Playing the New Tax Game

By Stephen Koepp.

Memo to: Mr. and Mrs. Joe Taxpayer

From: Alert Accountants, Inc.

Re: Things to hurry up and do before the new tax code goes into effect

1) Buy a brand-new station wagon. 2) Sell off your shares in Conglomerate Corp. 3) Give a generous donation to Ivy University. 4) Apply for a home- equity loan to pay for the new boat. 5) Take a trip to an investment seminar in Hawaii and deduct it as a business expense. 6) Schedule Joe's long- postponed gall-bladder operation. 7) Pay business expenses (like your accountant's fee) a year in advance so you can write off a larger sum.

America's beloved loopholes are suddenly closing fast. That chilling realization hit home for millions of U.S. consumers last week as they confronted the most sweeping federal income tax overhaul in more than 40 years. Overwhelmingly approved late last month by the House (292 to 136) and the Senate (74 to 23), the bill is expected to be signed into law by President Reagan within the next week or so. Scheduled to go into effect on Jan. 1, the measure is designed to create a more equitable tax code by phasing out dozens of cherished breaks and shelters. Result: its passage has touched off a scramble by taxpayers to squeeze as many write-offs as possible through the loopholes that will expire or become less attractive after the 1986 tax year.

Clients are besieging tax advisers with questions about what to buy and what to sell before the end of the year. The stakes are hundreds or even thousands of dollars in tax savings for 1986 alone. Says Alan Klein, a Roslyn, N.Y., dentist and investor: "We're suddenly in a new world."

Accountants and financial planners, whose busy season normally arrives near April 15, have an autumn rush on their hands. "The accountants and the H & R Blocks of this world must be rubbing their hands in glee," observes Raymond Kinzie, a senior vice president at Chicago's Lake View Bank. Indeed, tax advisers have been working overtime in a competition to develop the earliest and most detailed advice, and dozens of how-to books and pamphlets are already coming off the printing presses. Examples: the accounting firm Deloitte Haskins & Sells has published a free 96-page booklet, The Tax Revolution: A New Era Begins, and Pocket Books is coming out this month with J.K. Lasser's What the New Tax Law Means to You, a 320-page guide, priced at $3.95.

By and large the new tax code will be kind to consumers. It will entirely remove approximately 6 million low-income earners from the tax rolls. The overhaul will reduce taxes for about 60% of taxpayers, largely by simplifying and lowering the rate structure. The highest effective rate will drop from 50% to 38.5% next year and 28% after that. To finance those reductions, many tax preferences will be eliminated.

One of the casualties is the break on long-term capital gains, which has made taxpayers eager to cash in their profits on investments, ranging from stocks to real estate. The current top rate for taxing such gains is effectively 20%, but after this year, those profits will be taxed as regular income at higher rates. "I've seen a lot of my clients already selling stocks to benefit from the lower rate," says Mike Ryan, a Chicago financial planner.

Tax experts generally agree that people are wise to lock in longterm profits by selling investments that have already increased greatly in value. But taxpayers might be foolish to dump an investment that is in the middle of a growth spurt. Future profits might be worth far more than the tax advantage gained by selling them now, notes Wallace Turner, a New York City broker for the investment firm of Smith Barney. Says he: "Our culture has put such value on tax breaks that even the savviest investors wonder whether they should dump their best-performing stocks." Wall Streeters hope that any widespread selling urge on the part of small investors will be offset by the lure of a potentially bigger bull market ahead. In fact, some advisers are telling investors to sell their stocks to get the capital-gains deduc- tion and then buy the shares back again.

This year will be the last chance for consumers to deduct local sales taxes. Sellers of such big-ticket items as autos, appliances and jewelry are likely to enjoy a boomlet as consumers hurry to buy before January. Scott Rielly, 28, a Framingham, Mass., real estate appraiser with a wife and two children, spent $14,000 last month on two new cars -- a Hyundai and a Mitsubishi -- at least partly so that he could write off the $700 sales tax. Rita and Dan Houlihan, a Chicago couple, have the same strategy in mind because of 8% state and city sales taxes. Says Rita: "On a $14,000 car, we're talking $1,120 in sales tax that we could deduct if we buy a car this year." Many auto dealers in states with high sales taxes plan to start using the last-chance break as a year-end advertising gimmick.

