The old wheeze about something being as inevitable as death and taxes has a corollary: The tax rules will change every year. Some years the changes are major, some years minor. Some years the changes involve simplification; more typically, they add complexity. This year’s changes are numerous and individually small, adding still more complexity.

Right on Schedule

Inflation can cause indirect tax increases. Suppose you make $40,000 in year one. Suppose further that inflation in year two is five percent, and your income miraculously keeps up exactly with inflation, becoming $42,000. In real economic terms, you stood still: your $42,000 income in year two has the same buying power as your $40,000 income the previous year. But your taxes would have increased.

To address this problem, many tax thresholds and amounts are now “indexed,” that is, adjusted annually for inflation. But not all are. Subtle tax issues don’t excite the American public in the same way as war, abortion or religion. The issue was mostly raised by self-appointed surrogates for the public, i.e. a few high-profile political candidates and newspaper columnists. As a result, only the items most readily explained in sound bites were indexed: the personal exemption, the standard deduction, and the amount of income dividing one tax bracket from another. Others, more arcane but equally in need of indexing, were ignored.

Other scheduled changes result from Congress’ recent habit of phasing in tax law changes. Only one of this year’s phase-ins is likely to affect many Performink readers, but that one is important. Beginning in 2003, self-employed individuals can now deduct 100 percent of their health insurance premiums (or an amount equal to their profit from self-employment, whichever is less). That is the last step in a phase-in which began in 1996, when the deduction was increased from 25 percent to 30 percent.

The health insurance deduction is important because it is “off the top” and not part of your itemized deductions. Medical expenses (including any part of the insurance premium not covered by the special deduction) are deductible as itemized deductions only to the extent they exceed 7.5 percent of your income. Not many people reach that amount, and even those that do lose any tax benefit for the amount under the threshold. The special deduction should serve as a powerful incentive for the self-employed not only to buy insurance, but to buy insurance with broad coverage and lower deductibles so as to convert out-of-pocket costs to fully deductible insurance premiums.

Frequent But Irregular Changes

Certain other changes happen most years which are neither inflation indexing nor phase-ins. Two affect deductions dear to PerformInk readers: the deductible rate for automobile mileage and the per diem rates for out-of-town meals and incidental expenses.

The calculated inflation rate used for indexing is broadly-based, intended to reflect the overall bundle of goods and services bought by the average consumer. (Whether it actually measures that is the subject of much dreary debate among economists.) The automobile mileage rate, however, is adjusted annually, based solely on the change in the cost of owning and operating a car. For 2003, the rate is 36 cents per mile, which is actually less than the 2002 rate of 36.5 cents; the rate reduction was supposedly due to better measurement of data rather than any actual reduction in costs. For 2004, the rate will be 37.5 cents.

Each year brings some tinkering with meal per diem rates, usually just assigning particular cities to a higher or lower tier. This year, the changes are more substantial. As of Oct. 1, 2002, a new top rate tier of $50 per day was established, and certain places were subdivided. Manhattan, for example, has different rate from the rest of New York City. And as of Oct. 1, 2003, each tier’s rate was increased by $1, so that they now range from $31 to $51 per day. The changes happen on Oct. 1 because that is the beginning of the government’s fiscal year. The IRS does not actually determine the meal per diem rates; rather, they officially adopt the rates set each year by the General Services Administration for travel by federal employees. The IRS will graciously permit you to use the previous, lower rates for the last three months of the year.

Dubious Achievement Awards

My nomination for the change which will generate the most noise and confusion for the least effect is the much-ballyhooed reduction in tax rates on dividend income. Most Americans who own stocks do so through retirement plans such as IRAs or 401(k)s. Those dividend payments are not taxed when received; when the money is withdrawn in retirement, it is taxed at ordinary income rates. Not all dividends received outside of retirement plans are eligible for the reduced rate. Eligible dividends come from any U.S. company and “qualified” foreign companies (and you might be surprised at what companies are foreign), such as those listed on a U.S. stock exchange, or some (but not all) which trade less formally in the U.S., or those from countries with which the U.S. has a tax treaty meeting certain complex criteria. You must have owned the stock for more than 60 days out of the 120-day period centered on the ex-dividend date.

In the related category of “seemingly simple change with messy ramifications,” I nominate the reduced tax rates on capital gains occurring after May 5, 2003. The messes occur not just because of the divided year (in which one might have losses in one period and gains in the other), but also in the interactions with special rules, such as the recapture of depreciation on property sold, the sale of collectibles, and loss carryovers from other years. Suffice it to say that if you are so fortunate as to have capital gains this year, consult a tax professional.

Still Free

If you would like a copy of my “Checklist of Potentially Deductible Items” for those in the performing arts, just call, write or e-mail me, and we’ll be happy to send one out to you.

Are there money or tax questions you would like to see discussed in this column? Let me know, at 2835 N. Sheffield, Suite 311, Chicago, IL 60657, or call 773/525-1778 (888/525-1778 toll-free outside the Chicago area) or e-mail greg@gregmermel.com.

Greg Mermel is a certified public accountant whose clients in the arts range from individual performers to major theatre companies and suppliers. He also sometimes produces theatre.