It's your money

Nation's Business, Nov, 1986 by Ray Brady

It's Your Money

We all know that tax reform will give many Americans (not all, let it be added) some tax relief. We know, too, that most companies will be paying higher taxes. Where do investors stand in this?

Returns will change on many investments, including municipal bonds, real estate syndicates and stocks.

The biggest change, of course, is the end of tha tax break on long-term capital gains. Now, an investor who sells stock held six or more months pays federal income tax on only 40 percent of any profit. Which means the maximum rate is 20 percent. In the future, all the profit will be taxed, though federal income tax rates, limited to 15 and 28 percent brackets, will be lower. Which means the investor will pay as much as 28 percent--actually, 33 percent for a laarge chunk of upper income as of 1988.

(Why 33 percent? To phase out benefits for affluent taxpayers of the 15 percent bracket, there will be a surcharge--on a joint return it will start at $71,900 and end at $149,250. In 1987, a transitional year when the top income tax rate will be 38.5 percent, the long-term capital gains rate will be capped at 28 percent.)

The forthcoming end of the capital gains break is already having an effect on stock prices--it was one of several reasons for the sell-off on record volume September 11, when the Dow Jones Industrial Average plummeted 86.61 points.

Many buyers of stock want to pay Uncle Sam as little as possible of paper profits they have made over the years of the bull market. Also, there are the owners of some of the companies whose stock is involved. Again and again, I run into people who started businesses years ago, went public and now have millions of dollars locked up in company stock. Many are now selling. Their reasoning: Eight percentage points in taxes, particularly if millions are involved, are a mighty bite.

Starting next year, with the six-month waiting period gone, there will be much more in-and-out market activity, most investment professionals feel. Also, tax reform will take a lot of profit out of real estate deals and, of course, tax shelters. So, says Martin Zweig, highly respected editor of the Zweig Forecast: "Stocks and bonds will be more attractive, just as real estate and tax shelters will be less attractive."

There are extra risks in shooting for fast, short-term gains. So even if there is more volatility in the market, the investor may do well to follow old-fashioned principles, such as looking for a stock that seems undervalued and then hanging on until it reaches the price that is nearest its worth.

Geraldine Weiss, a La Jolla, Calif., investment adviser, believes there will be a pickup in popularity of stocks that pay good dividends, a change from the focus on growth-oriented issues in recent years. Her point: The lower tax brackets mean dividends paid many Americans will be hit less hard by Uncle Sam.

In what kinds of industries should you invest to cash in on tax reform?

Donald Trott, a partner in the New York investment firm of Mabon, Nugent & Company, says: "Reform could potentially give the consumer another shot in the arm." The less money people pay in taxes, the more they have to spend. That could help buoy stocks of consumer products companies.

Trott admits, however, that nobody knows yet what tax reform's full economic effect will be. He advises patience, arguing that the market may trend downward until investors can see just how the consumer and the economy react to reform.

If you think stock investors may be uncertain about the future, consider the poor fellow who has a portfolio full of tax-exempt bonds.

There has been a lot of discussion about how banks and casualty insurance companies will have new taxes to pay on tax-exempt bonds and how some types of bonds will no longer be tax-exempt. One point stands out: Municipals will be fewer in the future because the new law restricts tax exemptions.

In 1985, for example, about $205 billion in municipal bonds came to market. For best estimate for 1987: no more than $85 billion.

That could increase municipals' value, say bulls on the bonds. The bulls concede that lower income tax rates will make a bond's tax-free status less advantageous for the buyer. But they urge a look at these numbers: Even with a 28 percent tax rate, a municipal paying 7 percent will bring you the same number of after-tax dollars as a taxable bond paying 9.72 percent.

There will be curtailment of rights to issue so-called private purpose bonds--such as those for sports stadiums. But if you have one of those bonds now, its tax-free status will remain.

Certain private purpose state and local bonds will be subject to the alternative minimum tax, which is designed to ensure that everyone pays something to the Internal Revenue Service. That tax, however, will apply only to individuals who have so-called preference items on their returns--certain intangible drilling costs, for example--and if the private purpose bonds were issued after Aug. 7, 1986.