The Always Exciting Topic of Capital Gains Taxes

Projo business columnist Neil Downing points out that Rhode Island’s capital gains tax debate tends to get over-simplified to the point of inaccuracy. The oft-discussed phaseout (that the House has voted to delay this year) applies only to long-term capital gains, i.e. profits made from selling assets held for five or more years. Tax rates on the sales of assets held for periods shorter than 5 years are not changing at all. Downing summarizes the rules…

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....

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 of 5 percent if you’re an upper-income taxpayer, 2.5 percent if you’re a lower-income taxpayer....

Long-Term: If you’ve held the asset for more than five years, you currently 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 long-term rates will drop to zero starting in January, said Peter L. Chatellier, president-elect of the Rhode Island Society of Certified Public Accountants.

But the other capital-gains tax rates won’t change, said Chatellier, partner in Braver P.C., a regional accounting firm with an office in Providence.

A 2001 report from the Rhode Island Economic Policy Council offered this rationale for eliminating the long-term capital gains tax...

Capital gains tax relief is the single most important tax reform initiative before the General Assembly during this session – critical to the development of clusters of new economy industries, many of which rely on stock options to create competitive compensation packages. Phase-out of the tax would help the state begin to build a critical mass of the entrepreneurs and investors who serve as magnets for new economy business development, and increase our competitiveness within the Boston Metro – while benefiting a wide spectrum of Rhode Islanders across industries and income levels as the demographics of investment continue to expand.

...and, according to the 2006 Business Incentives Report from the Rhode Island Economic Development Corporation, Rhode Island already offers a complete capital gains exemption for stock options in specific industries...

Rhode Island grants complete personal income tax exemption for capital gains or ordinary income that result from the sale, transfer, or exercise of qualified or non-qualified stock or options for employees in software industries (defined by SIC codes 7371, 7372, 7373).

If it works for one industry, why shouldn't it work for others? Why not extend the captial gains exclusion to all industries (by eliminating the tax on long-term captial gains) and make RI a more attractive place for any small company that wants to locate here and stay awhile?