As we enter the 1991 tax filing season, taxpayers and preparers have another annual new tax law to contend with, the Revenue Reconciliation Act of 1990, but most of the changes in the new law won't take effect until the 1991 tax year.
The previous year's tax act, the Revenue Reconciliation Act of 1989, has its full impact with the 1990 tax year. Fortunately, virtually all its provisions are narrowly drawn, so they will have little broad impact on individual taxpayers.
We will highlight some specific changes and a few tax tips as we discuss how to go about filing your 1990 tax return.
Keep handy your 1990 booklet on 1040 forms and instructions because it contains information not covered in this special tax guide.
What's New for 1990 Military or Mideast tax breaks: In recognition of the Persian Gulf War, Internal Revenue Service announcements call attention to procedures designed to alleviate certain tax concerns.
Military personnel in the Persian Gulf area will have until June 15 to file 1990 returns, subject to further extension as conditions warrant. Military personnel may defer payment of any income tax due for up to six months after the end of their military service and no penalty or interest accrues during the deferral period. This rule also applies to military reservists whose ability to pay the tax is "materially impaired" by reason of their service.
Taxpayers who satisfy a foreign residence test or foreign presence test can generally exclude up to $70,000 of foreign earned income. The IRS has waived the foreign residence and presence tests for individuals who left Iraq, Kuwait or Yemen after certain dates in August 1990.
To qualify for a moving-expense deduction an employee must work in the new location for 39 weeks during the first 12 months after arrival; for self-employed workers the work requirement is 78 weeks in the first 24 months.
The IRS may waive the work requirement for taxpayers who show that, except for the Middle East crisis, they would have most likely met the requirement.
A taxpayer who sells a principal residence at a gain generally can avoid current tax on the gain by buying a new principal residence within two years of the sale.
The replacement period is extended while time is served in the military on "extended active duty," up to an additional two years. If the taxpayer is stationed outside the United States, the replacement period ends not before one year after his or her return to the United States.
Audit and collection relief may also be available to reservists, military personnel and detained citizens by calling the IRS. The number is 1-800-424-1040.
Further tax relief for Desert Storm participants is pending.
Standard deduction: The standard deduction is again increased to take account of inflation. For sighted taxpayers under 65 who can't be claimed as a dependent by someone else, the chart on page 6 shows changes in the standard deduction for three years.
For some taxpayers, such as those 65 or older, blind or dependents of others, the rules can be complicated. See the booklet instructions for line 37, Form 1040.
Earned-income credit: In 1990 this refundable tax credit, which is available to certain lower-income workers who provide a home for a dependent child, can be as much as $953. It phases out as earned income -- or adjusted gross income (AGI), if greater -- exceeds $10,750 and is fully phased out at $20,264.
Self-employment tax deduction: There is a new wrinkle regarding the self-employment tax -- individuals subject to self-employment tax may deduct an amount equal to one-half of the tax in arriving at AGI, on new line 25 of Form 1040. In addition, the earned income base for calculating the self-employment tax is reduced by one-half of the self-employment tax rate, for example 7.65 percent. These changes are intended to equalize the burden of payroll tax for self-employed people and employees.
Expanded Form 1040A: Form 1040A for 1990 includes new lines for reporting pension and annuity income, IRA payments, taxable Social Security benefits, estimated tax payments and the credit for the elderly or disabled, thereby making this form available to many more taxpayers, as an alternative to the longer and more complicated Form 1040.
Optional mileage allowance: The optional mileage rate for business travel in 1990 is 26 cents a mile for all business miles; for 1989 it was 25 1/2 cents for the first 15,000 miles and 11 cents after. Next year it is expected to be 27 1/2 cents.
Other optional mileage rates for 1990 are unchanged: 12 cents per mile for charitable transportation and 9 cents per mile for medical or moving expense transportation.
Series EE bonds: Starting in 1990, interest on Series EE bonds issued after 1989 to any taxpayer at least 24 years old may be tax-free, if when redeemed the bond proceeds are used to pay for certain higher education expenses of the taxpayer, his spouse or dependents. This tax break should benefit middle-income taxpayers; the interest exclusion phases out for married taxpayers filing jointly with modified gross income between $60,000 and $90,000. For single or head-of-household taxpayers, the phaseout occurs between $40,000 and $55,000.
The IRS has a new form, Form 8815, for use in reporting -- on line 3, Schedule B -- the exclusion of Series EE bond interest.
