Certified Public Accountants

HAPPY ANNIVERSARY TO THE PETALUMA POST

TAXING TIMES, JUNE 2014 EDITION

By Rick Torkelson, CPA and principal of Torkelson & Associates, LLP in Petaluma, CA

Congratulations are in order to the Petaluma Post who is celebrating 27 years of publication!  At the expense of dating myself, I’m going to take this opportunity to step into the time capsule and look back at the tax environment 27 years ago.

1987 was a benchmark year in income taxes.  Ronald Reagan was well into his second term and the effects of possibility the biggest tax act in U.S. history was unfolding – even the name of the Internal Revenue Code was officially changed to the Internal Revenue Code of 1986.

The most celebrated change that jumps out at you beginning in 1987 was that the maximum tax rate dropped from 50% to 28% – although technically, there was a “bubble rate” of 33% until all the income was taxed at a flat rate of 28%.  This was a huge windfall for the very high income tax payers as their tax rates were cut almost in half.  The lowest tax rate was increased from 10% to 15%.

The vast majority of taxpayers did not enjoy the tax cut you might expect as a result of such a dramatic drop in the maximum tax rate.  This is because several popular itemized deductions were eliminated.  Some of you older taxpayers will recall some of these favorite tax deductions.  Eliminated was the deduction for credit card interest as well as interest from your automobile loan.  In fact all “personal” interest of this sort was no longer deductible.  Another favorite lost deduction was the Sales Tax deduction.  We used to have a table which gave everyone a free Sales Tax deduction based on your income – or you could keep track for the year and deduct the actual amount.  This Sales Tax deduction is recently trying to sneak back in where we can now deduct the larger of state income taxes or sales tax – but unfortunately, this deduction typically affects only taxpayers from states without income taxes such as Texas and Florida.

Gone in 1987 was another favorite tax maneuver known as Income Averaging.  Whenever a taxpayer had an unusual windfall year, there was a tax computation you could make based on the taxable incomes for the four previous years.  This would save significant taxes in many cases based on the premise that it wasn’t fair to overtax someone just because they had an unusually high income year.

The popular IRA deduction was changed from a maximum of $1,500 to $2,000, but most importantly, the income restriction was removed – If you earned $2,000 you could deduct $2,000 – but if you were already in a pension plan where you worked, you couldn’t contribute to an IRA.  I never understood why Congress would restrict an IRA when they were concerned about U.S. Citizens saving enough for their retirements – and they’re still doing it.

Another tax provision starting in 1987 was with limited partnerships – simply stated, if you invested $5,000 in a limited partnership, you could only deduct $5,000 in losses.  This one made a lot of sense to me – I remember prior to 1987 a tax client of mine asked me to review the “tax promises” of a limited partnership he was presented with – and after my analysis, I was surprised to report that even if the partnership did not collect one dime of income, it would return in tax benefits more than he invested in the limited partnership – it could not lose.

One last big change was requiring social security numbers for any dependents claimed on the tax return.  It’s hard to believe that before 1987 all you had to do to deduct a dependent on you return was list their name.  During the first year, this anti-fraud change resulted in seven million fewer dependents claimed – and I’m still asked occasionally if you can deduct your pets.

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