TAX ACT 2003
WHAT IS IT ALL ABOUT
Some Real
Planning Pitfalls in New Tax Law
The "Jobs and Growth Tax Relief
Reconciliation Act of 2003" was signed into law on May 28, 2003. The Act
comes in at about 20 pages, and several of its more expensive provisions do
not have much planning potential, like a 2% rate cut, or a child credit or
marriage penalty relief for which you either qualify or you don't .
CAPITAL TRANSACTION AND DIVIDENDS
-
The
new Act taxes both dividends and capital gains at the same rate, and
deferral becomes less compelling at lower rates. Also, with low capital
gains rates, one might choose to take gains currently in case there is a
change in the rates with a change in politics, the
economy,
or other circumstances.
PLANNING OPPORTUNITIES
-
With low capital gains rates scheduled to increase again in 2009,
consider timing of capital gains.
-
Consider section 83 election to achieve capital gains on stock options.
-
Long-term capital gains on sales and exchanges after May 5, 2003 are
taxed at lower rates, so the one-year holding period becomes even more
important.
OTHER EFFECTED ITEMS
The reduction in the tax rate on dividends and capital gains might cause
one to rethink efforts to
shelter long- term investments from tax within a Roth I RA, a tax sheltered
annuity, or Section 529 plan to take advantage of tax-free appreciation.
These are taxed at very low rates outside these shelters, and the taxpayer
avoids administrative costs, has greater freedom to choose investments, and
has greater access to capital.
- Payments on installment sales
completed before enactment will receive the benefit of lower capital gains
rates, but installment sales should be structured with an eye towards
increases in capital gains rates, currently scheduled for 2009.
- Income investments should be
weighted more towards dividends, such as from preferred stock, to take
advantage of lower tax rates on dividends than on interest.
- Investment in tax exempt bonds
will be much less attractive with the increase in after-tax yields on
taxable investments This changes planning for both taxpayers and issuers of
exempt bonds.
LARGE
CAPITAL EXPENDITURES
- Small business capital
expenditures should be planned to use the more generous and available
Section 179 deduction for property placed in service during 2003, 2004, and
2005.
- The limit on first year
depreciation for "luxury" cars has increased substantially, reducing the
disincentive to purchase such cars.
- Section 179 expensing is
increased to a maximum of $100 ,000 and the level at which phase-outs of
expensing rises from $200,000 to $400,000. This allows a quick recovery of
capital from now until 2006, with proper planning.
Lack
of state tax conformity
with new Federal rules on bonus depreciation and Section 179 expensing may cause complexity for
taxpayers and practitioners, and extreme complexity for multi-state
businesses.
FOR
THE CHILDREN
-Tax planning for children's
income could be more lucrative and complex, with a broadening of the lower
rate brackets and lower taxes on dividends and capital gains. However,
remember the "kiddie tax" and college financial aid limitations.
THE
ALTERNATIVE MINIMUM TAX
- The individual AMT exemption
amount is increased for this year and next, making it easier for some to
avoid the AMT and allowing some escape altogether from AMT by structuring
transactions with AMT consequences within this time frame before 2005.
- Generally, fewer individual
taxpayers will be subject to AMT because of increase in exemption amount.
Although this is partially
countered by regular rate reductions, many of the tax benefits for the new
act (e.g., dividends and capital gains) are provided for both regular
and AMT purposes.
PLANNING
OPPORTUNITIES
- Adjust withholding and
estimated tax payments to the lower tax rates for 2003.
- Defer 25% of the September 15
corporate estimated tax payment until October 1.
OUTLINE OF JOBS AND GROWTH TAX RELIEF RECONCILIATION ACT OF 2003
I.
CHILD TAX CREDIT
A. The child tax credit was
increased for current year from $600 to $1,000, with the increased amount to
be paid in advance, beginning in July. Advance payment will only be sent to
those who filed tax returns last year showing a qualifying child, but if
credit is not received in advance, it can be claimed as a credit on the 2003
return.
Advance payment is intended to
inject cash into economy as a stimulus as well as to provide help for
families.
B. The credit will be built into
withholding tables for 2004
C. After 2004, prior law
applies, reducing credit to $700, with phased increases in future years,
back to $1,000 in 2010 then back to $500 for 2011, so timing is everything!
Fluctuations seem arbitrary to taxpayers, but are based on budgetary
constraints for the tax reductions.
II.
MARRIAGE PENALTY RELIEF
A. The standard deduction for
married taxpayers filing joint I returns is twice that of the standard
deduction for single individuals for 2003 and 2004. Beginning in 2005, prior
law is scheduled to return, which starts at 174 percent of standard
deduction for individuals, ramps up to twice standard deduction again in
2010, and then relief is eliminated in 2011 for budgetary constraints
imposed when 2001 Tax Act originally enacted this relief.
B. Size of the 15% regular
income tax rate bracket for married couples filing joint returns is
increased to twice size of the 15% bracket for single individuals for 2003
and 2004 in an acceleration of prior enacted rate relief for married
couples. Beginning in 2005, prior law is scheduled to return, which starts
at 1.8 times the size of the 15% bracket for single individuals, ramps up to
twice the size again, and then is eliminated in 2011 for budgetary reasons.
III.
INDIVIDUAL INCOME TAX RATE REDUCTIONS
A. This is third tax reduction
since 2001, including Economic Growth and Tax Relief Reconciliation Act of
2001 with 10 years of rate cuts for individuals and Job Creation and Worker
Assistance Act of 2002 which give specific tax benefits for businesses. The
new Act accelerates some of the previously enacted rate cuts.
