with the newlaw.

Janice Jones is thirty-two years old. She has a nine-year-old son who goes to public school and takes care of himself after school before Janice gets home from work. Janice is a typesetter at a small graphics company where she makes $10 an hour. Since she usually works between forty and fifty hours a week, her annual income is about $21,000.

Janice’s expenses include: $365 a month for a one-bedroom apartment in East Dallas; about $100 for utilities; a $290 car payment on Janice’s 1984 Toyota Celica GT. After grocery bills, there’s not much left at the end of the month. Janice doesn’t get child support payments from her son’s father, who lives in another state and is out of work. Janice has $900 in a non-interest-paying savings account.

Janice will also see immediate benefits from the new tax law; her tax will be less for 1987 than it was for 1986, and it will be reduced again in 1988. See the chart on Janice for details. Janice’s tax future is pretty simple. She’ll have a few more dollars to help make ends meet.

● The accountants at Arthur Young say the new tax laws are pro-family because personal exemptions (for the taxpayer and dependents) are increased, thus helping large families.

Sarah and Wayne Jurgen are both thirty-six years old. They have twin boys who just turned six, and a four-year-old girl.

Sarah is a systems analyst at a local computer company. Wayne is a real estate broker. Their combined income last year was $155,000. This year, Wayne is expecting his income to be substantially less than it was last year. Also this year, the Jurgens will be filing separate tax returns: they have just joined the statistics of the divorced in Dallas. Financial pressures were a part of their problems.

Sarah and Wayne have always lived just beyond their means. Their kids are in private schools and day care. They bought two new cars last year with bank loans, a Mercedes sedan and a Suburban: monthly payments on the cars and on credit cards are $1,908. They have a hefty house payment of $2,742 a month on their North Dallas home, which is valued at more than $250,000. The Jurgens have about $2,000 in savings.

Sarah will be getting custody of the three children, which will help her out at tax time, because of the increased personal exemptions for the taxpayer and dependents under the new law. For the purposes of this example, mortgage interest and real estate taxes for Sarah and Wayne individually will be equal to one-half of the total amounts they paid when they were married. The new tax law means a small break for both Sarah and Wayne, no pun intended. See the accompanying charts for details. Arthur Young accountants made the following observations:

● Sarah and Wayne could each consider anIRA while the deduction is still good in1986.

● The Jurgens are hurt most, together orseparately, by the loss of consumer interestdeductions. They should attempt to pay offtheir credit cards and cars as soon as possible. Sixty-five percent of their consumer interest will be deductible in 1987, 40 percentin 1988, 20 percent in 1989, and 10 percentin 1990. Sarah and Wayne could each consider taking out a second mortgage on theirhomes and using that money to pay off thecar loans and the credit cards. The interestfrom the second mortgage may be deductible despite restrictions in the Texas Constitution, if Congress requires the IRS to allowsuch deductions for Texans.

? Since the Jurgens have divorced, they will not be hurt by the loss of the “two-earner deduction” that allowed the spouse with a lower salary a 10 percent deduction up to $3,000.

Jake Buchanan is si\ty-two; his wife, Millie, is sixty. They have two grown, married children who both live out of state. They have three grandchildren. Jake and Millie still live in the same four-bedroom house off of Park Lane where they raised their kids. They are thinking about selling their home and moving into someplace smaller-but not too small, gotta have room for those grandkids.

Millie has never worked outside of the home for wages. She volunteers three days a week at the Scottish Rite Hospital. Jake is in middle management with a large oil company where he has worked for seventeen years. This year, to save money, Jake’s company offered him a lump-sum payment as an incentive to retire early. The offer was for 180 percent of his annual salary of 575,000. He”s retiring in 1987 and has the option to take the entire amount then, the following year, or half each year.

The Buchanans” investments include a stock plan at the oil company that amounts to about $100,000; their home, valued at $350,000; a lake cottage at Texoma worth about $55,000; $8,000 in an IRA; a money market account of about $5,000; municipal bonds amounting to $50,000; a $100,000 life insurance policy on Jake and a $50,000 policy on Millie. Two years ago, Jake invested $10,000 in a syndication deal- apartments in California-committing to subsequent payments of $10,000 annually for the next three years. The Buchanans have two cars-a 1984 Cadillac and a 1982 Cadillac-both are paid for.

The Buchanans have the highest effective tax rate of our examples, and they also are our only examples who stand to pay more tax under the new tax law. See the chart for details. Arthur Young makes the following observations:

● When fully phased in, the tosses fromreal estate limited partnerships may not offset other income such as salaries, interest,and dividends. The Buchanans should consider investing in other income-oriented realestate investments or other “passive” income generating investments to offset thepassive losses from their presently ownedlimited partnership interest. “Passive” is defined as any activity that involves trade orbusiness in which the taxpayer does notmaterially participate, or any rental activit.

● In regard to the retirement distribution,the tax law generally repeals ten-year forward averaging of retirement payments fortax purposes and makes five-year forwardaveraging available for an individual whoreceives one lump-sum distribution upon orafter the age of fifty-nine and a half. Sincethe effective date of the change is December31, 1986, it may be better for Jake to take hisentire $135,000 distribution this year to getthe ten-year forward averaging availableunder the old law. However, with the loweroverall tax rates in 1988, he could be betteroff deterring until then. Generally, for 1986and 1987, deferring income and acceleratingdeductions should be beneficial under thenew law as the lower tax rates are phased in.

● Under the current law, individuals get a60 percent deduction for long-term capital gains. If a taxpayer is in the 50 percent income bracket, the maximum effective tax rate for that income is 20 percent. Under the new law, the capital gains deduction is repealed and capital gains are taxable at the same rate as ordinary income up to a maximum rate of 28 percent. Generally, if the Empty Nesters’ stock investments have appreciated substantially, it would be wise to sell them in 1986 to get the capital gains deduction if sales of the stocks within three to four years were planned anyway.

● The money market account could be reinvested in T-bills or a certificate of deposit maturing in 1987 so that the income would be taxable at the lower 1987 rates.