A Stealth Tax Cut? (excludable distribution account)

INVESTOR'S BUSINESS DAILY ^ | Friday, January 10, 2003 | Editor

[Isara]

Stimulus: All the talk about President Bush's $674 billion stimulus plan has been focused on dividends. But slipped in among its provisions is a possible bombshell that could be very bullish for stocks.

It's called an "excludable distribution account." If that doesn't sound sexy, it should. At least if you own stock. These accounts potentially will boost returns for all shareholders - not just those who own shares that pay dividends.

The Bush administration - wisely, we think - wants to avoid giving stocks that pay dividends an advantage over other stocks.

The reasons for this are simple: Job growth, new products and innovations come primarily from small, fast-growing companies - exactly the kind that don't pay dividends.

If you give big companies an advantage over them, you kill off much of the economy's dynamism.

But how can you continue to encourage those companies to do their wonderful economic magic and still make the tax code fairer?

Bush's answer, we think, is ingenious: Since small companies don't pay dividends, but instead retain their earnings to invest further in growth, why not give a tax break for retained earnings?

That's exactly what Bush's tax writers did. Under the new proposal, after companies pay taxes they may put what remains of their profits - which accountants call retained earnings - into an EDA.

If the company doesn't pay that money out in dividends, but keeps it for the company's own use, its shareholders get a tax break.

The break comes when investors sell their shares. When that time comes, the cost basis of their shares - that is, what they paid for them - is adjusted upward based on how much has been put into the EDA.

That means, for tax purposes investors' taxable capital gains would be reduced, too. In effect, investors get a cap-gains tax cut.

Here's how it works. Say you bought XYZ Corp.'s stock for $10 a share. The company sets up an EDA, and over the next year puts the equivalent of $2 a share in it. XYZ doesn't pay that money out in dividends; it invests it back into the business.

Now say a year or so later, you sell the stock for $20 a share.

Ordinarily you'd have to pay a 20% tax on the $10-a-share capital gain - an amount equal to about $2 a share. But under Bush's plan, the retained earnings of $2 a share in the EDA are added to the cost basis of your stock. So you have to pay tax only on an $8-a-share gain - about $1.60. That's a 20% cut in cap-gains taxes.

This is more than just clever tax accounting; it's clever politics as well. The Bush people know that they would get hammered hard for putting a capital gains tax cut in their stimulus plan.

Democrats would love to have another "tax cut for the rich" to use as fodder against any tax cuts. So the Bush folks came up with their EDA accounts - which will encourage all people to plow their money back into the working economy through investments.

We're glad to see that the president wants a level playing field for all investments. In this case, it will mean more jobs, more growth and more new products - real stimulus for the long term.

[SJackson]

How would Enron stockholders have benefitted from this?

It would have increased/decreased their taxable gain/loss based on non monetary (to the investor) factors, and those who sold Enron the few years prior to their earnings restatements would have the pleasure of filing amended returns, most likely paying additional taxes, since I would assume if earnings increase your cost basis, losses would reduce it.

An example, buy an airline stock at 10, they report a $3 loss, sell it at 8, pay taxes on a $1 gain. Yeah, this is a simplified system.

[friendly]

This is absolutely brilliant! The economy will skyrocket with new jobs and real growth.

Dubya is extraordinarily intelligent on many, many levels. The democrats are trapped by their own rhetoric and propaganda that this Harvard Graduate School of Business alumnus is some kind of hick moron.

I hope they remain self deluded, always to be outwitted like Wile E. Coyote by the Dubya Roadrunner. BEEP, BEEP!!!!

[RobbyS]

I know little about such matters, but I have been told by an actuary that rich men--I am am talking about them as a class---are adept at tax avoidance, because money, unlike other forms of property is hard to capture.

[Isara]

Please keep this in mind. This article came from the editor of Investor Business Daily, not New York Times.