B. For 2003, the income levels
for the 10% regular income tax rate rise from $6,000 to $7,000 for single
individuals and from $12,000 to $14,000 for married filing jointly. For
2004, ceiling for this rate bracket is indexed, and for 2005, it is
scheduled to revert back to $6,000 and $12,000, increasing again in 2008 to
$7 ,000 and $14,000 and then indexed for inflation.
C. Other rates are reduced as
well, from 38.6% to 35%; from 35% to 33%; from 30% to 28%; and from 27% to
25%. Generally, while these rate reductions, coupled with broadening of the
10% bracket, will reduce tax burden nicely, they are not dramatic enough to
trigger any tax planning of shifting income or deductions.
D. Rate reductions are
retroactive to January l' 2003, and withholding tables will be adjusted for
remainder of the year to increase paychecks and provide a cash stimulus to
the economy.
IV.
INDIVIDUAL ALTERNATIVE MINIMUM TAX EXEMPTION AMOUNTS
A. Individual alternative
minimum tax exemption amount increases from $49,000 to $58,000 for married
taxpayers filing joint returns and surviving spouses and from $35,750 to
$40,250 for unmarried taxpayers for 2003 and 2004.
B. The increased exemption
amount should reduce the number of taxpayers with AMT liability, with other
reductions in this bill generally applying to regular and alternative
minimum tax, including child credit, capital gains, and dividends (see
below).
V.
INCREASE AND EXTENSION OF BONUS DEPRECIATION
A. For property that would
qualify for the 30% additional first-year depreciation under job creation
and workers Assistance Act of 2002 the first year bonus depreciation rate is
increased to 50% of adjusted basis. (The 50% is in lieu of 30%, not
in addition to it.)
B. This generally applies to
property acquired after May 5, 2003 and placed in service before January 1,
2005 (January l, 2006 for long-term production property).
C. For "luxury automobiles",
limit on first year depreciation is increased from $4,600 to $9,200 (an
amount that is not indexed), but bonus depreciation is not available where
auto is not used more than 50% for business purposes.
D. To provide an incentive for
further investments and to prevent a mere windfall for previously agreed
purchases, property will not qualify if there was a binding written contract
for acquisition before May 6, 2003.
E. The basis of the property for
further depreciation will be reduced by bonus depreciation amount.
F. Bonus depreciation is
deductible for both regular and alternative minimum tax.
VI.
SECTION 179 EXPENSING
A. Maximum amount that can be
expensed under Section 179 is increased to $100,000 for property placed in
service in 2003, 2004, and 2005. This amount will be indexed for inflation
after 2003.
B. The amount of property placed
in service before Section 179 begins to phase out is increased from
$200,000 to $400,000.
C. The election to expense may
be revoked by the taxpayer on an amended return, without permission from the
Commissioner. However, once revoked, the taxpayer cannot change back again.
VII.
CAPITAL COST RECOVERY GENERALLY
A. The new Act provides
enhancements in recovering capital costs, and depending on the amounts
involved, taxpayers could use more than one of the benefits.
B. Generally, the taxpayer would
first take the Section 179 deduction, then bonus depreciation on the
remaining cost, and finally regular depreciation on any remaining cost.
VIII.
CAPITAL GAINS TAX REDUCTION
A. The 20 percent rate on net
capital gains is reduced to 15 percent. For those in the 10 and 15 percent
rate brackets, the capital gain rate is reduced to 5 percent now and to zero
in 2008.
B. This applies to sales and
exchanges after May 5, 2003, and before January 1, 2009.
C. The lower capital gain rate
is used for computing both regular tax and alternative minimum tax.
IX.
DIVIDEND TAX REDUCTIONS
A. For individual taxpayers, the
Act provides that dividends will be taxed at the same rate as capital gains,
thus 15 percent for most taxpayers, and 5 percent for those in the 10 and 15
percent rate brackets, with the lower income brackets enjoying tax-free
dividends in 2008.
B. The reduced rates apply for
tax years 2003 through 2008. (The dividend rate applies to dividends
received beginning on January 1, 2003.
C. The reduced rates apply for
regular and alternative minimum tax purposes.
D. Dividends from domestic
corporations and qualified foreign corporations qualify for this favorable
treatment. Qualified foreign corporations are those incorporated in a U.S.
possession and those eligible for benefits of a comprehensive income tax
treaty with the U.S. and having an adequate exchange of information program
with the U.S. The foreign corporation's stock must also be readily tradable
on U.S. securities markets, and must not be a foreign personal holding
company, a foreign investment company, or a passive foreign investment
company.
E. There are special rules with
respect to extraordinary dividends and dividends from RICs or REITs.
X.
CORPORATE ESTIMATED TAXES
A. For the corporate estimated
tax payment that is due on September 15, 2003, 25% of the payment amount is
not due until October 1. 2003.
B. This is another example of
budgetary constraints on taxes, with no other purpose than to shift a
specific portion of the payment into the next Federal government fiscal
year.
XI.
STATE TAX CONFORMITY NIGHTMARE
A. Bonus tax depreciation and
direct expensing will be expensive for states that conform to the Federal
tax law in taxing asset cost recovery, but if they do not conform, their
taxpayers will face significant complexity. Some states have already enacted
conformity and others that are still in session could do so. Some who have
completed their session could come back in special session to enact
conformity. On the other side, although the Act contains $20 billion in
direct state aid, some states may choose not to conform, even to the point
of calling a special legislative session to decouple and avoid the lost
revenue for their tight state budgets.
B. The differences between
Federal and state rules will require separate records and calculations for
the life of the property acquired.
C. For multi-state corporations,
the variety of methods of accounting for cost recovery could be an
accounting
and tax
compliance nightmare.
