Will tax discrimination against coins end?

Coin collecting and investing was changed, for more than a generation, when the 1982 Tax Equity and Fiscal Responsibility Act (TEFRA) was passed by Congress. One small section of the law for practical purposes prevented placing rare coins and some other collectibles in Individual Retirement Accounts or Keogh accounts, and also changed the way gains on collectibles were taxed under the Internal Revenue Code.

Most hobbyists probably don’t think about this until after they have sold their coins and then realize the discriminatory tax rates that are applied.

This may be about to change as Congress has before it legislation that would lower the capital gains rate on collectibles, something that the Industry Council for Tangible Assets has announced again as a stated legislative goal.

Since 1982, and the passage of section 408(m) of the Internal Revenue Code of 1954 (now the Code of 1986, as amended), rare coin investments in individual retirement accounts has been prohibited by legislatively declaring that such an investment acts as a taxable distribution, causing the holder all kinds of financial penalties.

Capital gain taxation on collectibles has also been higher than it has been for stocks or bonds – which sort of directs investment capital in a particular direction, instead of making it a free choice.

As long as a trustee for a private pension is satisfied that rare coins are a prudent investment, not only has their use been appropriate, it has never been expressly disapproved. But in arriving at that decision, the gain or loss, and amount of taxation, has to be taken into account on eventual resale.

None of this is a guarantee that rare coins will go up in value or that they will not lose their value; the same is true of stocks and bonds. The trustee’s responsibility is to have assurance that the investment vehicle chosen has the opportunity for safe growth and that the choice has been carefully considered.

Americans lost an important investment option -- the right to put rare coins and some other collectibles into self-directed individual retirement accounts (IRAs) and Keogh accounts (the 401-K plans that are so popular among the self-employed, and some businesses) – with the passage of TEFRA.

Those who were involved in the coin market at the time remember the consequence: a precipitous decline in coin prices as a once fertile ground for placement of assets dried up as a potential purchasing source.

For a number of years since, a coalition of interested parties, led by ICTA has led the battle to overturn a small portion of the 1982 TEFRA legislation, which makes it useful to examine what brought about the prohibition, and why the right should be restored.

Named for Rep. Eugene Keogh of New York, the Keogh account was intended to provide small businesses with the equivalent of a pension – but without the heavy regulation that accompanies plans run by much larger companies.

At one time, a proprietor could contribute up to $30,000 each year to such a plan – and defer the tax due on the income of the sum set aside until retirement, or when the account was drawn against.
Designed to supplement pensions and Social Security, the plans were intended for long-term retirement planning, and severe penalties were imposed to make certain that the retirement plans were used as intended.

Still later, those who were not self-employed or working for small companies that lacked pension plans were allowed to set up their own plans known universally under the IRA acronym, and initially set aside up to $2,000 a year (also as deferred income).

Subject to some qualifications, in 2009 contribution limits are now $5,000 annually. However, if you will be 50 or older by the end of the year, you can contribute an extra $1,000, for a $6,000 total contribution limit.

Deferred compensation means that it isn’t taxed now, but rather is taxed when it is withdrawn, typically as part of an actuarially sound plan after a person reaches retirement age. The tax is paid on the sum withdrawn based on then-current tax rates.

Those who draw upon the resources before reaching age 59½ are subject to premature withdrawal penalties that include an immediate surtax on the sum withdrawn, the indignity of having to also pay income tax on the sum removed, and a prohibition against making further contributions for a period of five years.

Virtually all of the plans that were set up were self-directed, meaning that the owner had the right to designate how the funds were invested. The choice could be a simple bankbook which, back then, was paying 5 percent simple interest, the equities (stock) market, corporate bonds, real estate mortgages, real estate, rare coins – or in fact virtually any asset not otherwise illegal to own.

Wall Street’s dirty little secret is that billions of dollars went into the equities market with the self-directed plan as a source. Buy-ins were cheap – the government was in essence a partner for the marginal tax rate – and there was no capital gains tax (because it is collected only based on distributions).

Now here’s a novel result: the government sets up a system that allows unfettered investment virtually without regulation or taxation, and the equities market grows from a Dow Jones Industrial Average of 1,000 in 1972 to a much higher number that was in the 14,000 range in March 2008 when I locked in the statistics of my book Profitable Coin Collecting (Krause, 2008).

That contrasts to less than 9,000 today, but there has been no particular clamor on the part of Congress or the public to more heavily regulate the stock market or for that matter to protect IRA or Keogh owners against dramatic loss.

