Tax revision issues, 1976 (H.R. 10612)

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Title:
Tax revision issues, 1976 (H.R. 10612)
Physical Description:
12 v. : ; 24 cm.
Language:
English
Creator:
United States -- Congress. -- Joint Committee on Internal Revenue Taxation
United States -- Congress. -- Senate. -- Committee on Finance
Publisher:
U.S. Govt. Print. Off.
Place of Publication:
Washington
Publication Date:

Subjects

Subjects / Keywords:
Taxation -- Law and legislation -- United States   ( lcsh )
Genre:
federal government publication   ( marcgt )
non-fiction   ( marcgt )

Notes

Bibliography:
Includes bibliographical references.
General Note:
At head of title: Committee print.
Statement of Responsibility:
prepared for the use of the Committee on Finance by the staff of the Joint Committee on Internal Revenue Taxation, April 14, 1976.

Record Information

Source Institution:
University of Florida
Rights Management:
All applicable rights reserved by the source institution and holding location.
Resource Identifier:
aleph - 025878813
oclc - 02347319
lccn - 76601762
Classification:
lcc - KF6275.5 .I554
ddc - 343/.73/04
System ID:
AA00022127:00008

Table of Contents
    Front Cover
        Page i
        Page ii
    Table of Contents
        Page iii
        Page iv
    Introduction
        Page 1
    1. Holding period
        Page 2
        Page 3
    2. Sliding scale
        Page 4
        Page 5
    3. Alternative tax
        Page 6
    4. Deduction of capital losses against ordinary income
        Page 7
    5. Capital loss carryback
        Page 8
    6. Property used in a trade or business
        Page 9
    7. Residences
        Page 10
    8. Patents
        Page 11
        Page 12
Full Text
v\/L


-7--f K IT


[COMMITTEE PRINT]


TAX REVISION


ISSUEl:S-1976


(1I.R. 10612)



8


CAPITAL


GAINS AND LOSSES


PREPARED FOR TILE UISE OF TIHE


COMMITTEE


ON FINANCE


BY TIlE STAFF OF TIlE


JOI( NT


COMMITTEE ON INTERNAL REVENUE


TAXATION


U.S. GOVERNMENT PRINTING OFFICE


WA.i2INGTON : 1' 76


Fd~.I (1


70-023


JCS-I1;,- :6
















Digitized by the Internet Archive
in 2013










http://archive.org/details/issue00unit










CONTENTS



Introduction --------------------------- -----]
1. Holding Period-------------------------------------------------- 2
2. Sliding" Scale -------------------------------- 4
3. Alternative Tax------------------------------------------------- (
4. Deduction of Capital Losses Against Ordinary Income-------------- 7
5. Capital Loss Carryback -------------------------S
6. Property Used in a Trade or Business------------------------------- 9
7. Residences ------------------------------------------------------- 10
S. Patents ---------------------------------------------------------- 1
(II)











INTRODUCTION


This pamphlhet pre,.ents 1)backround infoniation o1 l a iltuill)(,ber of
proposals related to several aspects of capital gains taxation. 7he
subjects included here are the linimun holding period to qualify for
long-termin capital gains, proposals for a sli(ling scale to be u -'(- inll the
taxation of long-termn capital gains that would( reduce the atllount of
gain included in taxable income for properties held a ]onll time.
po,,-,ilble modifications in the alternative tax which limits tlhe rate on
the first $501000 of capital (,ains to 25 percent, possible iimodificatiOlIS
in tlhe tax on gains on property used in a trade or bsinei.. whether
the tax-f'ee rollover treaty ent on ('ains realized oil tlhe sale of a
residence should be modified and finally whether any chani's should
be made in the capital gains treatiilent of patents.
For each of these subjects, time pamphlet describes p)(,seit law and
the major issues relevant to each. VWhen tlhe bill 1past.d by the IHouse
(H.R. 10612) contained an amendment relating to one of thelIe sub-
jects. the House provisions also are described briefly. O()ne or more
subsequent pamphn)llets will discuss alternative prolpo:als for dealing
with thrsf issues.
(1)








