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Tax Reduction Targets Specific Groups, Behaviors

By Albert B. Crenshaw
Washington Post Staff Writer
Wednesday, July 30, 1997; Page A01

You can go ahead and sell the house, but you might want to put off dying for a few years. Your new baby may be a bit less expensive, but the family vacation on a low-fare airline could cost a little more. Saving for retirement and some other goals would become more attractive, but you'd better buy a computer first – you'll need it for the record-keeping.

These are among a wide range of benefits and costs that American taxpayers would see if the $94 billion tax cut deal announced by Congress and the White House becomes law.

Unlike the last big federal tax cut in 1981 and the wholesale overhaul of tax laws in 1986, both of which affected virtually all taxpayers, the reductions in this year's deal are aimed at specific groups of people and types of behavior that leaders of both parties wish to encourage.

As a result, education, homeownership and saving for retirement are singled out for special breaks, as are investment, small business and family farms. The benefits flow most to the well-to-do who have built businesses or have spare cash to invest and to lower-to-moderate-income working families.

Special credits and savings incentives flow primarily to families with annual incomes of less than $100,000, while investment benefits would go to those with lots of extra income that they can invest.

"If you have kids or have resources," you would benefit, said Greg Jenner, national tax policy director at the Washington office of Coopers & Lybrand LLP, an accounting firm. Moderate-income singles and upper-middle-class families won't see much.

"There is as much social policy here as tax policy. In fact, I would suggest, more," Jenner said.

For low-to-moderate-income families, the key elements of the deal revolve around children, and they are meant to put cash directly in taxpayers' pockets. There are two key ones:

* A $500-per-child credit ($400 in the first year) for working families with children age 16 and under. Unlike a deduction, which is a subtraction from taxable income and whose value is greater for taxpayers in higher brackets, a credit is a dollar-for-dollar reduction in taxes owed and has the same value at all levels of income. Thus, if a couple owed $1,500 in taxes, and had two children, their liability would drop to $500. By adjusting withholding they could get the money in their paychecks all during the year rather than waiting for a refund.

Under the deal worked out between President Clinton and congressional Republicans, couples with incomes up to $110,000 ($75,000 for a single parent) would get the full credit. It would begin to phase out at higher incomes. Couples with annual incomes as low as $18,000 could qualify.

* A credit for higher-education expenses of up to $1,500 during the first two years of college, followed by a a credit of $1,000 (rising to $2,000 in 2002) during the second two years.

The bill also permits a deduction of up to $2,500 a year for student loan interest. So-called personal interest – interest on debt other than investment or housing – was made nondeductible by the 1986 reforms. This bill would restore a part of that benefit.

Middle-income savers also would benefit from expanded individual retirement accounts. The income cutoff for deducting an IRA contribution would rise, and a new "backloaded" IRA with nondeductible contributions but no taxes on withdrawals would be created. The new IRAs would phase out for people with annual incomes of $150,000 or more.

Perhaps the biggest break for most middle-class families, though, is a provision that would exempt from tax up to $500,000 in profits on the sale of a home. Such profits are now taxable, though it is possible to escape the tax by plowing the money back into the purchase of a new home.

Current law, though, leads thousands of taxpayers, particularly retirees, to keep their houses or to buy large new ones to avoid tax. It also requires elaborate record-keeping. The change would eliminate all that, allowing home sellers to keep their profits or reinvest them as they prefer.

The new benefit would apply to homes sold after May 6 of this year.

For those largely at the upper end of the income scale, taxes on capital gains – profits from the sale of assets such as stocks, bonds and real estate – would be taxed at a maximum rate of 20 percent, down from the current maximum of 28 percent.

However, to qualify, taxpayers would have to have owned the asset for 18 months, up from the current 12 months, though assets sold between May 6 and Monday would qualify if held 12 months.

Middle-class people with mutual fund holdings – a group growing larger as the stock market soars – also would benefit from the provision.

Those who get through life and end up with something left over would also find it easier to pass it on to their heirs. The measure would gradually raise to $1 million from the current $600,000 the amount any person could bequeath tax-free. The amount for family farms and small business would climb to $1.3 million, beginning next year.

Much of the tax cutting is paid for with higher airline ticket taxes, and users of low-fare carriers would see a particular boost. In the past, airline taxes have been a percentage of the ticket price, which further raised fares for the carriers with the highest fares. The new tax regime would shift some of the tax burden to the low-fare airlines.

All of this would mean much greater complexity for individuals. Conceivably, an individual reaching retirement age could have an IRA with deductible contributions, nondeductible contributions, one rolled over from an employer plan and one of the new backloaded ones. Calculating the required withdrawals and taxes would be an adventure.

Likewise, the credits would add complexity.

"It's the opposite direction from 1986," said Gillian Spooner of KPMG Peat Marwick LLP in the District. "In that effort we were trying to remove all the special incentives to do things, and therefore we were able to lower the rates, and here we are introducing new incentives to do things."

But, she said, that's the consequence of trying to aim the breaks at certain people. "The moment you start targeting the benefits . . . you are introducing that complexity."

© Copyright 1997 The Washington Post Company

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