Clinton Plan Socks Investors Budget Proposal Boosts Capital Gains Taxes By Nearly $3 Billion

When it comes time to cash in their earnings from the booming stock market, investors of all stripes might discover a nastier tax bite if a Clinton administration proposal becomes law.

The proposal essentially raises capital gains taxes by $3 billion over five years by forcing investors to use the “average cost” accounting method when calculating their investment taxes instead of two other methods now commonly used.

Kenneth Kies, Joint Committee on Taxation staff director, said a preliminary estimate shows 10 million people a year would be affected by the change, a figure that senior Treasury Department officials say is about right.

Of all the proposals in the Clinton budget for raising revenue, “this probably has the broadest potential impact on wide groups of taxpayers,” Kies said.

House and Senate Republicans didn’t focus on the accounting change during last week’s Clinton budget hearings, as larger issues such as rescuing Medicare and the White House outlook for the economy dominated the proceedings. But one senior House Republican aide indicated the GOP majority might view this as a large tax increase on millions of individual investors.

Kies’ staff is trying to determine if the change would have a disproportionate impact on elderly or small investors who tend to acquire stock over time. Some small investors are angry about the proposal already.

“It probably will increase their tax bill when they do sell shares,” said Brian Goodhart of Sterling, Va., a management consultant and a director of the Washington-area National Association of Investors Corporations, an investment club.

“We didn’t blithely assume this would be without controversy,” a senior Treasury official said.

But taxpayers have to recognize the benefits of this plan, a dramatic simplification of one important aspect of the tax code, the official said.

Under “average cost,” investors would have their taxes based on the average cost of stock or mutual fund shares purchased, instead of the current system, which gives them greater leeway by deducting the cost of the shares.

Stock and bond holders have two general options for accounting for their gains or losses. Under “specific identification,” a taxpayer can pick securities sold for purposes of determining the gain or loss, regardless of when they were bought. The other is the first-in-first-out method, in which the price is figured from the oldest stock in the portfolio.

Depending on your circumstances, choosing one of these accounting methods can result in substantial tax savings.

For example, say an investor holds 100 shares of a computer company, 50 of which were bought for $50 last year and the other 50 having been bought for 25 before that. The investor sells 25 shares of the company at $60, he or she would designate that for tax purposes those 25 shares sold were acquired at $50, and so the capital gain is $10.

Under the Clinton plan, the average cost of the shares would be $37.50, and so the capital gain would be $22.50 - more than double the previous method.

The “average cost” issue wouldn’t apply when someone bought a block of stock at one price and then resold all of it later at a profit, since there is only one purchase price involved. But it would affect investors in so-called dividend reinvestment programs, where a stock’s quarterly dividends are used to purchase additional shares in the same company over time.

David Mangefrida of Ernst & Young LLP said the average cost method would greatly reduce the paperwork, since the taxpayer wouldn’t have to provide documentation to establish when the shares were bought and at what price.

Now, accountants have to figure in stock splits, dividend reinvestment and other factors to determine the stocks’ value for tax purposes.