1. Holding Period

(.Calpital ,:i is on plopertv li.ld for lo- than six miolitlis are delfinedl
--l ,eri],1ds of iie are tev Iated1 :- long-term l cap)ita] gains. Slhort-tevi-1,
capit:il :ain ,f individuals are t:axed a;' ordinary uiecomie, but one-
half 4f -lw.'-te'111 capital ;,ain- in exe..-> of short-term capital lo-ses
(net loui-teci.i capital .;;iiii.) is gelerall.y excludedi kroll adil-ted
'r,-- iiwa,.:,ii. Individuals also have the optionl of ]Iavin, the initial
.5( HX)iI) ){ 0 netI 1 ,ii-t eCll calitial .,,iin- tai i X d at a "-' i-1,F"ei altel' ati\e
rat,.
Idivi ].-ls liiav (leduct 1lheir ca])ital lo--es to the extent of their
<;pital it, ;!l if lo-' ex-.coeed I ins. up to ^1.0UO of these )-'-cs
ay11 ,, 1W o0I7:,t a[Iazi-I; or lin aryv inconie. If the nuet capital los:-es are
slhort-teri 'I t liev iav 1li deducted a.:i i ist ord i iarv income on a dollar-
for-(1ohlar ls-is (iup) to the Sl.000 liiiiitation), but only 5)0 perceit of
te1t loiu-teri ca(1)ital 1(i-- (- r.eaIlized ImIIaV 1 deducted a _raii.t ordinary
inlicmie. (Tl1us. S2.00)0 of long-termn cai ital lo:-e- is required to off-ct
S.1.)00 of ordin1ary incomile.) hIdividuals' 1o:e> in excess of the $1.,00
lititiation ]ay nvot I.e ca...rried lackl to prior v.ea;r-. but there is al
unliutite d(l (. trrvover to future years.

Fori the 1 ulk of lpropelrtvy, tle capital g'ain in fact i- usually spread
over thle holding,_, period, ibut tiet rc:idzMtion of the grain which 'reilts
in tax ,'-crs o0111yV when the pi-olperty is sold. When the aitset has lbeni
hel for a period of years, it is .en.erallv believed to be minfair to tax
several years of accrual under tlhe prov'.::-ive rate structure as though
it hlad 1 -'en earned at ote time.
Tlie provision inll pre.-nt law providing a minimum holding period
which distin-4i i: s ,i- between short-term and long-term capital gains is
ilten led to .-tablis a fair pro(edu,,r' for taxing the realization of a
capital gain that accrued throughout the holding period. Another
ba:-i., for ,_ivin(r separate I r'eatmient to longer term capital gainss tis hat.
since they can 1we ioaliz/ed or not, largely based on the taxpayer's deci-
sion. the eiilar tax rate might discourage realization. Others believe
loi ,ier term "a pital gains either are not income or are not the same as
other illcol.,,.
Some criti- of the prC-eCit six-month holding period believe that it
is t )o -!ort. They silrcest that capital gains realized within a 12-month
period should I1w treated( as ordinary iote. Tlheyv point out that the
iifairne-s a--iated with the bunching in one year for tax purposes
of a capital ,,'aiH that accrued over several years is not prevent in this
ca-,. They note that other forms of income earned or realized within
a 12-month period are treated as ordinary income. Proponents of main-
taiiini tOie iniimu'.m1ilit holding lpL )riod :- it is ill pte-enl law sNlugest that
(2)








property oni which tlihe capital gains accrue is a capital item and that
thle calpitl :ain is a ,anI2e in the value of tle pliopelrty, rather tlalt
incoelli. If slome ,ailis arIe to b)e taxed is or(linarv inlcolm'e, tlev believe
the holding period for this treatment should be as short as possible.
Ma ny itelis (;o property treated as capital a-;is for p1)rp)oses of t1eo
tax are traded on orga:iiuized stock exchanges. If the minimum holding"
period were to be increased from six months to one year, it is contended
that the normal activity of the exchal:ne,: would be disrupted since
trades that normally occur after the six-month holding period would
then be deferred for a further six months. If stocks were held off the
market until the longer holding period was met, stock prices might be
bid iup temiporarily because buivers (as conltrasted to sellers) wouldl
have no reason to defe teir 1)ii pu' r h)ases lere'ly ofau"c o1 a ch' an'ge iII
the holding period. Also, there would be a substantial loss in business
for brokerage houses in the first six months after a change in holding
period to one year.
There is little statistical evidence as to lhow long investors have held
stock. A study by the Internal Revenue Service of stock transactions
in 1962 indicates that of the total gain realized on stock t ransuctions in
that year, 6.0 percent was realized on stock held between (6 andI 12
months and 5.4 percent on stock held less than six months. These sta-
tistics sugge-st that stock sales occurring in the second six months of
holding do not account for a significant portion of market activity.
About a quarter of those sales occurred during the seventh month of
the holding period which suggests a short-term speculative (or in-
come) rather than investment objective.
Preliminary statistical data from a new study by the Internal Reve-
nue Service is being processed now and will be presented to the com-
minittee when it considers this subject. The behavior described in the
1962 study is consistent with the findings of earlier studies of capital
gains an(t the related holding periods that were based on income tax
data submitted to the Internal Revenue Service.
HIouse b1ill
The IHouse-p;.issed bill increases the holding period defining lon(g-
term capital gains from six months to eight months in 1976., to ten
months in 1977 and to one year in 1978 and future years. There is a
transitional rule for installment sales, whereby if a gain would have
been long-term in the year of the sale, it is considered long-term even
if it is included in income on the installment basis in a year in which
it would have been considered short-term. Gains on agricultural conm-
modity futures contracts are exempted from the increase in the holding
period.