TEFRA was genuine tax reform by the Reagan Administration, and substantially reduced the taxes that most Americans paid. It also made a list of prohibited acquisition assets for all self-directed retirement plans.

Reasons cited for the prohibition: the assets weren’t productive, and simply did not help the economy. The underlying rationale: the assets were risky, and people also shouldn’t be able to put a retirement asset in their homes, on their walls, or even be able to enjoy them before they were taxed on the consequences – the ultimate Puritan work ethic.

Now, who would have been the proponent of such a move to prohibit placing collectibles such as oriental rugs, rare coins and scotch whiskey into a retirement plan? Probably not rug manufacturers or antique dealers. Most likely the distilled spirits industry didn’t propose it, either. Hmm ...

Penny stocks and junk bonds that were highly volatile were permissible inclusions in a retirement account – even if it was highly likely that a pensioner would lose his shirt before he saw a profit.

Intelligent people can draw their own conclusions from facts and arguments, and who sponsored the proposal probably doesn’t matter anyway. They left no fingerprints; just a lot of circumstantial evidence.
Practical effect of the ban that took place was an immediate coin market disruption – just as if the government had said that you could no longer buy and sell real estate in your own name and had to only do it corporately.

Prices plummeted, because a major buyer category (those with IRA and Keogh assets) was removed from the marketplace, without warning, and without replacement plans on the drawing board.

(It’s worthwhile noting that non-self-directed plans can and do still include rare coins in their portfolios, but that requires an independent trustee to make the decision, to determine that it is prudent to do so, and to assume full liability if it is not. Some, but not many, are willing to make that choice.

About the only fortuitous result of this is that a National Association of Coin and Precious Metals Dealers was founded to help fight future assaults on the hobby, and later, an Industry Council for Tangible Assets was born to have a permanent Washington presence.

The NAC+PMD organization folded into ICTA a few years later, and since then, the Washington lobbying organization has saved the hobby’s proverbial cookies on more than one occasion, including the attack by the Internal Revenue Service on broker reporting, that at one time threatened with ridiculous paperwork the sale of even a simple silver Roosevelt dime.

By 1986, America had gotten into the business of selling gold and silver to the public, and it occurred to the best and the brightest that the U.S. Mint’s product line had a serious problem in the investment community that sold the bullion coins.

If the vendor made a sale and sold 500 ounces of silver as a bar, it could be kept in an IRA or Keogh account. But if the item purchased was 500 silver American Eagle coins, the inclusion into the IRA or Keogh account would trigger all of the negative provisions of section 408(m) of the Internal Revenue Code.

These included considering the purchase a distribution – making it taxable, with penalties – and prohibiting future additions for a five-year period of time.

Sensing that there was good profit to be made, and that there was not much difference between 500 ounces of brick silver and 500 silver Eagles, there was intense pressure to change the law relative to coins in IRAs.

And so on Oct. 11, 1986, the Tax Reform Act was passed, replete with an obscure provision that allowed Eagles to be placed in self-directed plans.

In 1996, a platinum Eagle was authorized, but for obscure legal reasons, a tax bill had to be prepared to allow its inclusion in self-directed retirement plans. That happened, and as Goldline’s Web site remarked, “The United States government allows both proof and bullion American Eagles to be utilized in IRAs.

Whether you prefer gold, silver, platinum, or a combination, these official U.S. coins can be added to your retirement savings by opening a new IRA account or transferring funds through an IRA “rollover.”
By the early 1990s, ICTA began to form a coalition designed to achieve equity and fairness in the treatment of the rare coin industry, and appears to have finally beaten back the non-productive asset argument. Small wonder.

What stock is ever productive? What stock purchase ever created a job, except in the same way that the sale of a rare coin creates one?

Yet in 2009, even as legislation has again been introduced to change another TEFRA bugaboo – making collectibles part of the 28 percent capital gain rate – there is some increased talk about trying to mount the IRA-Keogh fight to allow self-directed pension money to have a clear cut choice.

There are those who will argue that rare coins have no business in a retirement account; that purchasing silver has proven to be a bad investment, that gold buying is speculative, and that rare coins can’t be accurately valued and are prone to abuse.

The same can be said about stocks and bonds. Take a real blue chip, like IBM.

The graph included with this column takes into account IBM stock’s price performance. It has split three times since 1980; not counting dividends, IBM’s equivalent value per share today (of a share held in 1980) would be over $1,700. Also shown is the value of gold, silver and the Consumer Price Index.

Because I have the data that Dennis Baker’s NumisMedia has so generously supplied, I’ve also included comparisons with the Salomon Brothers coin portfolio using numbers well-published here over the last 20 years.

