Of tax cuts, budget deficits, and 'magician's; How President's tax measure tries to coax languishing dollars out of US cookie jars and into battle against industrial stagnation
Maybe you have a little tucked away somewhere. Your brother-in-law wants you to invest in his latest idea: cable radio. Your uncle, who hasn't read the Wall Street Journal in 20 years, thinks you should keep the money in a passbook account at the local savings and loan.
But now President Reagan's Economic Recovery Act has become law. You'd like to get your cash in on some of this economic recovering, so what do you do?
First of all, the government will let you keep more of your investment winnings. Income tax rates will be reduced 23 percent over three years, with the top tax bracket being pared from 70 down to 50 percent in 1982. This has the effect of cutting the capital gains tax, which is calculated as a percentage of your income tax bracket.
The magic day was June 9, 1981. The maximum capital gains tax after that date is 20 percent.
Assuming you bypassed the cable radio offer, what investments will be more attractive because of tax bill changes? What stocks may go up?
At the White House they must think Wall Street is narrow-minded and perverse. The Dow Jones average goes down like a diving duck at the merest mention of bad news, but refuses to rise in celebration at the tax bill's passage. The day Reagan signed the bill into law, the Dow Jones industrial average dropped 0.86.
"In terms of market response to it as a news event, that has long since taken place," says Larry Wachtel, first vice-president at Bache Halsey Stuart Shields Inc.
Analysts say the bill, by itself, is no cause for a general "bull" market. And they're not yet willing to single out companies that will especially benefit from the business tax changes.
"It's almost impossible at this time to rifle shoot" and pick individual winner stocks, says Monte Gordon, director of research at Dreyfus Corporation.
But certain industries will undoubtedly profit from the legislation, say experts. Some choices:
* Consumer stocks, such as textiles and retailers. The tax cut will give strapped citizens extra cash to spend.
* Dividend-paying stocks. The rate cuts may also lure money out of tax shelters and into stocks that feature a record of constant income.
* Defense. Though this industry will benefit more the budget, it's a "pretty obvious" choice, says Mr. Gordon.
* Heavy construction. Loosened write-offs for depreciation of fixed assets may prompt a lot of plant construction.
* Utilities. An obscure provision in the law permits public utility shareholders to deduct $750 in dividends, if they take those dividends in more stock instead of cash. One analyst says this reference accounts for the recent strength of utility stocks.
The act also encourages employee stock ownership plans (ESOP). For 1983-87, employers will be entitled to a tax credit based on the value of stock contributed to an ESOP.
What should investors know about the depreciation changes?
After the individual rate cuts, the Accelerated Cost Recovery Sytem (ACRS) is the glamour boy of the tax bill. Though it will undoubtedly increase busines investment, it may not be as good looking as advertised.
"This is very oversold," says Bernard Barof Seidman & Seidman. "There are entire sections of business which will not get any breaks."
ARCS replaces the old, creaky method of spreading tax deductions on business investment over the property's useful life. Instead, capital equipment if assigned to an arbitrary recovery period -- generally 3, 5, 10, or 15 years.
Some accountants say the changes won't make it easier for business to buy shorter-lived assets. For equipment that lasts a long time, however, ARCS will provide generous write-offs.
A Seidman & Seidman analysis estimates assets with a useful life of about eight years or longer will be more advantageous to buy under ARCS.
ARCS will "apply more to an industry that is capital-intensive" like steel and concrete, says Jeff Puma, a tax partner at the accounting firm of Peat, Marwick, Mitchell. Service companies, which don't need much heavy equipment, may not find it so beneficial.
but the new depreciation rules may have the Internal Revenue Service wiping its brow in relief. The IRS was constantly squabbling with companies about what constituted "useful life" for their assets. ARCS, with its arbitrary time slots , allows firms much less leeway -- and will probably lighten the government's caseload.
What about those companies, bruised and battered by hard economic times, that don't turn a profit? Accelerated tax write-offs don't help if you have no income to write off against.
A provision of the bill loosening government guidelines on leasing will, theoretically, let these less competitive companies join in on the fun.
The leasing provision is "the No. 2 in a one-two punch, perceived as a necessary condition to carry out the full intent of the law," says Jeff Puma. How will the tax bill affect investment in real estate?
There are two provisions in the bill real estate investors should be aware of.
The first is a trap. Under the bill, depreciable real estate is written off over 15 years, with a choice of accounting methods -- accelerated, or straight-line. But if landlords use the tempting accelerated method for nonresidential property, the government will "recapture" the tax break, by heavily taxing the proceeds when the building is sold. Moral: if you plan to buy commercial property depreciate it straight-line.
"The recapture rule is very dangerous," says Terence Kelly, tax partner at Seidman & Seidman.
the second is a loophole. The new legislation, for the most part, makes it harder to get tax credits for rehabilitating old buildings. But for one type of structure, it's easier: certified historic property. Anyone who renovates a home, warehouse, or other building tapped as historic by the Department of the Interior is entitled to a 25 percent tax credit.
"It's a terrific incentive to go out, buy a historic building, renovate, and rent it out," says Terence Kelly.
In addition, taxpayers with a lump of cash obtained from the sale of a home now have a two-year grace period, up from 18 months. If they reinvest the money in a new home during that time, there will be no capital gains tax. Otherwise, the IRS cometh. And taxpayers 55 and over who sell their homes can totally exclude $125,000 of the proceeds from capital gains, an exclusion increase of $ 25,000.