San Francisco Examiner, Business Section, Tuesday, April 11, 1995

By ROBERT L. SOMMERS - TAXMAN


"Contract With America" Tax Proposals

SHOULD YOU buy, sell or retain your assets? Get married? Have another child? If you're considering adoption, should you wait? Are estate taxes going up -- or down?

The answers to all of these could be affected by the Republicans' "Contract With America," what they're touting as this year's "mother of all remedies." Here are some of its benefits, championed by House Speaker Newt Gingrich. Whether they become law is another question.

Capital gains

Taxation of capital gains -- investments such as stocks, bonds and real estate held for longer than one year then sold at a profit -- is at a maximum of 28 percent. In contrast, the highest effective tax rate for ordinary income -- wages salaries, rents, interest and dividends -- approaches 40 percent.

The contract proposes a 50 percent deduction for capital gains. Purchases after 1995 of common stock, business property and tangible assets (excluding real estate and intellectual property such as patents, copyrights and licenses) would be indexed for inflation, so tax would be figured on gains only after inflation had been factored in.

For instance: If $100 worth of common stock was bought n 1995, held for 10 years and accompanied by a total of 50 percent inflation, then a sale of the stock for $150 would produce no taxable gain.

Family tax credit

This provision aims at middle-income wage earners with families. Both Democrats and Republicans are in favor of a $500-per-dependent credit against taxes owed. The Democrats want to limit the credit to families with adjusted gross incomes under $95,000; the contract would provide this credit for families with incomes under $200,000.

Taxpayers now have a $2,500 deduction per dependent. The proposed dependent credit could be interpreted as being in addition to this, although the contract is vague here. If, however, the credit replaces our existing dependency deduction, then taxpayers in the 28 percent tax bracket (most middle-class workers) would actually suffer under this proposal, because a $2,500 deduction at 28 percent reduces taxes by $700 under the existing law.

American dream accounts

The "contract" would establish "American dream" accounts, permitting annual nondeductible contributions up to $2,000. Earnings from these contributions would be tax-free, with no taxation even when the money is withdrawn, providing it is for retirement income, a first-time home purchase, qualified higher education or qualified medical expenses. These accounts could be established in addition to an IRA account, and the contribution amount would be indexed for inflation.

The dream account is more a political gimmick than serious savings proposal. By making the contributions nondeductible, the account is similar to any already-existing after-tax investment, including tax-free municipal bonds. But tax-free municipals have no time limits, use limits or tax penalties as those imposed on the proposed dream account.

From a retirement vantage, the account is a bad deal. compared with an IRA. You can now contribute and deduct a full $2,000 contribution to an IRA. If in the 28 percent tax bracket, you save $560 in taxes by making such a contribution.

In contrast, to put $2,000 of after-tax dollars into a dream account, you must earn $2780 -- just to cover the federal taxes!

Estate taxes

The Unified Gift and Estate Tax Credit (the subject of several previous columns) shelters the first $600,000 of assets. Under the contract this would increase to $700,000 in 1996, $725,000 in 1997 and $750,000 in 1998. In 1998, a couple with assets of $1.5 million would pay no estate taxes. The $750,000 shelter would be adjusted for inflation after 1998. The annual gift-tax exclusion (now $10,000 per year, per donee) would be indexed for inflation after 1998 as well.

Talk in Washington has centered on reducing the credit to $300,000; this provision would benefit those with accumulated wealth and will most likely face Democratic opposition. While this provision makes sense economically -- the $600,000 limit has not increased since 1987 -- it will be viewed as yet another bonus for the rich.

Accelerated death benefits (under a life insurance policy)

Traditionally, the death benefit of life insurance is paid only upon death. Life insurance proceeds are income-tax free, although the proceeds are an asset for estate tax purposes. The contract allows life insurance payments prior to death if the person insured under the policy is terminally or chronically ill. Terminally ill means having less than 24 months to live; the chronically ill provision applies to long-term care.

Miscellaneous

The "contract" provides a reduction of the Social Security benefits that seniors must claim as their taxable income; the adjustment would be a decrease from 85 percent to 50 percent.

And there is an increase in the amount small businesses can deduct in equipment purchases, from $17,500 to $35,000 by 1999.

The "home-office" definition would be expanded to permit use of your home when you have no other fixed location for administrative or managerial activities. This would be particularly applicable to sellers, surgeons and performers.

Certain adoption expenses would receive a maximum $5,000 credit against income taxes for those with an adjusted gross income of $60,000 or less.

Do not count on any of these provisions becoming law as long as the Democrats control the Executive Office. Remember: While many Republicans may be reluctant to admit this, under the Democratic administration, annual budget deficits have been declining, the economy has strengthened, and the stock market is hovering at an all-time high.





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