Some higher income earners approached the April 15 deadline for filing 1997 federal income tax returns with a new - and unpleasant - awareness of their "marginal tax rate". Those who wrote a larger tax payment check than they expected to are likely to remember that lesson in planning their 1998 tax profile.
A strategic approach is to calculate whether one's marginal tax rate projected for 1998 will increase or decrease compared with the next tax year. That will help the taxpayer decide whether to accelerate or defer income and deductions.
Through calculations based on each individual's income, the marginal tax rate is, simply, the tax rate paid on the next dollar of taxable income. The marginal tax rate is the income tax rate, plus the tax increase resulting from the limitation on itemized deductions [three percent of adjusted gross income (AGI) over $121,200] and the calculation of the phase-out of personal exemptions at the rate of two percent per each $2,500 or a fraction thereof by which AGI exceeds $121,200 for single filers and $181,800 for married joint filers, based on 1997 amounts.
The following table illustrates how two or three "little" items can boost the marginal tax rate to serious levels. This example is for a family of four with 1997 taxable income of more than $271,050 and AGI of less than $304,300:
[TABULAR DATA OMITTED]
For 1997, the 39.6 percent federal tax bracket for married filing jointly began at $271,050 of taxable income. The phase-out of the deduction for personal exemptions ended at a taxable income of $304,300. Therefore, these specific marginal rates listed above only apply for this range.
These rates will also be increased by the state tax rate net of the federal tax benefit of deducting state income taxes. When state taxes are included, many taxpayers may be boosted over the 50 percent level in total marginal tax rates.
Normally, the shrewdest tax planning is to receive income in the year you are in the lowest tax bracket and to take deductions in the year you are in the highest tax bracket. This year, however, that might not be the best strategy. To qualify for many of the new tax breaks created by the Taxpayer Relief Act of 1997, your income cannot exceed certain limits. For example, only taxpayers with AGI of $100,000 or less are permitted to rollover Traditional IRAs to the new Roth IRA.
Of course, tax planning is integral to one's overall financial planning and usually requires assistance by legal and accounting counselors and specialists in estates and trusts, investments and insurance. The following are three example strategies that combine tax benefits with other long-range financial planning objectives:
* Qualified retirement plans. Taxes can be reduced and future returns can be enhanced by contributing the maximum amount of money possible to your employer's plan or to your individual plan. …