Another reason for making large purchases before Jan. 1 is that the deductibility of interest charges on consumer loans will gradually be phased out over a four-year period starting in 1987. But consumers and the lending industry have already hit upon an alternative: the home-equity loan, which is secured by a house or condominium. Interest on such loans will remain deductible, within some limits. "You go out and buy a new washer and dryer and still get to deduct the interest because in effect you're paying for it with a home-mortgage loan," says Kinzie, the Chicago banker.

Lenders are discovering a huge market for such loans. Barrie MacKay, a vice president at Boston's Shawmut Bank, says, "The equity loan has probably become the most popular single investment for consumer credit: for education, for improvement on homes, for just about anything." Some taxpayers have started realigning their finances to take advantage of the home-equity loophole, which generally limits tax-deductible borrowing to the original cost of the property plus improvements. A real estate broker in Queens, N.Y., says one customer recently sold his house and then bought a similar one across the street in order to increase the amount of his tax-deductible mortgage borrowing from $70,000, the cost of the first house, to $270,000, the current price of the second.

Many deductions will remain allowable but will save taxpayers less money next year because tax rates will be lower. One such write-off is charitable giving, and many nonprofit groups are urging taxpayers to make donations now rather than waiting until after Jan. 1. Combined Jewish Philanthropies of Greater Boston has notified patrons about the tax advantage in its monthly billings and is getting better-than-usual payments on pledges. Dartmouth College plans to send a two-page tax advisory to 57,000 of its supporters to stimulate pre-1987 donations. Manhattan art appraisers are swamped with requests to evaluate expensive works that wealthy collectors want to give away before Jan. 1. "Half my colleagues are crushed with work, and the other half are turning down work because they are scared of getting into trouble" by obliging clients who want inflated appraisals, says Barden Prisant, an art appraiser in Garden City, N.Y.

Several other choice deductions will become less appealing next year. Trips to investment seminars in exotic places, for example, will no longer be deductible for anyone but financial planners. Thus individuals who enjoy investment seminars in Bermuda and the like may want to take one last tax- deductible fling in 1986. Accountants are telling their clients to pay for their 1987 business expenses in 1986 because such items will be treated less liberally next year. That means many consumers will be paying reasonably far in advance for everything from magazine subscriptions to, yes, accountant's fees. Tax advisers have even suggested to their clients that they might want to schedule elective surgery before Jan. 1 because a taxpayer's medical expenses will have to be much higher next year -- 7.5% of gross income, compared with 5% currently -- before any of the costs can be written off.

Because rates will be lower next year, many taxpayers can benefit by shifting 1986 income into the future. Ryan suggests that people in the current top tax brackets ask their employers to hold back part of their pay until next year. Similarly, lawyers, dentists and other professionals may want customers to take a few months longer to pay their bills so that the money comes in when rates are lower. Their customers might resist that idea, however, since they will want to take their deductions while rates are still high.

The tax-shelter game is about to lose its appeal. As soon as Reagan signs the reform bill, partnerships designed to lose money for tax purposes will cease making financial sense. Reason: the losses will no longer be deductible against regular income. That has already prompted taxshelter enthusiasts to start urgently searching for new investments. This time, however, taxpayers have begun to evaluate investment schemes from a completely opposite perspective: they will be looking for income instead of losses. Says Klein, the New York dentist: "We have grown up believing that sheltering income against taxation is more important than making money. Now we must adjust to the brave new world in which you keep more of what you make without gimmicks. It's too simple and sensible to be American. It makes you insecure." Newly eager to make profits, investors have begun looking for ways to boost their income, for example, by raising the rent on properties they own.

While many do-it-yourself tax planners have already swung into action, an even greater number are probably still trying to decipher the reforms. The bill was designed to make tax planning simpler in the long run, but some individuals are understandably bewildered by its wrenching changes. One immediate outcome is certain: many tax advisers will get rich this season helping clients find their way into the new era.

With reporting by Lisa Kartus/Chicago and Raji Samghabadi/New York