What it shows, by the way, for these MS-63 collector coins (no gold among them) is that rare coins are still a top investment strategy – and maybe that’s what those who oppose putting them into Keogh and IRAs are afraid of.

All this sort of reminded me about the time that I decided to add American silver Eagles into my retirement account, both as a hedge against inflation, as a strong affirmative statement that coins can be an investment tool, and to practice what I preach.

Silver had its ups and downs and came close to equaling IBM’s performance. – (Coins – the numismatic component not allowed in IRAs – did better).

Will collectibles someday be taxed at a regular capital gains rate? ICTA is trying to persuade Congress of the fairness of this position. But to fully understand what is being advocated, it will help to recall what a capital gain is.

Capital gains are the amount by which an asset’s selling price exceeds its initial purchase price. A realized capital gain is an investment that has been sold at a profit.

An unrealized capital gain is an investment that hasn’t been sold yet but would result in a profit if sold. The IRS change, if effected, would relate strictly to coins and precious metals that are sold.

The tax rates on net capital gains were recently reduced by Congress . Before the law was changed, the maximum tax rate a person paid on their capital gains was 28 percent. This was truly a tax break if your top tax rate was 31 percent or higher, but if you fell into the 15 percent or 28 percent brackets, you received no tax benefit from the maximum capital gains tax rate.

Today, investors can keep more of the profits from the sale of their capital assets. The new rate (for 2010) is 20 percent maximum but not for collectibles. If you end up in the 28 percent or higher tax bracket, the maximum tax rate that will apply to most of your capital gains is now 20 percent. If your tax bracket is 15 percent, the maximum tax rate that will apply to your capital gains is 10 percent.

Therefore, unlike before, taxpayers in all tax brackets will reap the benefits of the lower capital gains tax rates – unless you are placing your investments in collectibles, where the capital gains tax is still locked in at 28 percent.

Prior to 1982, rare coins were considered an investment vehicle, as was the purchase of bullion. It then was exiled to non-preferred status. How non-preferred: Long-term investments in collectibles are taxed at a flat 28 percent. Short-term investments in collectibles are taxed as short-term capital gains at your ordinary income tax rates.

Put in the federal “blue book” in 2005, named for its overview which quantifies federal budget plans, the proposal is called “Simplify taxation of capital gains on collectibles, small business stock and other assets”.

It proposed changes to a long-term old policy of classifying and taxing collectibles differently than other investment assets. Under existing rules, in 2009, taxpayers in the 10 and 15 percent brackets would have qualified for a zero percent tax rate on long-term gains.

According to the budget analysis, “Capital gains are generally taxed at the same rates under the alternative minimum tax (AMT) as under the regular tax. Special rates apply to capital gains on certain small business stock, collectibles, and certain real property.”

Under the Internal Revenue Code of 1986 as amended, “collectibles” include works of art, antiques, stamps and coins, metal or gems, alcoholic beverages, and other tangible personal property defined in Treasury-issued regulations.

Reason given for the change in the budget is that governmental filing requirements are difficult. The message says, “Schedule D and the associated forms and instructions are more complicated than necessary because of the special 25 percent and 28 percent rates that apply in only a small fraction of cases.”

The government is obviously concerned with how you spend your time accounting for tax dollars that need to be paid. “For example, the 28 percent rate requires an extra column on Schedule D and two worksheets of 51 and 7 lines, but affects only about 1 percent of taxpayers with capital gains (about 240,000 taxpayers).”

There are also complicated rules for calculating how these provisions interact with other capital gains and losses in particular cases. The report continues, “Eliminating the 25 and 28 percent special rates would simplify capital gains forms and calculations. About one in five taxpayers (more than 20 million) report capital gain or loss in a given year, and more than twice as many taxpayers report.”

Provisions of the 1982 TEFRA law affecting collectibles were added in a midnight conference, without public hearing, which is certainly legal and perhaps not even unusual – but it took the coin industry by surprise.

I was at an ANA convention when we learned that Congress was considering this legislation and, in that pre-cell phone era, stood off the convention floor dictating telegrams to the Western Union operator that eventually cost over $3,000 to have delivered – even though it was after a key vote.

ICTA has lobbied for more than 25 years to right the wrongs of TEFRA, including the taxation of collectibles – and has since found friends in powerful places. Before too long, it may well be up for consideration to change the rate of capital gain tax on collectibles, and to also allow collectibles – coins in particular – back in self-directed plans.

Whether that finally yields results will be up to the tax-writing committees of Congress. And to their constituents who care enough to write their members of Congress asking for help righting a wrong of a generation ago.