Deductibility of personal interest: The itemized deduction allowed individuals for personal interest continues to be phased out. For 1990, only 10 percent of otherwise deductible personal interest is allowed, compared with 20 percent for 1989. For 1991, none will be deductible.
Changes on Schedule A -- itemized deductions: Medical expenses for 1989 were to be categorized and reported on several lines on Schedule A; for 1990 all are reportable on a single line with no further detail.
Specific information about charitable contributions in excess of $3,000 to any one organization is no longer required. However, the IRS has retained the requirement that Form 8283 for non-cash contributions be filed to support non-cash contributions in excess of $500. The IRS has indicated its intention to increase its enforcement efforts regarding this requirement.
Lines have been added in the medical and miscellaneous itemized deductions sections for noting the adjusted gross income amount from line 32 of Form 1040. The purpose is to make it easier to calculate the AGI-based limitations on medical and miscellaneous deductions -- 7.5 percent and 2 percent, respectively.
Changes on Schedule B -- interest and dividend income: For 1990, the separate line for interest income from seller-financed mortgages has been eliminated and a new line has been added for subtracting Series EE bond interest used to pay qualified higher education expenses, as calculated on new Form 8815.
Change on Schedule D -- like-kind exchanges: Certain nontaxable exchanges of property used to be reported on Schedule D "Capital Gains and Losses." For 1990 the IRS has developed a new form -- Form 8824 -- for reporting so-called like-kind exchanges.
Change on Schedule E -- supplemental income and loss: The 1989 question (on line 3) about active participation in each rental real estate activity has been eliminated.
Change regarding Form 4562 -- depreciation and amortization: For 1990, taxpayers are not required to complete and attach Form 4562 if the only depreciation claimed is for assets (other than so-called "listed" property such as cars, cellular telephones and computers) placed in service before 1990.
New change of address Form 8822: In the past, the IRS has generally used the address shown on a taxpayer's most recently filed return as the taxpayer's address of record, unless the taxpayer wrote and told the IRS about a change of address. The IRS has developed a new form (Form 8822) for informing it of an address change.
New method for determining underpayment penalty: Individuals may be subject to an underpayment penalty if their withholding and timely estimated tax payments don't total at least 90 percent of the current year's tax or, if less, 100 percent of the previous year's tax. The penalty is generally based on separate quarterly calculations, using a separately mandated interest rate for each quarter. The penalty is figured on Form 2210. The 1990 version of Form 2210 includes a new "short method" for determining any underpayment penalty, using a single blended interest rate times the amount of the underpayment.
Electronic filing: If the bottom line on your return indicates that you have overpaid, you may choose to have your return filed electronically. The IRS estimates that refunds for electronically filed returns will take about three weeks, or two weeks if you request a direct deposit of your refund. These refund times are considerably shorter than for paper returns, which often take up to eight weeks, depending on when in the tax season you file.
Some tax returns have been filed electronically since 1986 and the number of such returns more than tripled last year to an estimated 4 million returns. The IRS is seeking to expand this program because the processing error rate for electronically filed returns is much lower than for paper returns.
Electronically filed returns are automatically checked and processed while paper returns must be manually sorted and numbered. Then the tax information must be manually coded, edited and selectively entered into the IRS's computer system.
For the state returns, only Maryland has an electronic filing program for refund returns. The IRS is thinking about how to initiate a joint federal-state electronic filing program.
Use the IRS telephone number for your area to find out who can electronically file your return and whether your refund or zero-balance return qualifies.
Looking Ahead to 1991
Although the focus here is on how to go about filing your 1990 return, time can be well spent by keeping in mind some of the changes that lie just ahead for the 1991 tax year, particularly those with fairly broad impact on individual taxpayers. You can skip this section if you just want to know about how to file your 1990 return, but you may be interested in the following changes that may affect your 1991 return:
Tax rates: Income for 1990 falls into four income tax brackets: 15 percent, 28 percent, 33 percent and 28 percent.
The 33 percent bracket is referred to as the "bubble rate" because taxable income at levels above and below the 33 percent bracket is taxed at 28 percent. The bubble rate is intended to phase out the benefit for high-income taxpayers of the 15 percent bracket and the personal exemption deductions.
For tax years beginning in 1991, income will be taxed at just three rates: 15 percent, 28 percent and 31 percent. The third bracket for 1990 and 1991, along with starting taxable income levels, is shown in the chart on this page.