2. Sliding Scale of Tax Rates for Long-Term Capital Gains
P *' .,, t lateL
Capital gains from the sale of property held longer than six months
are cla-sified as long-tclerm capital gaillns. Fifty percent of net long-term
gains (after offsets for shlort- and long-term losses) are included in
taxalble income and generallv are taxed according to the regular pro-
gre ssive tax rate 'chedule. The effect is to tax net longr-term capital
gains at half the rates that. apply to other income. Net long-termj
capital g.iains up to s.)0,000, however, are eligible for a 2.>-percent alter-
native tax ratt. If property is held by a taxpayer until his death. the
capital train is not taxed at any time although his heirs take as their
Ib:Isis for tfit, property its value at the tillme of death or six months
thereafter.
Issues
Many 1believ-e that it is inappropriate to treat all long-term capital
,r-ainS tlhe same for tax purposes whether the asset has been held for
just slightly over 6i month-s (or 12 months if the holding period should
1)e chang-ed) all the way up to perhaps 30 or 40 years or more. They
contend that much of the gain in the case of these assets held for a long
period of time represents increases in value due to inflation rather than
real value. Therefore, it is suggested that some adjustnient is appro-
priate so that thie tax on capital gains will only apply to increases in
real value.
There are two principal proposals which have been advanced to deal
with the various types of problems referred to abo-e. One of these is
referred to as a sliding scale of tax rates. Under this proposal, the
inclusion factor for capital gains would be reduced below 50 percent
for capital gains held for longer periods of time with the exclusion
factor being largest for those properties held for the longest period of
time. A second type of proposal often advanced is called a basis ad-
justmnent under which the initial cost of the asset is increased by a
percentage (either a constant annual percentage or a percentage vary-
ing with tlhe annual c(iangre in the cost of living) for each year the
property is held.
Those who believe that the isiue is- primarily that of adjusting for
inflationary increase,- in value favor dealing with the problems by ad-
ju-tiig the cost basis of the az-et upward rather than providing a
sliding scale of capital -ains; excluded from tax. The 1ienefit of an
exclii-ion of a part of tlhe gain under a sliding scale goes largely to
the property wlich las greatly appreciated in value. On the other
land. even where there is only a small gain. it mnay be thl;at all of this
gain represents an inflationary increase and, as a result, no part of it
s:0ould be subject to tax.
(4)







Others, however, favor an exclusionii of part of the gain under a
sliding scale which varies with tlie holding period. They believe tlhat
to tax capital gains held a 1ong time similarly to those held for a
short period of time discourages realization of the gains and colntrib-
utes to the holding of av:(ts (lock-in effect) longer than would be the
economically desirable in the absence of tax considerations.
The payment of a large tax on a potential capital gain discoir.lIg"s
realization because the taxpayer knows that if lie does not dispo-e of
the asset he can continue to benefit from the income attributable to the
portion which would otherwise be paid in tax. As a result, the tax-
payer may decide to hold the property until it will be included in his
estate. In that event, neither hlie nor his heirs will be taxed on the
gain since there is no tax imposed at the time of his death and the
heirs receive a step-ulp-in-basis, or current value, for the property. In
this way, the taxpayer avoids any taxation on the accrued gain, but
any economic benefit from the exchange of assets to reflect changing
circumstances and differing valuations has been lost because of the
lock-in effect.
Others argue that a sliding scale exclusion in capital gains rates is
needed to offset the fact that a property which has been held for iialny
years may result in having the gain taxed at highly progr.v-lve rates
without consideration for bunching of income that occurs on realiza-
tion of the gain. To some extent, the averaging provision in present
law under which capital gains may be included deals with this bunch-
ing problem. However, the present provision provides 5-year averag-
ing and, therefore, does not adjust for bunching which occurs over a
longer period of time.








