Newsletter

On May 23rd, Congress narrowly passed the third significant tax bill of the Bush presidency. This one is called the Jobs and Growth Tax Relief Reconciliation Act of 2003. The new law has nothing but good news for taxpayers because there are absolutely no “revenue raisers” (better known as tax increases) included in the package. In addition, some of the most favorable and important changes are retroactive to January 1st of this year. As you will see, the people who will be happiest about the new law are married couples with children under age 17, investors, high-income individuals, and small business owners. That said, almost everyone will find something to like in the 2003 Act.

Now for the inevitable qualifier: in order to placate certain members of Congress, all the favorable changes are subject to so-called sunset rules. So, all the breaks will expire in future years unless Congress takes further action. With that thought in mind, here’s the story on the new tax law and what it means for you.

Changes That Help Almost Everybody

Future Rate Cuts Accelerated Into 2003. Perhaps most importantly, the individual income tax rate cuts that were included in the 2001 tax legislation but delayed until 2004 and 2006 are accelerated into 2003 by the new law. (When it comes to rate cuts, sooner is definitely better than later.) It’s as if you woke up on January 1st with lower tax rates. (It’s not just a dream; it really happened!) Salaried employees will find their paychecks are increased when new tax withholding tables take effect this summer. Now let’s get specific. Here are the rate reductions:

The existing 10% and 15% rates remain unchanged. Furthermore, under a sunset rule, your rates will return to the pre-2001 Tax Act rates of 15%, 28%, 31%, 36% and 39.6% after 2010 unless Congress takes further action. The 10% rate would disappear entirely with 15% becoming the lowest rate.

Bigger 10% Bracket for Most Folks. In another favorable change, the new law widens the 10% rate bracket effective back to January 1st. The 10% bracket is expanded by $2,000 for married individuals who file jointly ($0 to $14,000 versus $0 to $12,000 under prior law). The bracket now is $1,000 wider for single filers and married individuals who file separately from their spouses ($0 to $7,000 versus $0 to $6,000 before). This means a bit more of your income will be taxed at the lowest 10% rate. However, this break was not extended to those who use head of household filing status (the 10% bracket continues to covers the first $10,000 of taxable income as before.)

Unless Congress takes further action, these expansions of the 10% rate bracket will expire after 2004.

Major Relief for Married Taxpayers (Finally). The unfairness of the “marriage penalty” has been a constant tax topic for many years. It just doesn’t seem quite right that getting married in and of itself can actually cause a higher federal income tax bill for the newly wedded pair. We have good news on this issue. While the 2003 Act doesn’t completely eliminate the problem, it nevertheless delivers significant relief to joint filers. It also helps married persons who file separately from their spouses. Here are the specifics:

• Thanks to the new law, the 15% bracket for those who file jointly is now twice as wide as the 15% bracket for single filers. This means the 15% bracket for joint filers now extends to taxable income of $56,800 (up from the old-law figure of $47,450).
• The standard deduction for joint filers has been made bigger too. It’s now $9,500, which is exactly double the amount for single filers (up from $7,950 under prior law).
• The 15% bracket for married filing separate status is now the same as for single filers. So, the 15% bracket now extends to taxable income of $28,400 (versus only $23,725 under prior law).
• Finally, the standard deduction for married filing separate status is now $4,750, which is the same as for single filers (under prior law it was only $3,975). Under yet another sunset rule, all these favorable changes will last only for 2003 and 2004 unless Congress takes further action.

Our New and Improved 2003 Federal Income Tax Rate Structure. This table includes all the taxpayer-friendly new rules we’ve covered so far.

Child Credit “Kicked up a Notch” to $1,000. For 2003 and 2004, the tax credit for each under-age-17 dependent child, stepchild, foster child, or grandchild is raised to $1,000 (up from only $600 for 2002). As under prior law, the credit is still subject to phase-out beginning at adjusted gross income of $110,000 for joint filers, or $75,000 for unmarried individuals.

If you are eligible for the credit, expect a tax rebate check from the government this summer (probably in July or August). Based on information in your 2002 tax return, you’ll automatically receive up to $400 for each child for whom you claims a credit last year (assuming the child is still under 17 as of the end of this year). However, if you have a qualifying child born this year, you’ll have to wait and claim the credit when you file your 2003 return next year (no automatic rebate check for you). One more thing: if you haven’t yet filed your 2002 return, please get right on it. You won’t receive the automatic rebate check until you file your 2002 return.

Now for the sunset rule: unless Congress acts, the $1,000 child tax credit will fall back to only $700 in 2005.

Alternative Minimum Tax Relief. For 2003 and 2004, the alternative minimum tax (AMT) exemption for joint filers goes up by $9,000 (to $58,000 versus only $49,000 under prior law). For singles and heads of households, the exemption rises by $4,500 (to $40,250, up from $35,750). For those who use married filing separate status, the exemption also increases by $4,500 (to $29,000 compared to the old-law figure of $24,500). These more-generous exemption amounts are supposed to prevent all of your advertised tax savings from being consumed by the AMT.

However, unless Congress takes further action, the exemptions for 2005 and later years will fall back to only $45,000, $33,750 and $22,500 respectively. Not good.

Great News If You Invest in Taxable Accounts

Dividends Now Taxed at Only 15% (Maybe Less). As long as anyone can remember, dividends paid on stocks held in taxable accounts were taxed as “ordinary income”. So, you paid your “regular” federal rate, which could be as high as 35% under the new law (down from 38.6% in 2002). Things have changed big time here.

