Tax overhaul or no, here's some advice on an IRA this year
Even if a sweeping new tax bill does not pass this year -- which seems increasingly unlikely -- it will have had one major effect. It has already kept accountants and other tax professionals busy answering clients' questions about how a new tax law would affect them. Some accountants have even been asked to prepare sample tax forms, showing how the tax bill might change a client's taxes this year and next.
``We've had several clients call and ask, `Should I be in favor of this tax bill? Should I write my congressman?' '' says Larry Goldstein, a tax partner at Arthur Young & Co., an accounting firm.
``A lot of people are concerned,'' agrees Stephen Corrick, tax partner at Arthur Andersen, another accounting firm. ``But I think a lot of the questions were asked after the House bill came out last year. People already had some idea of the general strategies they were going to take.''
One step that would not have been needed under the House bill may be necessary if the Senate Finance Committee's version passes intact. Under the Senate bill, only those workers who do not have a company pension would be able to take a deduction for contributions to an individual retirement account (IRA). Everyone else could still put money in an IRA and see the money grow tax free, but the taxpayer would not get the deduction. ``With the IRA going out the window, you'll want to put as much as you can into it this year,'' Mr. Goldstein says.
It does seem, however, that it is this Senate Finance Committee idea that may go out the window. The politics backing the IRA appears strong enough to keep the rules that have been in effect since 1982.
Still, a little defensive move wouldn't hurt: Put as much as you can into your IRA, up to the $2,000 limit. If you can do it before the end of the year, so much the better. This will help in a number of ways.
First, if the IRA rules are changed, it is possible that only those contributions made this calendar year will be deductible, not those made up to next April 15, which is the current rule. And if you also put money in a company-sponsored 401(k) or 403(b) plan, you may lose the IRA deduction after this year.
Finally, the sooner you put money in your IRA, the more time it will have to earn tax-free interest.
Another key feature of the Senate Finance Committee bill is the elimination of many deductions and the fact that a lower tax rate will make surviving deductions worth less in the future.
``Deductions will be worth more in '86, and some may not be around at all in '87,'' says Pamela Pecarich, tax partner in the Washington office of Coopers & Lybrand, also an accounting firm. One of those that won't be around next year if the tax bill passes is the one for non-mortgage interest and state and local sales taxes.
So if you're planning any major purchases, like a new car, boat, objet d'art, or large appliances, try to make those purchases this year.
Any other deductions you can get this year will be worth more, too, because of higher current tax rates. You could, for example, make your charitable contributions for 1986 and '87 this year.
On the income side, the possibility of lower tax rates next year means you should try to shift as much money as you can into 1987. If your employer normally showers you with a bonus at the end of the year, ask whether it can be postponed until next year. Bringing this up now will give your employer plenty of time to prepare for this change in procedure.
Also, if you do any free-lance work and don't need the cash immediately, you may be able to have the money owed for work in the third or fourth quarters held back until after New Year's Day, so it it will be taxed at a lower rate.
For investors, the Finance Committee's bill would tax all capital gains as ordinary income, with no special treatment for long-term gains. For a taxpayer in the 50 percent bracket, this means the tax on long-term gains would jump more than a third, from 20 to 27 percent. Also, you would pay 27 percent on any gains, whether you held the investment six months or six days. That would be great, of course, for people who hold investments less than six months and now see their gains taxed at up to 50 percent.
If you're in a high tax bracket and you think your stocks have gone up about as far as they're going to go, selling them this year, when the capital gains tax is 20 percent rather than 27 percent, could certainly save some money.
On the other hand, tax experts caution, don't rush out and make all kinds of sales and income shifts right now. It's not necessary and it may be costly.
``One of the messages we're tying to get across is, there will be a lot of time before a bill passes and the time it takes effect,'' Miss Pecarich says. ``People should not act in haste. There's always the possibility that it might not happen. Still, we have to advise people about where the risks are.''
One risk is not being ready for a possible ``blended'' tax rate next year. ``This is not all that unusual for a new tax law,'' says Lorin Luchs, tax partner at Seidman & Seidman, another accounting firm. ``I think it's sort of typical that a rate change comes into play starting July 1.''
If this is the case here, any income earned in the first six months of next year would be taxed at the old rate, while the rest of the year's income would be taxed at the new rate. For some taxpayers, this could result in a higher overall rate for the year, particularly because many deductions would be lost for the whole year, not just half of it.
If your tax situation is apt to be complicated by a new tax law, the best course now would be to visit an accountant or other tax adviser and see whether tax reform would be a boon or bane for you.