3. Alternative Tax on Long-Term Capital Gains


P /'i 0, ( 1,: t / I
eerally ;in individl:l1 taxpayer includc.- in inconie 50 1lrcent
if lo1-t ;;i capital gi- in ex1c-. of aita -. However, witl
rY'-j.,t to tlie i r-t S:,,()It (s I5.,<10 for arrived individi: 1 ls who file
sepl., ate rtun-), hlie 4'i! elect to be taxed instead ait ai rate of 2.)
pliltiit Onl tfi. entire net long-term capital g(ainl.
Iss I/
The al.te-niative tax benefit- only thos-e taxpayers with marginal
tax rati- '.fore their ';ipit:il aii- of 0 percent or more. Ti.s
imcliIL-s married couples.; with1 t a able income before taking into ac-
count1 their capital gains of over $52.000 and single persons witli in-
colies of over s.,S,000. (For others, the application of the regular
rate.- 1%.it with the exclusion of half the ,rain is more beneficial than
t]l, alternative rate.) At tlhe .amine time. this alternative rate applies
01olv to tle fir-, !.)0,010 of capital gains. As a result, the area of its
applip;Ition is relatively limited. In 1972. for example, only 5 percent
of capital ,_.:iis were taxed at the alternative rate. (This contrasts
with 33 percent prior to the Tax Reform Act of 1969.)
Prop!onents of the alternative tax contend that this provision is
d(.-irable I ie.au-e. for up to .50,000 of capital gain. it limits the extent
of the progressivity in the tax. They suggest that this may benefit
thohe v itih income. of S-,.2.000 or more (s.,s,000 or more for single
persons), who al-o have made a once-in-a-lifetime sale of an income-
pro)Iducing a--,,et.
Before the 1PIC Act, the alternative tax was available without the
$50.000 limitation. It was objected to at that time on the grounds
that it limited the progre-:ivity of the rate structure for those in the
upper income tax brackets, much of whose income was received in the
form of capital gains. The retention of the alternative rate. but with
t e. .50.OOO limitation, represented a compromi-e of those with oppos-
in" po-itions in this area. The opponents of the present provision
s1,,g,'.,t that the existing provi-ion is of limited application in any
event :ad. therefore, primarily represents an added complexity in
the lav,- rather thlian a;ny substantivee relief. They also point out that
there is no reason to believe that the provi-sion has its primary appli-
cation in the ,a-,e of thlio-e having large, one-time, capital gain-.
(6)








4. Deduction of Capital Losses Against Ordinary Income
PreYNenf 7h'(
Capital losses of inldividals are deductible in full a:gains-t -,,pital
gaLins, bUt lie1 exte-s 0o' capital lo-evs over (cl)itial ais calan b, (de-
ducted against or imary in come only )up to 1,0()00 each year ($500 for
a married person who ties a separate return). Only 50 percent of net
long-term caI pital losses in exce-s of net short-term'I c:I pital grains may
(be dedlucte(d fro o(dliar i come (since a)only 50 percent of ca Iong2-
teri capitlU1 gain would be in11lude( iln incoe). Thuis. $2.000 of net
lon-terl capital losseQs is required to offset 1.000 of ordinary incolmle.
(Capitai loss-es in exces-s of) the $1.000 limitation may be carried over to
future cars indefinitely.
LS I I Cu S
It is contended that a taxpayer should be allowed to deduct all his
capital losses against ordinary income, after adjustment for the 50-
p)ercent exclusion rule. Such an approach is symmetrical with the in-
clusion in full of 50 )perctit of capital gains in taxable, income.
Others disagree and point out that taxpayers have discretion over
the timing of realization of capital gains and losses. As a result, un-
limited deductibility of net capital losses against ordinary income
V/ A. 0n I,/l
would encourage investors to realize their capital losses immediately
to gain the benefit of the deduction against ordinary income while
they are deferring realization of their capital gains.
Some observers believe that although there should be limits on off-
sets of capital losses against ordinary income, the present $1,000 limit
should be increased, since prices have risen significantly since this
deduction was originally enacted in 1942.
House bill
Tihe HIouse-pa- .,d bill 11ic1-,,- the amniount of ordinary income
against which capital losses mavy be deducted from $1,000 to $2,000 in
1976, to $3,000 in 1977,. and to $4,000 in 1978 and future years. Thlese
amounts are halved for married persons who file separate returns. As
itinder present law, only 50 percent of net long-term capital losses inll
eX-cess of net. short-terni capital gains may be de,,ucted from ordinary
income.
(7)


