Don't Blink, the IRS May Be Doing You a Favor
The new tax accord out of Washington promises to make your life both financially richer and a bit more complicated.
The super-rich pocket the lion's share, financial planners and tax experts agree, but others stand to gain as well.
Example: If you own or plan to own stocks, you will pay less tax on the profits.
If you sell your home, you can do whatever you want with the profits (under $500,000). The old rules demanded that you reinvest the money in another primary residence or pay a capital gains tax on the profit.
Most of all, the accord should boost stocks and Wall Street. The day the tax/budget accord was announced, the Dow Jones Industrial Average jumped 53 points to a record. The next day, it added 80 points for another record.
The plan makes stocks attractive - "particularly smaller company growth stocks" - says Ed Slott, an accountant in Rockville Centre, N.Y.
Many investors could now favor investments that appreciate in price or pay small or no dividends, he says, such as growth stocks. Dividends and interest are taxed as ordinary income, making them more expensive.
Capital gains are profits from selling an investment, and Uncle Sam takes his share - albeit a smaller one now.
Annuities and bonds - where income and dividends are common - may not fare quite as well, Mr. Slott says.
Most middle class investors, however, should avoid immediate changes in their financial portfolios just because of the new tax code, says Gary Schatsky, a financial planner and attorney here.
"Don't let the tax-code tail wag the dog," Mr. Schatsky says.
"Wait a few months to see how the dust settles on the proposed changes. There's still some confusion" about the details and start-up dates.
"You might want to make a few short-term changes, such as selling some stocks or mutual funds that you wanted to get out of the way anyway," Schatsky says. "But think through your investment objectives, and then make certain any changes you make are based on those objectives."
One thing is clear, though, Schatsky says. If you have varied investments - such as stocks, bonds, annuities - you will need to weigh the impact of the tax agreement on your 1997 taxes due in 1998.
Some changes - such as alterations in taxes on capital gains - will only affect securities sold after May 7. So taxes that come due next April will answer to both the new and old sets of rules.
"Is this tax reform? Yes," says Schatsky. "Is this tax simplification? No. The changes make your tax preparation more difficult and more complex" than they are now.
Keep all your paperwork on investments, Schatsky says. If a major decision is made, something that might involve substantial outlays or gains, consider checking with a financial professional first.
Here are the key changes:
Capital gains: The plan lowers the capital gains tax rate from a maximum 28 percent to 20 percent, retroactive to May 7. Taxpayers in the 15 percent tax bracket get a new 10 percent capital gains rate, also retroactive to May 7. The minimum holding period for capital gains treatment will be one year for assets sold from May 7 through July 28, rising to 18 months on July 29, 1997.
After 2001, the capital gains rate moves lower. Assets held for five years will be taxed at 8 percent if you are in the 15 percent tax bracket; 18 percent above that.
Sheldon Jacobs, editor of the No-Load Investor newsletter, based in Irvington-on-Hudson, N.Y., also recommends selling only below average performers. That way you will have cash on hand for other investment possibilities helped by the tax changes, Mr. Jacobs tells his clients.
Home sales: Currently, you have two, limited choices for escaping a capital gains tax when you sell your primary residence. You can roll the money into another home, of equal or greater value within two years.
Or, if you're over 55, you can skip taxes on profits up to $125,000, but you can only do it once.
The new law bumps the maximum to $500,000 for married couples, removes the age restriction, and lets you do it all every two years.
If you're single, the profit cap is $250,000.
Individual Retirement Accounts (IRAs): Middle income Americans get two new IRAs and some improvements in the old one.
The new IRA Plus lets you earn money tax-free and then withdraw it tax-free and penalty-free to pay for college or a first home. You have to leave the money in the account for five years, and, unlike traditional IRAs, the initial contribution is not tax deductible.
And if you want, you can switch money from your traditional IRA to an IRA Plus, although you have to pay taxes.
The benefits phase out for couples earning more than $150,000.
The plan also establishes a new education IRA that helps with college expenses,. and it expands eligibility for the traditional IRA.
But remember: Keep all paperwork. With three different IRA possibilities, the potential for a monster tax problem is significant if you mix contributions, withdrawals, rollovers, and earnings between different types.
Collectibles: Alas, if you own collectibles, such as coins or paintings, the proposed changes in capital gains do not apply.