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Interest-Bearing Securities Seen as Leading Investment

August 18, 1986|BILL SING | Times Staff Writer

For investors, the sweeping tax overhaul bill conveys a clear signal: interest-paying investments such as bonds generally will become more attractive, while hard assets such as real estate will become less attractive.

The new tax bill also favors saving over borrowing. Lower personal tax rates will allow savers to keep more interest earnings, while the loss of the deduction for interest on credit card, auto and most other consumer loans will increase the cost of borrowing.

The bill also encourages investors to take as many deductions as possible this year. Many write-offs will not be available next year, and what will be available will be worth less with lower personal tax rates.

The bill also socks wealthier investors more than their less-affluent counterparts. Wealthier taxpayers will receive fewer advantages from some favorite tax dodges, such as limited partnerships, individual retirement accounts, 401(k) company savings plans and vehicles for shifting income to their children. Another favorite, the investment tax credit, will be eliminated entirely, retroactive to last Jan. 1.

But middle-income investors will not emerge totally unscathed; they will see a sharp rise in the tax on capital gains and may suffer most from the loss of deductions on consumer loan interest.

Whether these changes boost savings and investment, as President Reagan and other tax revision proponents hope, is uncertain. Lower tax rates in theory increase incentives for saving, but the tax rate cuts of 1981 have not stopped a decline in the savings rate.

However, what is clear is that investors must increasingly evaluate deals based on their profitability and less on their potential tax write-offs.

"Investment decisions will have to be based on economics," said William G. Brennan, a tax accountant and publisher of a Valley Forge, Pa., tax shelter newsletter.

Here is a look at how the new tax bill will affect various areas of investment and financial planning:

YEAR-END TAX PLANNING

Taxpayers are being urged to take as many deductions as possible this year. Lower personal tax rates next year will make deductions worth less in 1987.

Taxpayers thus should consider moving charitable contributions planned for next year into this year, advisers said. They should also consider buying big-ticket items, such as cars or furniture, before the end of the year to take advantage of the sales tax deduction, which will not be available next year under the tax overhaul plan.

Taxpayers also should consider prepaying this year union dues and other employee business expenses, fees for the preparation of tax returns and subscriptions for job-related publications. Those expenses are fully deductible this year, but next year under the new bill they can be written off only to the extent they exceed 2% of a taxpayer's adjusted gross income.

STOCKS

The impact of the new tax plan on stocks is generally mixed, financial experts said.

The provision to tax long-term capital gains with a top rate of 28% next year and 33% in 1988 and beyond could discourage investors from holding stocks for long periods of time, some said. Currently, gains on stocks or other capital held longer than six months are taxed at a top rate of 20%.

Middle-income taxpayers are expected to see sharper rises in capital gains taxes than higher-income taxpayers, because some middle-income people now enjoying capital gains rates lower than 20% will have to pay the new maximum rates, the same as on ordinary income. By contrast, capital gains rates for the wealthiest taxpayers will only go from 20% to the maximum rate of 28%.

The rise in the capital gains tax, which takes effect Jan. 1 of next year, also could lead to some year-end selling of stocks by investors wanting gains on their stocks taxed at the current lower rates.

But in the long run, the higher capital gains tax will not discourage people from buying stocks, said David M. Blitzer, chief economist for the investment firm of Standard & Poor's. "When people buy stocks, they are hoping for enough appreciation to pay the tax man," he said.

And on the positive side, the lower personal tax rates under the new tax plan will actually result in a tax cut for those owning stocks for short periods of time. Under current law, short-term capital gains are taxed as high as 50%.

"So you're going to see more trading rather than less, and that means more interest in the stock market," said John D. Connolly, chief investment strategist for the brokerage firm of Dean Witter Reynolds.

BONDS

Bonds are clear winners under the new tax bill, experts said.

First, by taxing long-term capital gains as ordinary income, the new tax bill will treat interest earnings from bonds the same as capital gains from stocks, thus making bonds more competitive with stocks.

Corporate, Treasury and other taxable bonds will benefit because lower individual tax rates will increase their after-tax returns.

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