The 18 Month Conspiracy
A.K.A. the Tax Preparers' Full Employment Act

by Ann Coleman

Reston, VA (April 7, 1999) -- Politics makes for strange tax laws. In the summer of 1997, Congress revised the tax laws on capital gains. For several years, taxpayers weren't getting much of a break on capital gains. Some guys wanted long-term capital gains taxes capped at 15%, others favored the then current 28% maximum, which meant that all capital gains, short or long term, were taxed at the same rate as regular income for most Americans.

Well, lots of opinions and studies, along with some turkey, pork, and bull, all went into that great big sausage mixer across the river. It went 'round and 'round for quite a long time. When it came out, there were gasps of amazement, shocked silences, howls of outrage, and malicious grins all across the country.

The top capital gains tax had been reduced, yes, but instead of two types of capital gains, short-term and long-term, we had four, with 9 possible tax rates just for stocks. Don't even think about the rates for collectibles and real estate! Those hidden grins of delight belonged to a few CPAs with a sadistic bent who immediately began drawing up plans to expand their businesses. Most tax professionals, however, found the whole construct laughable and referred to it mockingly as the Accountants and Tax Lawyers Full Employment Act of 1997.

A year later, Congress came to its collective sense and changed things again, removing the medium term category (12 to 18 months) but keeping the top tax rate for long-term gains at 20%. They also left in a super-long-term category, which is a good thing, even if it does complicate matters.

Unfortunately, we published a couple of books (which can't be corrected like this wonderful online publication -- see below for an example) during that brief time of congressional madness. Also, and this is just my impression, it seems like very little fanfare accompanied the change, so that to this day, people are still writing in asking about the 18-month hold. It's gone, folks! And good riddance.

In fact, when they changed the law the second time last July, it was made retroactive to the beginning of 1998, so it does not apply to anything sold last year. Whew!

Luckily, when Congress abolished the 18-month holding period, they kept the good part of the 1997 reform -- the super-long-term category. This one was made for Fools! It rewards long-term buy-and-holders. (It won't help you with the Foolish Four, but you were planning to branch out a bit, weren't you?)

Starting in 2001, capital gains on assets held for more than 5 years that would normally be taxed at 10% will only be taxed at 8%. Starting in 2006, the top rate of 20% will be lowered to 18% for assets held more than 5 years, but only if purchased in 2001 or later. ("Here, take this," says the right hand. "Now, give it back!" says the left.)

This could be interesting. Say you buy Youth-in-a-Bottle, Inc. in July of 2000 with every intention of using it to finance your retirement in 2030. Since you have no intention of being in a lower tax bracket then, your realize that your eventual taxes will be 18% instead of 20% (which reduces your total tax by 10%) if you wait and purchase it in January 2001.

Congress thinks of everything (which is why things take so long, I guess). Taxpayers who own stocks that they intend to hold for a long time can elect to "treat" their holdings as sold and repurchased on January 2, 2001. They can pay any tax due up until that point, then all gains from that point on will be subject to the 18% rate. The kicker is, you have to pay the tax with your 2001 return. For someone who has been holding Coca-Cola (NYSE: KO) since 1962, that could be close to impossible without actually selling some stock. I suppose Congress is hoping for a huge windfall from taxes being paid in advance from this. Dream on. Or maybe it was just to keep people from postponing stock purchases. Then again, if that means the tax would be at the short-term rate instead of the long-term rate....

Aaaaaah! Sorry about that digression -- every time I think I am going to make a quick detour down a tax side road, I seem to end up 50 miles down a the tax superhighway with no exits in sight! Scary. For more on all of this mess, please see Publication 550, Investment Income and Expenses; Chapter 4 - Sales and Trades of Investment Property, Reporting Capital Gain at the IRS website.

I now gratefully bow out of the tax business for a while. If you have questions, we have a lively tax area in our Fool's School and a tax message board if you need additional help.

Fool on and prosper!

Call Your Boss a Fool.

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Today's Stock Lists | 1999 Dow Returns

04/07/99 Close
Stock  Change   Last
CAT  +   1/8   48.50
JPM  +3  1/2   127.44
MMM  -   5/8   71.31
IP   +   7/16  44.06

                   Day   Month    Year   History
        FOOL-4   +0.83%   3.53%   6.47%   8.05%
        DJIA     +1.22%   3.06%  10.23%   9.79%
        S&P 500  +0.68%   3.15%   8.26%   8.52%
        NASDAQ   -0.73%   3.36%  16.04%  17.63%

    Rec'd   #  Security     In At       Now    Change

 12/24/98    9 JP Morgan    105.51    127.44    20.78%
 12/24/98   24 Caterpillar   43.08     48.50    12.58%
 12/24/98   22 Int'l Paper   43.55     44.06     1.18%
 12/24/98   14 3M            73.57     71.31    -3.07%

    Rec'd   #  Security     In At     Value    Change

 12/24/98    9 JP Morgan    949.62   1146.94   $197.32
 12/24/98   24 Caterpillar 1034.00   1164.00   $130.00
 12/24/98   22 Int'l Paper  958.12    969.38    $11.26
 12/24/98   14 3M          1030.00    998.38   -$31.63

              Dividends Received      $15.04
                             Cash     $28.26
                            TOTAL   $4321.99