Pruning due on tax reform gives opportunity

No one thought tax reform would stay reformed very long. But what peeves the folks on Capitol Hill is how quickly it seems to be unraveling. It has not been six months since Congress passed the most sweeping overhaul of the tax code in decades. The unpleasant fact, however, is that it lowered individual tax rates at a time of $100 billion-plus deficits, and something must be done to fill the gap.

While no one can predict precisely what changes will occur over the next two or three years, accountants and those on Capitol Hill suggest some target areas. And if a taxpayer is alert, he can have in place contingency plans that could save him some money.

Rhetorically, at least, the erosion of tax reform has already begun. In a break with his predecessor, who was unwilling to push for higher taxes unless the President endorsed them, the new Speaker of the House, Jim Wright, says he wants to raise taxes by some $20 billion to close the budget deficit - and he is gathering reluctant support.

The Texas Democrat is brimming with ideas about how this might be done. One ways is to freeze the tax rates at this year's level - a maximum of 38.5 percent - rather than letting them fall next year to a maximum of 33 percent (when a 5 percent surcharge is included). While one aide on the Senate Finance Committee says that tax writers are ``highly unlikely'' to delay the rate cuts, legislators in both the House and Senate are starting to show openness, even cautious support, for the proposal.

A more likely scenario has rates falling according to plan in 1988, but rising again in 1989 or '90, after the presidential elections. How much is a matter of dispute. Richard Lager, national director of tax practice at Grant Thornton International, an accounting firm, thinks the maximum will be 35 percent, while Mario Borini, director of taxation at Seidman & Seidman, another accounting firm, believes it will go higher.

That means you should consider deferring income into 1988 to take advantage of the lower tax rates, says William Taylor, a partner at Deloitte, Haskins & Sells, accountants, in Chicago. ``But I'd be very leery'' of deferring 1988 income into 1989, he says. Of course, if you can defer income for, say, eight to 10 years (through life insurance contracts or deferred compensation plans, for example), you would effectively pay no taxes on that money at all.

A taxpayer may also want to pile up deductions this year, when they are worth more at the 38.5 percent rate than at the 33 percent rate, Mr. Borini points out. He suggests treading water for a little while in 1987 to see if rates are likely to be jacked up the next year; if so, wait and take the deductions at the higher rate.

Another of Speaker Wright's ideas - initially played down even by his staff - is gathering momentum. Earlier this month the Speaker suggested imposing a ``transfer tax'' of one-half percent every time someone buys or sells a share of stock. That would raise $17 billion a year, he figures.

Such a tax would fit the mood of Congress, which sees a sullied Wall Street as an easy target. It would also put more of a burden on the wealthy. Dan Rostenkowski, the chairman of the House Ways and Means Committee, is studying the idea, and positive murmurings are coming from the budget-writing committees in both houses.

A transfer tax would make frequent trading in stocks very expensive. Gillian Spooner at Touche Ross & Co., accountants, thinks that unless some provision were made, mutual funds, which change stocks in their portfolios frequently, would be the biggest casualty.

Not all the tinkering may be bad for taxpayers, however. Say you own a house that you rent out, and your expenses for keeping up the house - depreciation, heating, etc. - are higher than the rent you receive. Under the new tax law, you can use that net loss to lower your taxable income - but only up to a point. If you and your spouse have a combined adjusted gross income of $100,000, you start losing the benefit; at $150,000, you can't deduct any of the loss, except from other ``passive'' income (rent from other properties, for example). While this clearly affects high-income families, a lot have been caught in the net. ``You only need two yuppies to reach that level,'' Ms. Spooner observes.

The effect is already working its way through the real estate market. ``Many people are now looking at rental properties they own and see that the benefits have decreased significantly,'' says Mr. Lager at Grant Thornton. ``As the rate of return [on real estate] falls below that of stocks or bonds, I believe that will spur many people to sell those properties this year.''

That is, unless Lloyd Bentsen, the new chairman of the Senate Finance Committee, comes to the rescue. The senator recently wrote a letter to his constituents in Texas saying he isn't happy about treating real estate as a passive investment. Some think he will try to get the provision repealed - if not this year, then next - or at least grandfather the properties that were owned before tax reform was passed last fall.

And that could make for nice investment opportunities, says Borini at Seidman & Seidman. ``I would be holding onto real estate. As a matter of fact, I'd be looking around for some real estate bargains, and there should be some around because of this tax law,'' he says.

The individual retirement account (IRA) is another question mark. Tax reform took away many of its benefits - an unpopular move with the middle class, but one that raised billions of dollars in revenues. Some tax analysts think that Congress will push through taxes that fall outside of the income tax system, such as a value-added tax or a national sales tax. That would ``take pressure off of the income tax'' to raise revenue for the deficit, Mr. Taylor says, ``and we could see restoration of some benefits, like the IRA.''

However, a staffer at the Senate Finance Committee sees that as unlikely, however. ``If you want to pick up money for deficit reduction, you want to spend it on the deficit, not redistribute it,'' she points out.

The best strategy is to keep abreast of events and be ready to act. Notes Borini, ``It's a year-by-year decision.''