First in a series
As the new Congress prepares to begin debate on another major tax bill, taxpayers will wrestle when filling out their federal income-tax returns with a series of tax law changes wrought by the last Congress.
Embedded in 1996 returns is a relatively sizable number of tax-law revisions, some of which are certain to be welcome, some not.
This tax season's changes aren't the sort of sweeping measures that Republicans in Congress tried to enact last year and which they plan to push again this year, such as family tax credits, capital-gains tax relief and expanded Individual Retirement Accounts.
But the hodgepodge of changes incorporated in 1996 returns will, nevertheless, have an impact on millions of individuals. The new rules affect the reporting of a young child's investment income, the earned-income credit, employer-provided educational assistance, annuity payments, U.S. Savings Bonds, state prepaid tuition plans, Social Security taxes, personal injury awards, write-offs for cars and employee death benefits.
Most of the tax changes stem from the Small Business Job Protection Act of 1996, which, despite its name, contains numerous measures affecting individuals and large corporations. Other changes stem from the new welfare reform law, a bill expanding taxpayer rights, and the annual inflation adjustments to the tax system.
''You take all those bills, and you have a lot of changes affecting individuals,'' said Sidney Kess, a New York tax attorney who trains thousands of accountants across the country each year on tax-law developments. ''It's one of the more significant years we've had in terms of changes.''
The tax changes won't have a major impact on most taxpayers' bills. For example, the increases in the standard deduction will provide a tax savings of only $15 to $42 for most non-itemizers. The increased amount of wages subject to Social Security tax will increase the tax bills of higher-paid employees by no more than $93. And the increased mileage rate for business use of a car will amount to no more than a few dollars' tax savings for each 1,000 miles driven.
But some tax changes will have a much bigger impact on certain groups of individuals. For instance, a sharp increase in the earned-income credit for workers with two or more children will mean as much as $446 more in the pockets of the lowest-income families this tax season. The revival of the tax exemption for employer-provided educational assistance could mean more than a thousand dollars in tax savings for many employees. And the tougher tax rules governing damage awards in personal injury lawsuits could conceivably end up costing some individuals tens or hundreds of thousands of dollars - or more - in taxes.
The tax forms didn't require any major alterations to accommodate the tax-law changes. But the IRS did make a few modifications.
For instance, getting your tax refund deposited directly into your bank account by the IRS will entail a bit less paperwork this year. The IRS deleted the extra form that used to be required to request direct deposit. All the necessary information will now be reported right on Form 1040, 1040A or 1040EZ.
The IRS also made a couple of adjustments to Schedule C-EZ so that more self-employed individuals could take advantage of the simple form for reporting their business profits.
Here is a rundown of the major changes that individuals will encounter when working on their 1996 returns:
Kiddie tax: For children under age 14, the first $1,300 of investment income will be given preferential treatment regardless of whether the income is reported on the parent's return or on a separate return for the child. Previously, parents who added the income to their own return found only the first $1,000 of the child's income accorded preferential treatment.
Educational assistance: The $5,250 tax exemption for employer-provided educational assistance, which lapsed at the end of 1994, was reinstated by Congress retroactive to Jan. 1, 1995. But there is a new wrinkle: Graduate-level courses that began after last June 30 are no longer eligible for the exemption.
Social Security numbers: Congress has given the IRS authority to play hardball this tax season with taxpayers who file returns with missing Social Security numbers. If you fail to list a Social Security number for a dependent, the IRS can automatically disallow the dependency exemption, as well as the child-care credit and the earned-income credit. Social Security numbers must now be listed for any dependent born before Dec. 1, 1996.
Savings Bonds: More individuals are now eligible for a tax break when they use Series EE U.S. Savings Bonds to pay college tuition. Interest on Series EE bonds purchased since Jan. 1, 1990, can be fully or partly tax-exempt if the bonds are used to pay higher-education expenses, depending on your income. Congress sharply raised the income-eligibility limits for the break.
Annuities: Individuals who started to receive annuity payments from an employer retirement plan after Nov. 18 are generally required to use a less favorable formula for determining the tax-free portion of the distributions.
