The rules on capital gains and losses have changed dramatically. The difference between long-term and short-term capital transactions has been eliminated -- for 1988. But for the 1987 tax year you must still differentiate between the two, although the difference in tax liability will affect only higher-income taxpayers.
In theory, all capital gains are taxed as ordinary income, although they will continue to be reportable separately on Schedule D. In practice, this will be true next year; but for 1987 there is a tax ceiling of 28 percent on long-term gains -- gains on capital assets held for a period of at least six months.
That's a significant difference because the top tax rate for 1987 is 38.5 percent. The top nominal rate for 1988 will be 28 percent, corresponding to the ceiling on long-term gains for this year. But in fact, upper-income taxpayers will be paying 33 percent, as a result of the gradual phaseout of personal exemptions and the standard deduction for taxable income exceeding a specified amount -- $43,150 for a single taxpayer, $71,900 on a joint return.
If you expect your 1988 taxable income to exceed whichever of these ceilings applies, then you can save that extra 5 percent tax bite by selling long-term assets this month. As usual, however, don't be so caught up in the potential for saving tax dollars that your vision is clouded; tax savings should always be secondary to sound investment judgment.
Short-term gains, on the other hand, operate in reverse for high-income taxpayers because the top rate will drop in 1988 to that 33 percent ceiling from 1987's 38.5 percent. So if you're in the top bracket, it might pay -- from a tax point of view -- to let short-term profits ride, even if they go long term in the interim.
Both short-term and long-term losses are deductible in full against other income in both years, up to the continuing ceiling of $3,000 a year. (Unused losses are not wasted; they may be carried forward to succeeding years and applied, at the $3,000 annual rate, until used up.)
You may want to apply losses against income this year when tax rates are generally higher than next year. But if you will be in the 33 percent bracket next year and expect to have capital gains, you may prefer to save those losses to apply in 1988, when long-term gains will not be protected by the 28 percent ceiling.
If you're concerned about a market drop in the next couple of weeks, you can protect your gain and still defer tax liability until 1988 by "selling short against the box" the stock you hold, then delivering your shares to close out the short sale in January. You must realize, however, that selling short to protect your gain also wipes out the possibility of realizing additional gain on those shares if you guessed wrong and the market rises after you order the short sale.
The "installment sale" option that permitted you to select the tax year in which you reported gains on sales made in the last week of December has been eliminated. The "trade date" is now the date of sale for a securities transaction involving either a loss or a gain; the "settlement date" may no longer be used.
If you hold more than one lot of a security you want to sell, specify to your broker the particular lot you want to sell -- the lot that gives you the greater tax benefit.
If you don't designate, then the "first-in-first-out" rule must apply; that is, the lot with the earliest purchase date is the lot considered sold.
One more reminder: If you are claiming an adult -- a parent, for example -- as your dependent, the old rule still applies: You must provide more than half of the support in order to qualify for the exemption. Make a tally before the end of the year to be sure the exemption is available to you.
Total everything your potential dependent has spent from his or her funds during the year on items of support. (The source of the funds, and whether taxable or nontaxable, doesn't matter, so you must include Social Security benefits.) Then be sure you have spent on support -- or given to be spent -- more than that amount.
Abramson is a family financial counselor and tax adviser. Questions of general interest on tax matters, insurance, investments, estate planning and other aspects of family finances will be answered in this column. Advice cannot be given on an individual basis. Address all questions to E.M. Abramson, The Washington Post, Business & Finance News, 1150 15th St. NW, Washington, D.C. 20071.