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Capitol Fight Over Capital Gains

QUESTION: How realistic is it that the drastic capital gains changes proposed for the new tax laws will actually come to pass? Are capital gains really likely to be 100% taxed, just as ordinary income is? Or is a compromise between the current 40% and the proposed 100% likely?--M. R.

ANSWER: You can expect one last push by lobbyists to restore this controversial tax break, which Sen. Bob Packwood (R-Ore.) has blasted as “the biggest loophole for the rich.” But don’t bet your house on that challenge succeeding.

Remember that just three months ago most Americans had written off tax reform. And now, of course, it is certain that the nation’s tax laws are about to be drastically altered. Only their exact form is uncertain.

Senators central to the tax reform movement say no single provision of the Senate-passed tax reform bill has stirred as much 11th-hour lobbying as that eliminating the preferential tax treatment of capital gains. They predict an even better-focused push over the next three weeks as Senate and House members prepare to work out their two versions in a conference committee.

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Leading the lobbying push are the American Council for Capital Formation, a group of large corporations, Wall Street firms and venture capitalists; the Securities Industries Assn.; the American Electronics Assn., and the National Venture Capital Assn. You might consider contacting one or more of those groups if you still want to get in your two cents’ worth.

On the capital-gains front, there are major differences between the House and Senate versions. The House bill retains the preferential treatment. The Senate does not.

Capital gains--the profits realized from the sale or exchange of capital assets, most commonly securities or real estate--are currently taxed at a maximum rate of 20% if the assets are held for at least six months before being sold. (Only 40% of such income is taxed, and the current top tax rate is 50%; thus the 20% maximum tax rate for capital gains. The maximum rate on wages is 50%.) Why the break? To encourage people to invest in real estate and in the stock of corporations.

The House proposes to raise the capital gains tax rate slightly--to 22%. The Senate bill would tax capital gains at the same rate as wages, eliminating any preference for capital gains.

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But don’t forget that one of the cornerstones of the proposed tax reform is significantly lower tax rates. The Senate proposes that the maximum rate be 27%. So, capital gains would be taxed no higher than 27%, not obscenely higher than the current 20% maximum. The gap would be much wider under the House version since that bill proposes a maximum rate of 38%.

Q: I know that if the Senate version of tax reform becomes law, my IRA contributions are no longer tax-deductible. But I would keep contributing anyway because tax due on the interest those contributions generate is still deferred. My question is this: For those of us who sometimes borrow the money to make the yearly IRA contribution, will the interest charge on those loans continue to be tax deductible?--I. W.

A: No. Under the Senate plan, interest on loans used to fund an IRA would no longer be tax-deductible--just as IRA contributions by employees with employer-sponsored retirement plans would not be.

The Senate plan would end all deductions of consumer interest expenses, which are fully deductible under current law. The consumer interest category includes interest payments on such things as cars and charge-card purchases. Interest on money borrowed for investment would still be deductible by some investors--to the extent that the investor has investment income.

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The House plan is less restrictive on interest expense deductibility. It would limit the deduction of all types of interest expenses to $20,000 over the amount of investment income reported by a couple filing a joint return.

Debra Whitefield cannot answer mail individually but will respond in this column to financial questions of general interest. Do not telephone. Write to Money Talk, Los Angeles Times, 780 Third Ave., Suite 3801, New York, N.Y. 10017.


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