Last week I pointed out that the reduction in the maximum capital gains tax from 28 percent to 20 percent had no real significance to anyone who was in the 50 percent or lower tax bracket.
As I said then, this reduction was not really an independent action (except for the early effective date) but rather the automatic result of a drop in the maximum tax on all income from the present 70 percent level to 50 percent, to be effective Jan. 1.
Now let's look at the other side: the impact of the reduction in maximum tax on upper income taxpayers--those who have been in a bracket higher than 50 percent.
If you've been a faithful reader of the Annual Tax Guide, you should know that the tax ceiling on earned income--salary or wages, retirement pay, earnings from self-employment--has been 50 percent all along.
But beginning in 1982 the maximum tax will be 50 percent on all income, regardless of the source. So this ceiling will now apply to such things as interest, dividends, and short-term capital gains.
And by virtue of the 60-percent exclusion rule, the maximum tax on long-term capital gains will drop from 28 to 20 percent. (This is the part that was made retroactive to last June 10.)
One of the purposes of this reduction is to encourage capital formation for industry by reducing the tax penalty on profits from speculative capital investment.
Unfortunately the lowered tax rate that permits a high income investor to keep more of any gain resulting from his investment also has an adverse effect: More of his own money is at risk.
A top bracket taxpayer who ends up with a short-term capital loss or a pass-through loss or investment credit from a limited partnership this year finds that the federal government will reduce his income tax by 70 cents for every dollar of the loss deduction.
So in effect there is an out-of-pocket cost of just 30 cents for each dollar lost. But given the same situation in 1982, Uncle Sam will only subsidize half of the loss; the taxpayer will have to pick up the other 50 percent himself.
Although not quite as dramatic, the difference on a long-term capital loss is still substantial. Keep in mind that there is a 50 percent exclusion on long-term losses, as opposed to the 60 percent exclusions on gains.
So the maximum tax exclusion on such a loss drops from 35 percent (half of the loss times a 70 percent tax rate) to 25 percent (based on the new 50 percent tax ceiling).
The federal government is still a partner in every speculative investment made--but the participation rate is less. The high-income taxpayer is therefore risking more of his own money--a fact which may have an impact on the availability on capital for the more speculative, and usually more innovative, new ventures.
Question: If an individual is self-employed and already has a Keogh retirement plan, can he also establish a tax-deferred IRA under the new tax law?
Answer: Yes. Starting in 1982 if you are self-employed you will be eligible for both a Keogh plan and an IRA on the same income.
You can deposit up to 15 percent of your net earnings from self-employment into your Keogh account, subject only to the new 1982 ceiling of $15,000 (double the present $7,500).
Then you can put as much as $2,000 into an IRA, or $2,250 if your spouse is not employed for pay and you want to open a spousal IRA.
About the only restriction is that the combined total of the IRA and Keogh investments can't exceed your net earnings for the year.
Q: I work for a charitable organization and am covered by a tax-sheltered annuity there. Am I eligible for an IRA in addition?
A: No--unless the amount of your annual TSA contribution is less than the $2,000 IRA ceiling. In that event you can have an IRA for the difference between your TSA contribution and $2,000 ($2,250 if you qualify for a spousal IRA).
This is a reasonable restriction. Your contributions to a TSA are already excluded from taxable income. Much like an IRA itself, the funds in a TSA accumulate without tax liability until you withdraw money from the account.