• For all of 2003 through the bitter end of 2008, your qualified dividends from domestic corporations and qualified foreign corporations will be taxed at no more than 15% (the same as the new maximum rate on most long-term capital gains).
• If you happen to be in the 10% or 15% rate bracket (see the new rate table presented earlier in this letter), your dividends will be taxed at only 5%. (For 2008, your rate will be an unbeatable zero percent, but just for that single year.) Naturally, there’s a catch, but it’s not too bad. To be eligible for the new, drastically reduced rates on qualified dividend income, you must hold the stock on which the dividends are paid for more than 60 days during the 120-day period that begins 60 days before the ex-dividend date (the last date on which shareholders of record are entitled to receive the upcoming dividend). If you fail this test, your dividends are taxed at your regular rate (up to 35%). Also, a slightly longer holding period applies to preferred stock.

Observation: Unfortunately, this change doesn’t help a bit for dividends received by tax-deferred retirement accounts (such as 401(k), SEP, Keogh, and traditional IRAs). Dividends that you accumulate in these tax-deferred accounts will still be taxed at your regular rate (up to 35%) when withdrawn as cash distributions. (As before, dividends accumulated in Roth IRAs can be withdrawn tax-free if you meet certain guidelines.)

Needless to say, the dividend break has a sunset rule too. Unless Congress acts, dividends received in 2009 and beyond will once again be taxed at your regular rate.

Ditto for Long-term Capital Gains. We have more good news. If you invest in securities via taxable accounts, your long-term capital gains from sales after May 5, 2003 will be taxed at no more than 15% (down from 20% under prior law). Those in the 10% or 15% rate brackets will pay only 5% on long-term gains from sales after the magic date (in 2008, the rate will be zero percent, but just for that one year). These same much-reduced rates also apply to the long-term capital gain component of installment sale payments you receive after May 5th of this year. So far, so very good. However, the rates for certain types of gains were not reduced by the 2003 Act.

• A maximum rate of 25% remains in effect for long-term real estate gains attributable to depreciation deductions claimed against your property (?unrecaptured Section 1250 gains?).
• A maximum rate of 28% remains for long-term gains from sales of collectibles and certain small business stock.
• Finally, long-term capital gains from sales that occurred before May 6 of this year will be taxed at the old-law rates (20% maximum rate for gains in the higher brackets, 10% maximum rate for gains within the 10% and 15% brackets, 8% for five-year gains within the 10% and 15% brackets).

Observation: The new, lower capital gains rates don’t apply to investments held in tax-deferred retirement accounts (such as 401(k), SEP, Keogh, and traditional IRAs). Gains that you accumulate in these tax-deferred accounts will still be taxed at your regular rate (up to 35%) when withdrawn as cash distributions. (As before, gains accumulated in Roth IRAs can be withdrawn tax-free if you meet certain guidelines.)

One more thing: unless Congress acts, long-term capital gains will once again be taxed under the “old rules” in 2009 and beyond.

Great News for Small Business Owners, Too

Huge Increase in Annual Section 179 Allowance. If you own a small business, the very best part of the new law from your perspective may be the huge increase in the Section 179 first-year depreciation break. Under the much-loved Section 179 rule, you can generally instantly deduct 100% of the cost of most new and used personal property (non-real estate) assets in the year you place them in service. Until the new law, however, this year’s Section 179 deduction was limited to $25,000. That was then. You can now deduct up to $100,000 for tax years beginning in 2003, 2004 and 2005 (subject to a taxable income limitation and another limitation if you add over $400,000 of qualifying assets during the same tax year).

Bottom line: Many small businesses can now deduct the entire cost of all equipment additions in the first year. No more complicated multi-year tax depreciation schedules! (Nobody is going to miss those things.)

The 2003 Act also makes most computer software eligible for the Section 179 deduction, which means you can deduct the whole cost in the year of purchase. (Under prior law, you generally had to depreciate software costs over 36 months.)

What about the sunset rule you ask? Good question. The favorable Section 179 changes will cease to exist after 2005 unless Congress acts. So if nothing happens, the Section 179 allowance will fall back to only $25,000 for tax years beginning in 2006 and beyond.

Bigger and Better Bonus Depreciation Break. Last year’s tax legislation introduced a new first-year bonus depreciation deduction equal to 30% of the cost of new (but not used) assets with a normal depreciation recovery period of 20 years or less. The 2003 Act takes the bonus depreciation idea and makes it bigger and better.

For qualifying assets acquired after May 5, 2003 and before 2005 (and placed in service before 2005, or 2006 for certain assets with long production periods), you can deduct a whopping 50% of cost in the first year. Wow! This break is available regardless of the size of your business. Qualifying assets acquired before May 6th of this year are still eligible for 30% first-year bonus depreciation.

Under a sunset rule, however, the bonus depreciation rule will vanish after 2004 unless Congress takes further action.

More Bonus Depreciation for Business Autos, Too. If you use a car for business purposes, you are no doubt aware of the incredibly unfavorable depreciation rules. Until now, the maximum first-year depreciation write-off for a new (not used) vehicle placed in service this year was a paltry $7,660. Thanks to the new 50% bonus depreciation break, you can deduct up to $10,710 worth of first-year depreciation for new (not used) vehicles acquired after May 5th of this year. For new autos acquired this year but before May 6th, the maximum first-year depreciation deduction is still only $7,660 (under the 30% bonus depreciation rule). For used vehicles placed in service at any time this year, the maximum first-year depreciation deduction remains at only $3,060.

Micro-break on Corporate Estimated Tax Payments. Corporations qualify for a break on this year’s estimated tax payments. Specifically, 25% of the installment otherwise due in September can be postponed until October 1st without penalty. Please hold your wild applause! Still, it’s better than nothing.