7O-023- _6 2








5. Capital Loss Carryback
1 (.',^ nf , ,r
ntider pr(-.niit la I in di vid-llx :s ca in dedlt ;ic lfital lhss(-s to t lie extent
of their captal gaills. In addition, if anl iildividl al's capital losses ex-
c('li his ca pit a l 'gails, hlie all (c deduct :capital lohsL.-: aga i .st up to .1l,()l0
of ord lillai il'comllie t'aicl vyear* ( SO0 for niarried individluaIs whvio ile
,epa rate retliirins). Individuals' capital losses in1 exce-s of tlie S1.(O1
limitatioll iay Ilnot A e caIrried back to prior y(ealrs, but there is an un-
liiited carryover to future years.
Is* /, .*"
It has leen sg(r,,sted that individuals, like corporations, should be
:1)1e to (edl(uct capital oses against prior year- capital gai. Under
exist ij, law, if an individual sustains capital losses in one year and
eap)ital gains in the next year, lie can carry over the capital losses and
de(luctf thei against. the siulsequent capital gains. If his capital gains
preced(le his capital loss', hlow(ever, he ca-inot carry the capital losses
lack and deduct them a.-":iist I)rior capital gaims. It is believed that
this result is inequitable and ser ives no useful purpose. Fuirtlihertiiiore,
it is pointed out that the failure to provi(lde a capital loss c arryiback
leads to tax-motivated :elling at the end of each year. Investors who
have realized capital gain.s in a year and who have unrealized(l capital
losses cannot be sure that t heyv will have capital gains in the future
aIaiist which to deduct the capital losses, and as a result, in some cases,
they realize their capital losses at the end of the year solely for tax
purpo. es.
It is contended, on the other hand, that since the tinuini of the real-
ization of capital gains and losses is largely in the control of the prop-
erty owner, this (loes not usually represent an important problem for
him.
Some have suggested that a capital lo.s carryback should be avail-
able primarily as a relief measure where it is unlikely that the carry-
forward in perhaps the next 5 years will be adequate to offset the capi-
tal loss. Under present law, up to $10,000 of capital loss could be off-
set against ordinary income in a carryforward over 5 years (under
the provision included in the House-passed bill described in the pre-
ceding section, this is increased to $4.000). It ]ias been suggested that
a carrylback of capital losses is required on the grounds of equity for
those who have had very large capital losses and have the prospect of
receiving inadequate capital gains or ordinary income in the future to
offset such a loss.
Others argue that a carryback of large losses would be beneficial
primarily to the wealthy individual and of no benefit to new businesses
which may not have capital gains in past periods against which the
capital loss may be offset.
(s)








6. Capital Gains Treatment for Property Used in a Trade or
Business
Present law
Under present law, depreciable property used in a trade or busini-s
is treated like a capital ;iset if the taxpayer realizes a net capital
gain.1 This means that in such a case, if the taxpayer is anll individual
he will receive the benefit of the 50 percent exclusion (and alternative
rate limitation). If the taxpayer is a corporation, it will have the gain
taxed at a maximum rate of 30 percent. On the other hand, when a tax-
payer realizes a net capital loss on the sale of depreciable assets used in
a trade or business, the net loss is treated as an ordinary loss and,
therefore, may be deducted in full against ordinary income.
Current law also provides that in the case of depreciable personal
property and in the case of certain other tangible property, not includ-
ing buildings, the gain on the sale of the property is treated as ordi-
nary income to the extent that depreciation deductions have been taken
with respect to the property. In the case of real property, generally,
depreciation taken to the extent it exceeds the amount that will be al-
lowed under straight-line depreciation is treated as ordinary income
up to the amount of any gain on the sale of the property.
Issues
In the case of personal property, it is understood that the recapture
rules referred to above have the effect of treating most of the gain on
the sale of property used in a trade or business as ordinary income
despite the fact that the so-called general rule would treat this as cap-
ital gain. In view of this, questions have been Iraised whether, in the
interest of simplification, it is more appropriate to apply ordinary
income (as well as ordinary loss) treatment in the case of personal
property used in a trade or business.
While there is general agreement that tangible personal property
used in a trade or business generally is subject to ordinary loss treat-
ment because of the recapture rules, it has been suggested that this was
not true in the case of intangible personal property such as player con-
tracts of sports teams. It is argued, in addition, that to treat such gains
as ordinary income would present economic hardships for the sports
teams involved.
This treatment applies only if the property is held for more than 6 months. This
treatment is not available in the case of property properly includable in the taxP ayer's
inventory or in the case of Iprop'rty held for sale to customers or to a copyright literary,
musical or artistic composition or letter or memorandum held by the person whose per-
soual efforts created the property. The term "propiierty" used in a trade or business also
includes timbr, coal and iron ore with a retained economic interest.
(9)








