About this series
The Enquirer will continue its Tax Time series, begun Feb. 9, every Monday through April 13.
Today: Profiting from the stock market last year came with a bonus: some tax relief. But the change has made filling out Schedule D a complicated affair.
Feb. 9: An overview of this season's tax breaks.
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Many investors who cashed in profits from last year's profitable stock market will find some welcome tax relief this filing season thanks to the new tax law's cut in capital gains rates. You'll also find some not-so-welcome complications when filling out your 1997 income tax return.
The complexity will be instantly apparent when you take a look at Schedule D, the form for reporting capital gains and losses. The form has been vastly expanded. It now contains 54 lines, more than double the 23 lines on the 1996 version.
In the end, many investors will find their capital gains taxes slashed by as much as a third as a result of the new lower capital gains rates added by the Taxpayer Relief Act of 1997. The new rates apply to certain long-term investments sold on or after last May 7.
But because the changes created a more complex rate structure, an additional holding period and a two-step phase-in, investors are likely to find the paperwork exasperating. Computing capital gains taxes and filling out the forms will be tougher and more time-consuming this year.
"If you work through Schedule D, it's not intuitive," said John Gardner, a senior manager in the Washington, D.C., office of the accounting firm KPMG Peat Marwick "It's definitely going to take more time this year."
All the additional lines, calculations and boxes on Schedule D reflect the fact investors could have their 1997 gains subject to tax at as many as four different rates. Depending on when the investment was sold, how long it was held and the type of investment, investors in the top tax bracket could see their gain taxed at rates of 20, 25, 28 or 39.6 percent. Under the old law, an investor's gains were subject to tax at no more than two different rates.
The new, complicated rules and form are likely to send more investors to tax preparers this filing season. But that needn't be the case.
Filling out Schedule D can be done on your own "if you're capable of reading the instructions, follow what they say and understand the basics of the legislation and the holding periods," said Mark Luscombe, principal federal tax analyst at CCH Inc., the legal publisher.
In some respects, Schedule D looks more complicated than it will prove to fill out. Most of the lines added to this year's form are for simple math calculations or for inserting amounts from other sections of the return.
If you're using computer software, most of the extra lines will be automatically computed. Indeed, investors are likely to find that using computer tax software will greatly ease the process - especially if they have numerous gains to report, said Edward Slott, a certified public accountant in Rockville Centre, N.Y. "I don't know how anybody can do it by hand," he said. "There are so many chances to make a mistake."
Regardless of whether you use a computer, Mr. Slott cautions investors to be sure to list the correct date of the investment's sale.
"People are not careful about the right sale date," he said. But this year, listing the correct date will be critical. How your investment is taxed can vary sharply depending on when it was sold.
New rules
The most important step is transferring the sales information from your broker and mutual fund to the right spot on Schedule D so it gets taxed at the correct rate.
The first section of Schedule D will be familiar landscape to investors because the treatment of short-term capital gains was unchanged by the new law. Investments held one year or less will continue to be taxed like wages at regular rates of 15 to 39.6 percent.
All the new law wrinkles affect "long-term" gains and losses from investments held more than one year.
Investments sold before May 7 are governed by the old law, which taxed investments held more than one year at a top rate of 28 percent (15 percent for those in the bottom 15 percent tax bracket).
For sales on or after May 7, the new law adds a new lower rate of 20 percent (10 percent for those in the 15 percent bracket). The new 10 percent and 20 percent rates apply to investments held more than one year if sold between last May 7 and July 28. Investments sold after July 28, 1997, must have been held more than 18 months to qualify for the lowest rates.
For sales after last July 28, investments held more than one year but not more than 18 months are taxed at a rate of 28 percent (15 percent for taxpayers in the 15 percent tax bracket).
- Collectibles: Art, antiques, stamps, coins, precious metals and other collectibles don't qualify for the new 10 percent or 20 percent tax rates. They are generally taxed at rates of 15 percent or 28 percent if held more than one year - the same as under the old law.
- Depreciable real estate: Special rules apply to post-May 6, 1997, sales of real estate. If you sold real estate that you depreciated, your gain will generally be subject to tax at a 25 percent rate to the extent of depreciation deductions you previously claimed.
- Capital losses: The new tax law didn't change the general rules for deducting capital losses. As before, you can use losses to offset your capital gains plus up to $3,000 of other income, such as salary from your job.
But the new law does install a more complicated set of rules for determining how your losses offset your gains under the new capital gains rate structure.
- No more short cut for fund investors: In the past, investors who received a capital gains distribution from a mutual fund but had no other capital gains or losses to report, weren't required to fill out Schedule D. The distributions could be reported right on the front of Form 1040.
But on 1997 returns, this short-cut option is no longer available because of the changes made to the capital gains rules.
If you cashed in only part of your holdings in a particular mutual fund last year, you might be able to minimize the tax bite by taking advantage of the "average cost" method for figuring your capital gain.
Average-cost method
The average-cost method can be a salvation for investors who made a partial redemption of shares that were acquired at different times and different prices.
Unless you specifically instructed the fund manager at the time of the sale which specific shares to unload, the IRS generally makes you assume on your tax return that the first shares you acquired were the first shares sold. Trouble is, if your fund has steadily risen in value, this "first-in, first-out" (FIFO) formula could produce the biggest taxable gain possible, because the shares presumed sold would be those purchased at the lowest price.
Most fund investors, however, have the option of computing their gain based on the average cost of all shares in their account. If your fund has steadily risen in value, the average-cost method will usually produce a smaller gain than the FIFO method.
Averaging can also be the simpler method to use. Many mutual fund companies send shareowners a statement each tax season showing the average cost of shares in their account.
The capital gains changes necessitated a major reprogramming of IRS computers. As a result of the reprogramming, the IRS said it wouldn't be able to accept electronically filed returns containing Schedule D before this past Thursday.
Conventional paper returns could still be sent. Although their Schedule D won't be processed until the computers are reprogrammed, "we can at least get it (the return) through the first few steps of processing," IRS spokesman Don Roberts said.