Diesel credit: A 12-year-old tax break for buyers of new
diesel-powered cars was abolished for vehicles purchased after last Aug. 20. Vehicles purchased on or before Aug. 20 are eligible for a tax credit of $102 for a diesel car or $198 for a diesel van or light truck.
Death benefits exclusion: Also abolished was the $5,000 tax exemption for death benefits paid by an employer to the family of an employee who died. The exclusion was repealed for payments related to an employee who died after last Aug. 20.
Earned-income credit: This tax break for lower-income workers has become more valuable. But the welfare reform law tightened the eligibility requirements. As a general rule, the credit is no longer available to workers who earned more than $2,200 in investment income last year. The previous limit was $2,350. (The old limit still applies for 1996 to most workers who received advanced payments of the credit through their employer last year.) For those eligible, the maximum credit for workers with two or more children is $3,556, a $446 increase from 1995. For workers with one child, the maximum credit is $2,152, a $58 increase. For childless workers, the credit limit is $323, up $9.
Car deductions: To compensate for the increased cost of operating a car, the IRS raised the standard mileage rate for business use of an automobile to 31 cents a mile, up from 30 cents in 1995. Individuals who use their car for business have the option of writing off actual expenses or claiming the IRS mileage allowance plus parking and tolls. The mileage rate for job-related moves and transportation to doctors' offices was also raised, to 10 cents, from 9 cents in 1995. The mileage rate for volunteer charity work, however, was left unchanged at 12 cents a mile.
Employee parking: For employees who received free or subsidized parking at work from their employer, the tax exemption for the fringe benefit has gone up a bit, from $160 to $165 a month. Workers are required to pay tax on the benefit to the extent that its value exceeded $165 a month in 1996.
Employee taxes: Higher-paid workers will see a bit more of their wages gobbled up by Social Security tax. Employees will pay Social Security tax at a rate of 6.2 percent on the first $62,700 of their wages on 1996 returns, up from $61,200 in 1995.
Personal injury awards: More individuals who win personal injury lawsuits will be forced to share their awards with the IRS. Congress sharply restricted the tax-free treatment of damage awards, which have been the source of numerous tax disputes in the courts. With few exceptions, amounts received after last Aug. 20 are tax-exempt only if they are compensatory damages for physical injury or sickness. In the past, some courts had sanctioned tax-free treatment for compensatory damages awarded for ''emotional distress'' in non-physical injury cases involving employment discrimination and defamation. The courts also disagreed about whether punitive damages in physical injury and sickness cases were taxable.
Prepaid tuition plans: To the relief of many states and parents of college-bound children, Congress clarified the tax treatment of state prepaid tuition plans, which had been unclear for more than seven years. These plans essentially allow parents to lock in a child's tuition rate years in advance of enrollment. Congress decided to permanently safeguard the tax-exempt status of the state plans and to allow participants to defer paying tax on the increased value of the tuition contracts until the child enrolls in college.
Inflation adjustments: Almost everyone will benefit to some extent from the annual inflation adjustments to the tax brackets and other elements of the tax system. Personal exemptions, for instance, have increased by $50. The standard deduction has increased by $100 for single individuals and by $150 for married couples filing jointly and heads of household.
TeleFile: Many more taxpayers will be able to file their simple Form 1040-EZ returns by touch-tone telephone through the IRS's TeleFile system. TeleFile, which used to be restricted to single individuals, can now be used by married couples without dependents. Only those who received special TeleFile packages in the mail from the IRS in January will be able to file their returns by phone. With TeleFile, all the necessary data from your return is punched in on your touch-tone phone keypad during your call to the IRS computer.
Schedule C-EZ: More self-employed individuals will be able to take advantage of the simple Schedule C-EZ to report their business profits. The form, which is a streamlined version of the regular Schedule C, is no longer restricted to sole proprietors with gross receipts of $25,000 or less. There is no income limit now. In addition, the IRS increased the amount of business expenses that can be claimed on the form, from $2,000 to $2,500.
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