Eye on taxes
Investors and savers must keep abreast of the ever changing code
There's little doubt where Christopher Bergin stands on the tenor of the Bush administration's changes to the tax code. "This administration rewards people who make their money through savings and investment much more than people who make their money by the sweat of their brow," says Bergin, chief executive of Tax Analysts, a nonprofit Arlington, Va., tax research and publishing group.
President Bush and his supporters in Congress would certainly cry foul--a number of the tax changes do, after all, benefit noninvestors--but the push for "an ownership society" is making the current environment a golden one for investors and savers, at least as far as taxes are concerned. Today's 15 percent or lower tax rate on capital gains and dividends is far better than during the 1970s, when gains were taxed as high as 49 percent and dividends as high as 70 percent.
Before the presidential election, many investment advisers were wary about the staying power of the dividend and capital-gains tax cuts and the odds of success for proposals to expand tax-sheltered accounts for retirement and other nest-egg building. "If [John] Kerry had won, there would have been a stampede out of stocks to cash in on capital gains at a 15 percent rate," says Lewis Walker of Walker Capital Management in Norcross, Ga.
A scaling back of the various tax cuts is still possible in the face of yawning deficits. But Walker and others are generally optimistic. "I don't see Congress going backwards and taking away these rates," says Mel Schwarz, director of tax legislative affairs at the accounting firm Grant Thornton. Instead, a Republican-led Congress is likely to push to make lower rates permanent. The break on gains and dividends, for example, is set to expire after 2008, while the diminishing estate tax is scheduled to roar back in 2011 after disappearing in 2010.
Taking turns. One bit of breathing room for investors dealing with rapid mutations of the rules: The call to make the code "simpler" and attempts to grant more tax breaks to savers and investors will probably have to wait in line behind Social Security reform and possible budget fixes. Even then, actual changes may amount to modifying the existing tax structure rather than an across-the-board overhaul.
The disparity in how different types of income are taxed can influence investment tactics. Financial planner Benjamin Tobias in Fort Lauderdale, Fla., says he is now fervent about advising clients to direct assets that produce highly taxed ordinary income such as bonds mostly into tax-deferred accounts in order to delay the bite, while putting stocks with potential large capital gains into taxable accounts to take advantage of the low rate on gains. "There is an absolute problem of people who put too much in tax-deferred accounts and may end up paying more overall tax when they take money out," he says.
With the tax bite down, says Walker, "high-dividend stocks are in." He and other experts caution that even with lower overall tax rates, it is important to avoid the old-fashioned habit of lumping together fully taxed interest and partly taxed dividends as "income."
Today's low rates may make deferring tax less of a winner. "The old perception was that as you got older your income and your tax went down, but that's not true for many people," says tax attorney Donna LeValley, an editor of J. K. Lasser's Your Income Tax . Putting less money into a tax-deductible retirement account, for example, may mean paying more tax today. But such a move could boost future spendable income when withdrawals from alternative accounts such as Roth IRA s are made with possibly little or no tax due. President Bush has previously proposed savings accounts for both retirement and other purposes that would not offer a deduction for deposits but would allow tax-free withdrawals of earnings. That could make all or much of some people's savings tax free.
There are bound to be more stumbling blocks, such as the iffy future of the estate tax and the yet-to-be-fixed alternative minimum tax, which is gradually hitting more people with a higher tax bill. The dividend and capital-gains breaks on federal 1040s, moreover, don't typically count for state tax, cautions Jeffrey Pretsfelder, a senior analyst at tax guide publisher RIA. New York may be the nation's financial center and Washington, D.C., its seat of government, but their residents get no special deals.
This story appears in the January 17, 2005 print edition of U.S. News & World Report.
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