Capital-gains tax remains tricky
Now that Congress has ended some of the uncertainty over capital-gains tax by extending the current favorable treatment of investment profits through at least 2010, you would think everything is fine.
Not so. There are still issues involving how the tax is applied and growing attention to capital-gains tax that goes uncollected because of evasion and confusion.
Here is a map for tiptoeing through the capital-gains thicket:
Different investments, different tax rates: Long-term gains from selling stocks, mutual funds, and many other investments are taxed at a top rate of 15 percent if the asset had been owned longer than 12 months. That compares with a top rate of 35 percent on wages, interest, or short-term gains on assets sold before a year passed. People in the lowest tax brackets may pay only 5 percent on long-term gains through 2007, then zero percent through 2010.
But there's a rub that irritates art dealers, investors in coins and precious metals, and others who roam about outside the stock market. Profit from paintings, other artwork, antiques, and "collectibles" such as stamps and coins is taxed as high as 28 percent, almost double the top rate on securities. Included in the definition of a collectible is gold and silver bullion. Also collectibles, says the IRS, are investment coins that substitute for bullion, such as the American Eagle and the recently introduced American Buffalo, though some dealers and collectors mistakenly believe otherwise.
Gilbert Edelson, administrative vice president of the Art Dealers Association of America, says the treatment of artwork penalizes those who assist cultural growth by investing in such items. The higher tax on precious metals punishes portfolio diversification, argues Michael DiRienzo, executive director of the metal industry's Silver Institute. He notes that even exchange-traded funds that track the price of gold and silver are subject to the higher capital-gains tax. (ETFs are a type of security that trades like a stock.)
Bills to extend the lower capital-gains rate to artwork and precious metals have been introduced in Congress, but the outlook for passage anytime soon is not good for art and only modestly better for metals.
Surprise! You have taxable income: Mutual fund investors are sometimes surprised to receive a capital-gains distribution when a fund sells shares from its portfolio. The distribution is immediately taxable even when the investor automatically reinvests the payout into the same fund and thus receives no current cash.
Legislation to defer tax in such cases has been introduced in both houses of Congress but again enactment is a long shot.
The depreciation trap: In another twist, capital gains can be tricky to figure for people who sell real estate on which depreciation has been deducted. They may face a special tax rate of 25 percent on at least some of the gain.
With all the rules, some investors innocently foul up. Others exploit cracks in IRS enforcement to understate income.
Misreporting of capital gains may cost $17 billion a year in lost tax revenue, according to Sen. Evan Bayh, an Indiana Democrat, who has introduced legislation to require more reporting to the IRS by stock brokers and mutual fund firms. They must now report only the amount received by an investor when securities are sold. Bayh's proposal would require them to also report the cost of such securities, thus enabling a check on the amount of profit a taxpayer reports. (Some coin dealers, meanwhile, "wink" in promotional material that they report neither sales nor purchases to the tax collector.)
Enhanced reports would hinder understating gains. But a June report by Congress's Government Accountability Office says that better reporting could also benefit a sizable contingent of confused people who mistakenly overreport their gains.
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