Tax Experts Rush to Find New Loopholes

Tax advisers report a mini-boom in cattle-feeding tax shelters by investors seeking write-offs this year. Brokers report increased calls from investors asking whether to sell stocks now to avoid higher capital gains taxes.

Bankers are preparing new types of home equity loans to help consumers circumvent proposed new restrictions on loan-interest deductions. And accountants and other tax experts are seeking strategies to help clients exploit new loopholes in provisions cracking down on income shifting and other tax breaks.

Indeed, even as final details of the sweeping tax overhaul bill are being written, taxpayers and their advisers are beginning to scramble for ways to use current tax breaks before they expire, or new opportunities the bill creates.

Interest Is Phenomenal

“It’s just phenomenal the interest we’re getting,” said Carolyn J. Cole, a marketing official at the brokerage firm of Paine Webber. An advertising campaign offering a toll-free number for investors to call to receive a booklet about tax-revision strategies has generated more response than any other advertisement in the firm’s history, she said.

Such activity is likely to accelerate, experts say, after congressional staffers finish writing the specific language of the tax bill and after it is approved by the full Congress and President Reagan sometime next month as expected.

However, ordinary taxpayers seeking common, easy-to-exploit loopholes are likely to be disappointed, experts say. While the new bill allows some specialized loopholes--such as exempting Aleutian Indians from reporting income from reindeer hunting--it eliminates many loopholes used by a wide number of people, as a trade-off for lowering rates.

“Most of the goodies seem to be gone,” said Leon M. Nad, associate vice chairman for tax consulting at the accounting firm of Price Waterhouse.

For example, tax overhaul ends most of the schemes used by parents to shift income or assets to children. Parents typically have done this to have the income taxed at the children’s lower rates. The new bill requires that such income be taxed at the parents’ rate.

But the bill allows income from gifts from grandparents, relatives, friends or others to be taxed at the child’s rate. This could result in friends’ agreeing to give assets to each other’s children, or grandparents’ giving to children and being reimbursed by gifts from parents, accountants say.

“If it’s hidden, it’ll work,” said one accountant, adding that he does not advise people to do this because it might be considered illegal tax evasion.

Another loophole involves using home equity loans to get around provisions that kill deductions for interest on auto, credit-card and other non-mortgage consumer loans. While the bill limits deductions on interest on home equity loans, bankers nonetheless say many homeowners can still tap this type of borrowing and use it to finance purchases of cars and other big-ticket items.

“We are anticipating it (demand for home equity loans) and are moving forward in product development,” said Jack Levine, head of product management for Security Pacific National Bank. However, like other bankers, he would not disclose specifics about new products.

Specific Language

Experts caution, however, that they will not be sure about the effectiveness of these strategies until specific language is written into the bill. At that point, other loopholes may emerge.

“They (tax writers) may not think of everything,” said Sidney Kess, director of tax policy and planning for the accounting firm of KMG Main Hurdman. “They are extremely able but they are working under tough time constraints where it can be easy for something to slip through.”

One group of strategies under debate involves whether spouses should file separately to lower their combined tax. If one spouse is earning a high income and the other is not, it might be advantageous for the couple to shift real estate and other assets to the lower-wage spouse, said James Godbout, a partner with the accounting firm of Ernst & Whinney.

Taxpayers expecting lower personal tax rates next year are investing in schemes to shift income from this year to next year. One such tactic is cattle-feeding tax shelters--which may be making the last big stand for all kinds of shelters before the tax bill eliminates many of their tax benefits.

Cattle-Feeding Appealing

Cattle-feeding shelters are appealing because they essentially offer write-offs this year, when tax rates are high, and shift income into next year, when tax rates will be lower, said Fuhrman Nettles, a vice president of Robert A. Stanger & Co., a Shrewsbury, N.J., tax-shelter advisory firm.

Sales of publicly offered cattle-feeding limited partnerships are up 207% through the first seven months of this year and up 1,256% in July over the year-earlier month, Nettles said. That comes as sales of shelters in equipment leasing and oil and gas drilling have declined amid concern that tax reform will hurt their tax benefits, he said.

But cattle-feeding shelters could be a mistake, some advisers say. Demand for them could drive up their costs and make them unprofitable, said William G. Brennan, publisher of a Valley Forge, Pa., tax-shelter newsletter.

