Planning ahead for next year’s scheduled drop in Rhode Island’s capital-gains tax rate?

You may have to come up with another plan.

The General Assembly is talking about freezing, at current levels, Rhode Island’s long-term capital-gains tax rates.

You need to know about this now, for your planning purposes, because it could affect your pocketbook.

Here’s why.

Rhode Island law currently provides favorable tax treatment for profit on the sale of certain assets that you’ve held for more than five years, such as stocks, mutual fund shares, land or similar assets that you hold for investment.

If you sell such an asset at a profit now, the maximum capital-gains tax rate is 1.67 percent.

If you sell such an asset next year, you’ll pay no tax, because the tax rate is scheduled to drop to 0 percent.

Under the proposal, however, the maximum long-term rate would remain at 1.67 percent, the same as it is now; it wouldn’t drop to zero. So instead of paying no tax, you’d have to pay at least some tax.

For instance, suppose you were planning to sell stock or another such asset at a net profit of $10,000 next year. You’d have to pay a maximum of $167 in Rhode Island capital-gains tax; you wouldn’t be able to escape the tax altogether, as you would if current law remained in force.

The freeze is part of a proposed budget unveiled yesterday by state Rep. Steven M. Costantino, D-Providence, and approved later in the day by the House Finance Committee, which Costantino chairs.

It comes in response to a state budget deficit. To help close the gap, the budget would cut spending in some areas, and raise revenue in others.

If the rate freeze becomes law, what would Costantino tell taxpayers? “It’s the same as this year. You didn’t lose ground, and you’re not worse off than your neighbor,” Costantino said during a briefing at the State House yesterday. He said he was referring to Massachusetts, which generally taxes long-term capital gains at a rate of 5.3 percent, the same as wages.

By freezing Rhode Island’s long-term capital-gains rates, Costantino estimates that the state would save $9.8 million for the fiscal year, which starts July 1.

In other words, taxpayers would pay $9.8 million more than they would if the rate were to drop to zero.

(The revenue would come in the form of quarterly estimated tax payments due in April and June 2008, said Michael O’Keefe, House fiscal adviser.)

The proposal comes as no surprise to John E. Barrett Jr., a former director of the Rhode Island Society of Certified Public Accountants.

“Did you ever really think we’d get to zero?” he said. “Any time you have a phase-in or a phase-out of a tax benefit [over a number of years], you’ve got to be wary,” said Barrett, who is also president of Barrett Valuation Services of Cranston.

“The states and cities are always faced with budget constraints, and this is an easy pullback,” he said. “If there’s not a lot of resistance, and it raises some revenue, they’ll do it.”

Patricia A. Thompson, former president of the Rhode Island Society of Certified Public Accountants, said, “When they put those rate [reductions] in so many years in advance, I always figure they’re going to change.” (The current long-term rates are the result of legislation enacted in 2001.)

In other words, she doesn’t count on them. You shouldn’t either, for tax-planning purposes. “Don’t let the taxes drive the transaction. They’re a consideration, but they shouldn’t be driving it,” said Thompson, tax partner at Piccerelli Gilstein & Co. LLP, an accounting firm in Providence.

Besides, she said, “People should not be holding off [on a sale] for tax reasons, because you don’t know what the market value of your asset is going to be a year from now.”

What about taxpayers who may have been waiting until next year to sell, when Rhode Island’s long-term rate is scheduled to drop to zero? “They’re out of luck” if the proposal is enacted, Barrett said.

But long-term rates, as they exist, are still pretty good, he said. To understand why, take a quick look at how Rhode Island’s capital-gains rates work:

Short-Term: If you’ve held the asset for 12 months or less, the gain is generally treated as ordinary income, such as salary or wages. So it generally gets taxed at the usual Rhode Island income-tax rates, as high as 9.9 percent. (This law wouldn’t change under the proposal.)

Medium-Term: If you’ve held the asset for more than 12 months, but less than five years, you generally pay a maximum Rhode Island tax rate of 5 percent if you’re an upper-income taxpayer, 2.5 percent if you’re a lower-income taxpayer. (This law wouldn’t change under the proposal.)

Long-Term: If you’ve held the asset for more than five years, you pay tax at a maximum rate of 1.67 percent if you’re an upper-income taxpayer, 0.83 percent if you’re a lower-income taxpayer. (Under current law, these rates were to drop to zero starting in January. Under the proposal, the rates would remain in force for next year and beyond.)

(In these examples, by the way, you’re a “lower-income taxpayer” if your Rhode Island taxable income ordinarily falls within the state’s 3.75-percent bracket. That generally means you have less than $31,850 in Rhode Island taxable income if you’re single, less than $53,150 in Rhode Island taxable income if you’re married and file a joint return.)

Keep in mind that this is still a proposal; it still needs to wind its way through the House and Senate, then come before Governor Carcieri.

So it’s not a slam-dunk. But it comes from the powerful House Finance Committee, which, like the House and Senate, is controlled by Democrats.

Thus, you’ve got to figure it’ll be taken seriously. So it’s something you’ll need to keep in mind if you’re planning ahead.

Neil Downing is a Journal staff writer and author of The New IRAs and How to Make Them Work for You. Questions about your money matters? Call us at 1-401-277-7484 and leave a message, or e-mail:

moneyline@projo.com

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