For taxpayers whose incomes don't put them above the 28 percent bracket for either 1990 or 1991, the new rate structure shouldn't affect their tax liability. Those taxpayers just above the 28 percent bracket in 1990 may find their 1991 top rate to be slightly lower than before, such as 31 percent rather than 33 percent.
Some affluent taxpayers, whose incomes took them all the way through the 33 percent bubble and back into the second 28 percent bracket in 1990, may find that their 1991 top rate will be higher than before -- 31 percent rather than 28 percent.
New limitations on personal exemptions: The former 33 percent rate will no longer be available to phase out personal exemptions. To retain the personal exemption phaseout for 1991 without simply enacting higher tax rates, the Revenue Reconciliation Act of 1990 provides for the direct phaseout of personal exemptions for taxpayers with adjusted gross incomes above certain threshold amounts.
Each personal exemption is $2,050 for 1990 and $2,150 for 1991. The 1991 personal exemption is subject to phaseout at the rate of 2 percent (4 percent for married couples filing separately) per $2,500, or fraction thereof, of AGI in excess of: $150,000 for joint filers, $100,000 for single taxpayers, $125,000 for heads of household and $75,000 for marrieds filing separately.
For example, a 1991 single filer with $150,000 of adjusted gross income will be entitled to a $1,290, rather than $2,150, personal exemption.
New limitations on itemized deductions: To the extent 1991 AGI exceeds $100,000 ($50,000 for married people filing separately), the sum of the following itemized deductions -- determined after any other limitations, such as the 2 percent floor on miscellaneous itemized deductions -- is reduced by 3 percent of AGI in excess of $100,000. But such reduction is not to exceed 80 percent of the total of such deductions.
The itemized deductions to which this "haircut" applies are taxes, interest expense other than investment interest, charitable contributions, moving expense and miscellaneous deductions.
Long-term capital gains: Preferential tax treatment for long-term capital gains -- absent from the tax law since 1986 -- has been restored starting with 1991. The income tax rate on long-term capital gains is capped at 28 percent, whereas ordinary income may be taxed at up to 31 percent.
This will represent no change for taxpayers who for 1990 and 1991 find themselves in the 15 or 28 percent brackets. For 31 percent taxpayers, the modest capital gain preference is perhaps even more modest than it seems -- 28 percent vs. 31 percent -- when you consider the indirect effect of the new personal exemptions phaseout and limitations on itemized deductions.
These new limitations are based on AGI -- that is, the higher AGI, the less benefit from these deductions -- and the full amount of long-term capital gains continue to be included for purposes of determining AGI.
Social Security tax: The Social Security tax rate for 1991 will remain the same, 15.3 percent, consisting of two components: 12.4 percent for old-age benefits, and 2.9 percent for Medicare hospital insurance.
Self-employed workers pay the full tax. Employers and employees each pay half; this means if you are an employee, you pay 6.2 percent old-age tax and 1.45 percent Medicare tax.
For the first time in 1991, there will be different earnings bases for the old-age payroll tax and the Medicare payroll tax: $53,400 and $125,000 respectively. For 1990, the base was $51,300 for both parts of the tax.
Social Security numbers: For 1991, a Social Security number must be obtained for any child over age 1; for 1990 the requirement applies at age 2.
The IRS is checking recent years' returns for compliance with the Social Security number reporting requirement for claimed dependents.
Extensions: According to the IRS, 6.5 million taxpayers apply for an automatic four-month extension -- until Aug. 15 -- to file their returns. The extension doesn't postpone the April 15 due date for paying tax due. Form 4868 is used for this purpose.
The IRS is developing a new, paperless system called Automated Processing of Extensions, or APEX, for securing an automatic four-month filing extension, whereby, if a taxpayer files his return by Aug. 15 and has by the prior April 15 paid either 100 percent of the tax due for the return year or 100 percent of the prior year's tax liability, the return will be deemed timely filed, thus doing away with the need to file From 4868.
The new system may be ready in 1992 with respect to 1991 returns. For 1990, however, if you don't file by April 15, 1991, be sure to request an automatic four-month extension, using Form 4868.
How Long Will It Take?
The 1990 IRS Form 1040 instruction booklet contains a table of estimated times required to complete and file various forms, including Form 1040 and several often-required schedules.
You may want to consider these time estimates as you consider whether to do your own return or seek professional help.
In this regard, having your return prepared by computer offers considerable advantage in terms of time, effort and cost, as well as the opportunity to have it filed electronically, and you may want to consider exploring this possibility.