7. Tax Treatment of Capital Gains on Residences


pi', .\, .if t7,11,
l nd'lor 1pr-elnt law, two -Jecial tax 1)rovisions are available for
<.l;pitil ainls arisin" from tie sle of all indivi-(lm-as princil
'-idli.nce. iThie-e :ire provided in addition to the general caI)ital grains
excln:ion proviO:ion. First, when the proceeds of the sale of a tax-
Ipayer's prillcil):ll re'-ilenice are invested illn new principal residel'ce,
the taxpayer iimay defer realizatioll of the .:i1 onl the sale of thell( old
l'rsidCnce until he Mclls the new residence. Secoll(d. there also is an ex-
tclu-ion for the -ain in the case of the sale of a principal residence for
l0,(i)0 or less by a 1persoi aire 65 or over who has used tihe house as a
principal residence for 5 out of 8 years prior to sale. When tlhe sales
price exceeds :-20.000, the exclusion is a fraction equal to .20,000 di-
vided by tihe sales price. The provision of the exclusion for tlhe elderly
is. how\ ever, available only once.
1[88 /.
There are .-everal issues in current law as it relates to the tax treat-
ment of capital gains on res-idences. With respect to tlhe provisions
for the elderly, it has been s,,'og-ested that the *20,000 base sales price
is too low. In this view, the recent inflation, especially in the value of
single family dwellings, has materially reduced the equity in the
exclusion which was fir-t provided in the Revenue Act of 19)(4. Sin(e
1!(;4. the xenieral pri'e level has risen 74 percent, and the index of
housing costs 78 percent. There is also a question about whether the
exclusion should relate to the l)ase sales price, or the capital grain
realized from the sale of the home. On the other hand, increasing th(e
base sales price or extending the exclusion might result in permanei itly
exempting an individual from ever paying capital gains taxes on
residential property.
There are several i.--us related to capital gains on re.-idences which
involve the definition of a prinlcil)al residence. Many public officials,
including Members of C('ongress and the Pres-ident. maintain a resi-
(lence in Wa1-liiir'ton, I).(C. and one elsewhere in the Nation. There are
currently no spl)'ial rulve. to determine which of thle-e is the principal
residence. For a Member of Coireiv'-s who spends a considerable
amount of time in his district, and who maintains a re-ideumce in
Was l-hinton, the qust ion is which is his principal residence. For tlhe
purpose of d(eterimimmi.ni" what are deductible travel expenses, a
Member's residncce is the residence in his districtt. However, it is
also po'sil)le to treat a Washington residence as his principal residence
for the purpos)te's of nonrecogin ition of ,ain i upon sale.
(10)




UNIVERSITY OF FLORIDA

ill, ",lilli", II IIIl
3 1262 07125 7322



S. Gains on Sales of Patents
Present ltaw
Under pre-ent law, gains on the sale or exchange of p):ttents are
treated as long-termi capital gains if the sale or exchange is by the in-
dividual inventor whose efforts created the patent or by someone, other
than the inventor's realtives or employees, who bought the patent from
the inventor prior to the actual reduction of the invention to practice.
Is88sues8
A reason often given for providing long-term capital gains tre(at-
ment to inventors and certain piir-c'irs of patents from inventors is
to encourage this socially useful ai(d risky activity. Under certain
circumstances, however, long-term capital gains treatment for the sale
of patents leads to a higher effective tax rate than would treatment as
earned income. This occurs because of the combination of the regular
income tax, the minimum tax, and the preference income offset to the
maximum tax on earned income. An individual in the 70-percent
bracket with a substantial amount of earned income ill five consecutive
years can have his capital gains taxed at an effective rate of 54.5
percent. (This is the sum of the 35-percent regular income tax rate, a
1.5-percent effective rate of minimum tax. a 10-percent increase in tax
on earned income owing to the preference offset to the maximum tax
in the year the gain is received, and 2 percent increases in tax on earned
income in each of the next four years because of the five-year averag-
ing provision in the preference offset.) Capital gains are also not
eligible for such benefits as H.R. 10 plans or individual retirement
accounts.
(11)