Category: Individuals
Subject: Capital Gains Tax Rate
Title: Election to Have Capital Gains Taxed at Ordinary Income Rates
IRC Sections: 1(h)
Filename: 1306.html
Date Produced: 03/94

Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com

Issue
Is the 28% maximum tax rate on capital gains mandatory, or can the taxpayer elect to have capital gains taxed at ordinary income rates?

Answer
As you are aware, a taxpayer may elect to have capital gains taxed at ordinary rates in exchange for being allowed to claim such capital gains as part of investment income for purposes of the investment interest deduction. Absent such an election, it appears that the 28% tax rate on capital gains is mandatory.

Discussion
The 28% maximum rate on capital gains was enacted by §302 of the Tax Reform Act of 1986 in order to shield capital gains from higher rates of taxation should the maximum tax rate put in place by the 1986 Act (28%) be subsequently raised. The relevant code section-- then §1(j), now §1(h)--and the accompanying legislative history make no provision for electing out of the 28% maximum rate. In other words, the provision seems to be mandatory just like the remainder of tax rate structure.

The concept of electing out of the 28% maximum rate is a product of Omnibus Budget Reconciliation Act of 1993 §13206(d)(2) which requires taxpayers electing under §163(d)(4)(B)(iii) to treat capital gain income as part of investment income for purposes of the investment interest limitations to tax capital gains at ordinary rates.

Accordingly, the literal answer to your question is the 28% capital gains tax rate is indeed mandatory absent an election under §163(d)(4)(B)(iii). It occurs to me that you might consider simply making the §163(d)(4)(B)(iii) election (assuming the election does not hurt your taxpayer in some way) even though the taxpayer does not need the additional investment income. There is no indication either in the code, the committee reports, or the newly issued temporary regulations that the election must somehow be needed in order to be effective. Incidentally, the IRS has announced in Temp. Reg. 1.163(d)-1T that the election is made on Form 4952.