1993 Tax Act and Real Estate Page: 2

                                
Tax Rates, Deductions
and Capital Gains
Several key provisions of the 1993 Tax Act
are interrelated, prompting a simultaneous
effect on both a taxpayer's tax liability and
effective marginal tax rate. The effective
marginal tax rate on additional income is the
increase in tax divided by the additional
income. Thus, if $10,000 of additional income
results in a $3,500 tax increase, the effective
marginal tax rate on that income is 35 percent.
Under the 1993 Tax Act, effective marginal tax
rates can exceed 45 percent for married
taxpayers who have more than $250,000 in
taxable income-a rise of 10 percentage points
from previous rates. Married taxpayers with
taxable income of more than $140,000 can face
effective tax rates exceeding 40 percent.
The effective marginal tax rate is affected by
higher income tax rates and self-employment
tax increases, as well as the interaction be-
tween income tax rates and phaseouts of
personal-dependency exemptions and item-
ized deductions. Each is briefly discussed and
illustrated in this report. Some provisions of
the 1993 Tax Act become effective for 1993,
and others start in 1994.
Individual Tax Rate Structure
Prior to the 1993 Tax Act, tax bracket rates
for individuals were 15, 28 and 31 percent.
The act adds 36 and 39.6 percent brackets for
high-income taxpayers. For 1993 and 1994, the
36 percent bracket begins at $140,000, and the
39.6 percent bracket begins at $250,000 for
married taxpayers filing jointly. For single
taxpayers, the 36 percent bracket begins at
$115,000, and the 39.6 percent bracket begins
at $250,000. The 15, 28 and 31 percent brackets
have been widened to reflect inflation. Com-
plete rate schedules for 1992, 1993 and 1994
are in the appendix.
Taxpayers whose tax bracket rates have
increased to 39.6 percent will experience
effective tax rates of 45 percent or more on
some of their income. The higher effective rate
is created by an increased self-employment tax
along with an interaction between the rate
schedule and other tax calculations.

Personal and Dependency Exemptions
The personal and dependency exemption for
1993 was $2,350. The 1994 exemption is
$2,450. Thus, total exemptions for a joint tax
return filed for 1994 by a married couple with
two dependent children is $9,800 ($2,450 for
each person).
One reason a high-income taxpayer's effec-
tive tax rate can exceed their tax bracket rate
(36 or 39.6 percent) is the phaseout of personal
exemptions. Exemptions are phased out by 2
percentage points for each $2,500 ($1,250 for
married filing separately) or fraction thereof
by which a taxpayer's adjusted gross income
(AGI) exceeds the applicable "threshold." The
1994 thresholds, adjusted annually for infla-
tion, are $167,700 for joint returns; $139,750 for
head of household; $111,800 for single and
$83,850 for married filing separately. The 1993
Tax Act makes the phaseout provision perma-
nent. Under prior law, it would have expired
in 1996. The 1993 thresholds were $150,000 for
joint returns; $125,000 for head of household;
$100,000 for single and $75,000 for married
filing separately.
An example may help. Assume a husband
and wife have a 1994 combined salary income
of $218,000 and four exemptions totalling
$9,800 (including two for dependent children).
They are in the 36 percent tax bracket. If there
is no other income, the exemptions are re-
duced to $5,684 ($9,800 less 42 percent). The
42 percent is computed as follows:
[($218,000 AGI - $167,700 threshold)/$2,500] rounded up x 2
Based on the phaseout rule, exemptions are
eliminated once AGI reaches $122,501 more
than the threshold amount. Referring to the
above example, once AGI reaches $290,201 (or
$122,501 above the $167,700 threshold),
exemptions are eliminated. These phaseout
calculations raise the couple's effective tax rate
on some of their income to more than 40
percent even though they are in the 36 percent
tax bracket. The same calculation can raise the
effective tax rate above 45 percent for taxpay-
ers in the 39.6 percent tax bracket. An ex-
ample illustrating this phenomenon follows.
Itemized Deductions
The most common itemized deductions
consist of home mortgage interest, property

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