‘Not Highly Profitable’

“Cattle feeding is not highly profitable to begin with,” said Ed Uvacek, an economist with the agricultural extension service at Texas A&M.; Many cattle feeders have suffered low profits or losses in recent years, analysts say.

Also, tax writers may inject language into the tax bill to limit cattle feeding as a tax dodge, Nettles suggested.

But while the stampede in cattle feeding is expected to be short-lived, advisers say, sales growth is likely to be sustained in real estate limited partnerships that emphasize income over tax breaks. While many real estate deals that rely on big deductions from borrowing costs and depreciation will be hurt by the tax bill, these income-oriented deals borrow less and funnel more rental income to the limited partners.

Income-oriented deals are likely to become even more popular because of a provision in the tax bill requiring that losses from tax shelters be written off only against “passive” income--that deriving from trades or businesses in which the taxpayer is not an active manager, such as limited partnerships. Under current law, limited-partnership losses may be written off against income from any source, including wages or stocks.

Master Limited Partnerships

Thus, by stressing income over tax breaks, these real estate limited partnerships will be valuable to investors seeking passive income to offset losses from other tax shelters. Master limited partnerships, a variation with shares traded on stock markets, also could grow in popularity for the same reason, experts say.

“Some of our real estate partnerships that were not selling well before all of a sudden are starting to sell,” said Ronald W. Weiss, head of real estate products at the brokerage firm of Shearson Lehman Bros. Inquiries about real estate limited partnerships have “doubled” since last week, he said.

However, real estate limited partnerships are not the only hot items. Taxpayers are flooding tax experts with questions about general strategies for reducing taxes. Need for such advice is expected to keep these experts busy for months.

Types of Advice

Tax experts say the most common types of year-end advice they are offering includes:

--Taking long-term capital gains before year-end. Experts are urging investors to consider taking profits before Dec. 31 on stocks held longer than six months. Then profits will be taxed under current long-term capital gains tax rates, now a maximum 20%, instead of a maximum of 28% next year and 33% in 1988. However, investors with short-term capital gains should wait until next year before selling, when tax rates on ordinary income will fall, experts say.

--Buying big-ticket items now. Because the deduction for sales taxes will end next year under tax overhaul, taxpayers planning purchases of cars, boats, furniture or other expensive items should consider buying before year-end, advisers say.

--Deferring income. Experts suggest having bonuses or December paychecks paid next year if taxpayers expect their tax rates to decline. Experts also suggest buying Treasury bills or bank certificates of deposit, as interest income on them is taxable at maturity, which could be next year or later. Self-employed individuals could delay billing customers until next year or later.

Income Averaging

On the other hand, those with low incomes in the last three years may want to move expected income from future years into this year, experts say. Then it can be included under income averaging, which will be eliminated next year.

--Accelerating deductions. Taxpayers are urged to prepay for job-related magazine subscriptions, union dues, legal and accounting fees, employee business expenses and other miscellaneous expenses. They are fully deductible now, but under tax revision they will be deductible next year only to the extent they exceed 2% of adjusted gross income. Also, employee moving expenses no longer will be deductible next year for non-itemizers.

--Making charitable contributions this year. With higher tax rates, the deduction will be worth more this year, experts say. Also, under tax revision, non-itemizers cannot write off charitable contributions starting next year.

--Prepaying interest expense. Taxpayers should consider paying off credit-card or auto loans, as interest on nearly all non-mortgage consumer loans will not be deductible next year, experts say. Taxpayers also should consider paying interest this year on tax owed to the IRS from previous years, advisers say. Tax-payment interest also will not be deductible under the new bill.

Contributions to IRAs

--Putting maximum amounts into individual retirement accounts and 401(k) company-savings plans. Deductions on these will be cut back for higher-income taxpayers.

--Taking the historic rehabilitation credit or the low-income rental housing credit. Taxpayers may get a maximum 10% credit (down from 25% under current law) for costs of rehabilitating a building constructed before 1936 and a 20% credit for rehabilitation of certified historic structures. This will phase out for taxpayers with adjusted gross incomes between $200,000 and $250,000.

A new 9% credit will be available for investments in low-income housing (4% credit if the project receives government subsidies). This also will phase out for taxpayers with incomes between $200,000 and $250,000.