Reagan plan means big changes in the way investments are taxed

By , Staff writer of The Christian Science Monitor

``What we are talking about is revolutionary change,'' President Reagan said Wednesday in describing his tax-reform plan. One area where the tax revolution would be felt most strongly is in its treatment of personal investments.

Virtually all investments -- including private homes, pensions, college savings plans, and life insurance -- would be affected.

There are no blanket rules for dealing with the proposed changes except avoiding panic and ``trying to accelerate deductions and postpone income,'' says Lawrence Axelrod, tax-reform coordinator at the accounting firm of Touche Ross & Co.

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One reason not to panic: Congress is expected to make significant changes in the Reagan administration's proposals before they become law. So changes that may appear drastic -- such as the elimination of the deduction for state and local taxes -- could be changed.

The loss of the deduction for state and local taxes, including property taxes, would be drastic, its supporters claim. They say its elimination would boost the cost of owning a home. As a result, ``the value of people's homes would decline,'' argues Jack Carlson, president of the National Association of Realtors.

Speeding up deductions to the extent possible and postponing income are important for two reasons, says Mark Brumbaugh, a tax partner at the accounting firm of Coopers & Lybrand.

First, some deductions will be eliminated in 1986 if the reform plan passes. There the individual is faced with a case of use it or lose it.

And even those deductions that remain would provide smaller tax savings to individuals after 1985. That is because the maximum individual tax rate would be cut from 50 to 35 percent, effective July 1, 1986. So rather than each added dollar of deduction saving up to 50 cents in taxes, it would at most save 35 cents.

One way to speed up deductions is to ``make sure your state income tax for 1985 is fully paid by the end of the year. And if you have to err, err on the side of overpaying,'' Mr. Axelrod says.

Income is hard to defer unless a taxpayer's employer pays a bonus that can be postponed or the taxpayer owns his or her business and can ask customers to postpone payments into 1986. A more common tactic for postponing income is to invest in a certificate of deposit that does not mature until 1986, thus postponing interest income, Axelrod notes.

Individual investors also should be careful to ``avoid anything being sold on the basis of tax benefits that are realized over the long term,'' Mr. Brumbaugh says, since the tax law is in flux.

Here are some major ways the Reagan tax-reform plan would affect individual investors:

Residential real estate. Mortgage interest deductions would be unlimited on a person's primary residence. But all other interest deductions, including those on a second home, would be limited to $5,000, plus the amount of an individual's investment income. Under current law, all mortgage interest is deductible.

The Reagan plan would not allow deductions for state or local property taxes unless the taxes were incurred during income-producing activity. Under current law such taxes are deductible.

Stock dividends. All dividend income would be taxable. Under current law individuals may deduct the first $100 in dividends. Couples may deduct the first $200. Under the Reagan plan corporations could deduct 10 percent of the dividends they pay to stockholders.

Under current law, corporations can't deduct their dividend payments.

Capital gains. Fifty percent of the gain on the sale of stocks, bonds, and other capital assets held longer than six months would be excluded from income. Thus the maximum tax rate on capital gains would be 17.5 percent. Under current law the maximum rate is 20 percent.

Life insurance. On new policies, taxpayers would declare as interest income the buildup in the policy's surrender value.

Holders of variable-life policies, in which the policyholder directs the investment strategy, would be exempt.

Under current law, the so-called inside buildup of value in insurance policies is not taxed.

Individual retirement accounts. The limit on IRA contributions for spouses who do not work outside the home would be boosted to $2,000 from the current $250. Thus a married couple could set aside $4,000, even if only one spouse works outside the home. The current limit for one-worker couples is $2,250 and $4,000 for two-worker couples.

Salary reduction plans. Employee contributions into employer-sponsored salary reduction plans, often called 401 (K) plans, would be limited to $8,000, less an employee's IRA contribution. Under current law the salary deferral is limited to the lesser of $30,000 or 20 percent of salary.

College saving. The Reagan plan would effectively block the transfer of investment assets to children, as, for example, permitted under the Uniform Gifts to Minors Act. Such gifts often are made so income is taxed at the child's lower rate to speed the growth of funds for college. Unearned income of children under age 14 in excess of $2,000 that is attributable to property received from their parents would be taxed at the parent's top tax rate.

Income from a Clifford Trust, under which a parent shifts income-producing assets to a child for 10 years and a day, also would be taxed at the parent's top rate.

Under current law, income from such arrangements is taxed at the child's lower rate.

Miscellaneous investment deductions. A variety of investment-related deductions -- including safe deposit rental fees, tax return preparation costs, and fees for investment services -- would be lumped into a new category.

The grouping also would include employee business expenses and state and local taxes incurred in income-producing activity. Included items would only be deductible to the extent they exceed 1 percent of adjusted gross income. Under current law such deductions are not limited.

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