Tax Code Forcing Everyone to Rethink Investment Strategy

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NEW YORK - People accustomed to finding ways to shrink their taxable income should start changing their habits.

The landmark tax legislation expected to become law later this year marks a retreat from using the federal tax code for social and economic engineering. So it offers few credits and deductions aimed at enticing taxpayers to pay for goals deemed appropriate for the public good.

Methods some taxpayers have used to create losses and thereby shield income would be abolished. Congressional reformers took direct aim at the abusive type of tax shelter that the Internal Revenue Service has been battling for years.

""Master recordings of films, or books, exotic nut plantations, gold mines in New Jersey and orange groves in Alaska. Those things are dead and gone and good riddance,'' said David A. Berenson, adjunct professor of taxation at New York University.

But less exotic, more productive ways of writing off income would also be wiped out or sharply curtailed.

""Everyone will have to rethink their whole investment strategy,'' said John L. Norman Jr., national director of the accounting firm Pannell Kerr Forster in Washington. ""A lot of traditional tax shelters no longer make sense.''

Tax sheltering would be radically transformed because losses from most ""passive'' pursuits could not be deducted from other income, including salaries, stock dividends and bond interest payments.

The bill defines passive shelters as limited or general partnerships in which the investor does not actively participate in management.

The passive loss provision would go into effect gradually as the legislation is now written and be fully phased in by 1991. Starting in 1987, the legislation would permit taxpayers to use 65 percent of the losses they could deduct under current law.

""Shelters, as we've come to know them, will be gone,'' said James Godbout, a tax partner with the Ernst & Whinney accounting firm in Washington.

What he means is that protecting a portion of your salary, or most other income, from Uncle Sam's tax bite would be much more difficult - but also perhaps unnecessary for many people because of a lower tax rate.

The purchase of tax-free municipal bonds would be one of the few sheltering methods left largely unchanged. The ability to tuck dollars into Individual Retirement Accounts to escape current taxation would be curbed.

David J. Kautter, director of the national group of Arthur Young & Co. …