WELL-TO-DO TAKE A DIRECT HIT TO THEIR WALLETS: AS DEDUCTIONS ARE PHASED OUT, TAX BILLS RISE: ONLY CAPITAL GAINS MAY SEE LOWER RATES

While Congress and the president have been trumpeting lower tax rates for everyone over the last year, one tax attorney is warning that the effective rates for higher-income taxpayers are actually going up — thanks to stricter limits on deductions and other tax advantages.

The public “is being told one thing, but reality is another,” says Janice Johnson, a lawyer and accountant with New York executive search firm D.S. Wolf Associates who does consulting work for CPA firms.

The Taxpayer Relief Act of 1997 lowered taxes for many high-income people by reducing the capital gains tax to a maximum rate of 20%. Previously the maximum rate was 28%. But hidden throughout the tax code are numerous provisions that sta rt phasing out itemized deductions and personal exemptions, and raise Medicare and Social Security taxes, Ms. Johnson says.

“If you want to pile the states on it’s even worse,” she says. New York, for example, has cut back on itemized deductions that higher-income taxpayers can take. As a result, New York taxpayers could lose up to 50% of their itemized dedu ctions, she says.

Those with taxable incomes of more than $250,000 are the hardest hit, she says. Because of higher eligibility thresholds for deductions, a family with $300,000 in income could easily have paid $6,000 more in 1997 federal taxes than a fami ly with that income would have paid for 1990, according to Ms. Johnson.

“Some people are seeing huge increases in their income because of the hot job market as well as the stock market,” she says. “It’s useful to realize when you’re making decisions like buying a home that, yes, your mortgage interest is d eductible and, yes, your real estate taxes are deductible, but you may not be getting the full benefit of the deductions. You really need to sit down and work the numbers.” Mortgage interest and real estate taxes are normally taken as ite mized deductions.

“People think they have to buy a house,” she says. “If they really look at the tax benefit it’s going to give them they may not be so impressed. It was very different when the (maximum) tax rates were 50% and you got the full deduction . But the folklore is still in their minds.” The highest rate now is 39.6%

help is on the way

“Over the last 12, 15 years, statutory rates for higher-income people have increased,” a congressional aide says, noting that they were raised in 1990 and again in 1993 after being lowered in 1986.

A report published in February by the Joint Committee on Taxation found that the effective marginal tax rate differed from the statutory rate on more than 33 million tax returns, or nearly a quarter of the total.

In addition, figures compiled by the Treasury Department over the last 40 years show that for families with twice the median income, federal, Social Security and Medicare taxes combined have climbed from 17.5% of their income in 1975, whe n the marginal rate was 32%, to an estimated 19.7% this year — with the marginal rate expected to be 25.6%. The rates dropped slightly for 1995-98 from the previous three-year period because the 1997 law lowered effective tax rates on tax payers with incomes of more than $75,000.

The Joint Tax Committee report lists 22 provisions in the tax code that generally limit high-income taxpayers from claiming some deductions, tax credits or other tax benefits, such as income limits for taking advantage of child- and depen dent-care credits and deductions for individual retirement accounts.

The different incentives for taxpayers to work, save money or donate to charities — an itemized deduction for most taxpayers — “may distort taxpayer choice,” and result in inefficient use of capital and other resources, according to t he February report of Congress’s Joint Tax Committee. The incentives, the report adds, also complicate the tax code and lead taxpayers to believe the tax code is unfair.

Tax brackets are indexed for inflation, the congressional aide notes, but not for real growth. “That’s part of what’s going on.” The brackets don’t reflect the added burden on higher-income people, he adds, but merely address the increa se in such taxpayers.

“Starting with the 1986 (tax) act, although tax rates came down, the intent of the law was to remove certain deductions and other tax preferences so that the playing field was leveled” says Steven Woolf, a director in the Washington off ice of PricewaterhouseCoopers LLP, the New York-based accounting firm.

He notes that the recently passed bill restructuring the Internal Revenue Service contains several provisions which are likely to help high-income taxpayers.

If President Clinton signs the bill as he has indicated he will, taxpayers can take advantage of lower long-term capital gains tax rates for assets held longer than 12 months. Currently, there is a mid-term rate for assets held between 12 and 18 months.