After months of political debate, Congress has passed the "Jobs and Growth Tax Relief Reconciliation Act of 2003"-- its third major tax cut package in three years. President Bush signed the legislation on May 28, 2003. This tax relief package, touted as the third-largest tax cut in U.S. history, provides tax relief to virtually every person who pays federal income tax. For individuals, the 2003 Act accelerates previously-scheduled income tax rate reductions to January 1, 2003. Low-income and middle-income taxpayers who have children, not only benefit from these rate reductions, but also benefit from an increase in the child credit which is also retroactive to January 1, 2003. In fact, if you qualified for the child credit on your 2002 return, you may receive an IRS tax rebate check of up to $400 for each qualifying child as early as this July.
Businesses that buy depreciable property are provided substantial tax relief with the new law's quadrupling of the immediate write-off allowance for qualified property, and the substantial increase in the first-year bonus depreciation deduction. If you are an investor, you may reap significant tax benefits from the lowering of the capital gains rate from 20% to 15%, and the reduction of the tax rate on dividends from 38.6% to 15%.
To help you take maximum advantage of this new law, this letter summarizes the changes made by the Jobs and Growth Tax Relief Reconciliation Act of 2003.
This tax legislation contains a roller coaster of effective dates. Few of the items contained in the 2003 Act are permanent. Consequently, timing is critical to ensure we take advantage of the many new tax benefits. As you read this letter, please pay special attention to the effective dates which change from one provision to another. To help you, we have highlighted the effective dates of each provision discussed. Furthermore, we offer planning ideas throughout this letter. However, you cannot properly evaluate a particular planning strategy without calculating your overall tax liability (including the alternative minimum tax) with and without the strategy. Please be careful! Call us before adopting any tax planning recommendation.
This letter is intended to be a summary of the 2003 Act provisions that we believe affect the largest number of our clients. Accordingly, we do not address every change made by the Act. If you are interested in a tax change that is not addressed here, or if you want more information on topics not discussed in this letter, please call our office. Also, most states have not adopted the provisions of the Jobs and Growth Tax Relief Reconciliation Act of 2003. So, state income tax implications of these changes are uncertain at this time.
At this point, the primary information we have regarding these new tax provisions is the statutory language of the 2003 Tax Act and the Congressional Committee Reports. Our interpretations of these new rules are based primarily upon the information contained in those two documents. Additional clarifications will be issued later by the IRS in the form of regulations and other official pronouncements. Our firm will monitor these future developments.
More Income Taxed at 10% Effective January 1, 2003. Retroactive to January 1, 2003, the new law increases the amount of income taxed at 10% to $7,000 of taxable income for single filers (a maximum savings of $50) and $14,000 for joint filers (a maximum savings of $100). For heads of households, the 10% tax bracket was not changed and continues to apply to the first $10,000 of taxable income. Planning Alert! The new expanded 10% tax bracket for joint and single filers only applies for 2003 and 2004. For 2005 through 2007, the 10% bracket reverts back to its original levels. In 2008, it will again return to $7,000 for single taxpayers and $14,000 for joint filers. The 10% rate does not apply at all to trusts or estates. The following is a summary of the modifications to the 10% bracket:
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| 2002 |
2003-2004 |
2005-2007 |
2008-2010 |
After 2010 | Size of 10% | Bracket: Joint - |
Single - |
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Acceleration of Rate Reductions to January 1, 2003. The new law accelerates individual marginal tax rate cuts that were, previously, scheduled to be fully effective in 2006. Effective January 1, 2003, the top four tax rates are reduced to 25%, 28%, 33%, and 35% (down from 27%, 30%, 35%, and 38.6%). For income taxed in the highest bracket, this is a 3.6% rate decrease. For income taxed in the 27%-35% tax brackets, it is a 2% rate decrease. However, due to the sunset provisions of the 2001 Act, these new rates will increase to 28%, 31%, 36%, and 39.6% after 2010. Tax Tip. By mid June, the IRS is expected to mail updated wage withholding tables to employers that reflect these tax rate cuts. The revised tables are available now at the IRS website (www.irs.gov). Planning Alert! Certain itemized deductions and personal exemptions are reduced as your adjusted gross income exceeds certain thresholds. Therefore, your "effective tax rate" is usually greater than these "official rates." Caution! Even though the tax rates for 2003 have been reduced, if your total tax liability for 2003 is greater than your total liability for 2002 (e.g., because your income is up or your deductions are down), you may wish to ask your employer not to change your withholding. Reducing your withholding without careful planning, could result in an underpayment penalty. If we worked with you to establish the amount of your 2003 withholding, please have your employer continue withholding the amounts we suggested until you talk with us! The following is a summary of the changes in the tax rates for individuals:
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| 2002 |
2003-2010 |
After 2010 | Top Bracket |
Fifth Bracket |
Fourth Bracket |
Third Bracket |
Second Bracket |
Initial Bracket |
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Alternative Minimum Tax Exemption Increased. We actually have two tax systems. The regular tax system and the alternative minimum tax system (AMT). Your tax is calculated under each system and you pay the higher amount. The AMT was originally enacted so individuals who reduced their taxes with aggressive deductions (e.g., tax shelter deductions, accelerated depreciation, etc.) would pay some "minimum tax." However, each year the number of individuals paying the AMT increases. One reason more people are paying the AMT is that income levels are increasing, but, the amount of income exempt from the AMT has not increased significantly. For years beginning in 2003 and 2004, the AMT exemption amount is increased from $49,000 to $58,000 for married taxpayers, and from $35,750 to $40,250 for single taxpayers. Planning Alert! These increased exemption amounts do not solve the alternative minimum tax problem. However, they provide a small amount of relief. The following is a summary of the AMT exemption amounts:
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| 2002 |
2003-2004 |
After 2004 | AMT Exemption | Joint Returns |
Single Returns |
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Child Tax Credit Increased. For 2002, you were allowed a $600 tax credit for each child under age 17 and the credit was reduced if your "modified adjusted gross income" on a joint return exceeded $110,000 ($75,000 if single). Starting in 2005, this $600 credit was scheduled to increase until it reached $1,000 in 2010. For 2003 and 2004, the new law increases the child tax credit to $1,000. Planning Alert! The new law does not change the income phase-out levels. Also, the credit will be reduced after 2004, but will again reach $1,000 in 2010. Tax Tip. Remember, you may be entitled to a refund of your child credit even if the credit exceeds your federal income tax liability. For 2003, you may receive a refundable credit to the extent of 10% of your "earned income" in excess of $10,500. The following summarizes the amount of the child tax credit:
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| 2002 |
2003-2004 |
2005-2008 |
2009 |
2010 |
After 2010 | Child Credit |
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Marriage Penalty Relief. If you are married and file a joint return with your spouse, you may be paying more income tax than the total you and your spouse would pay if you were each single. This so-called "marriage penalty" generally occurs when each spouse has significant income. Sometimes, this penalty makes it advantageous for engaged couples (both of whom have significant income) to postpone November or December weddings until January of the following year to save taxes. The new law reduces the tax penalty for marriage by increasing the standard deduction and the size of the 15% tax bracket on a joint return.
Additional First Year Depreciation Increased from 30% to 50%. In 2002, in order to stimulate purchases of business assets other than real estate, Congress enacted a new first-year 30% additional depreciation deduction for the cost of "qualified property" purchased after September 10, 2001 and before September 11, 2004. This additional depreciation deduction is allowed for both regular and alternative minimum tax purposes. Under the 2003 Act, this first-year depreciation deduction is increased to 50% for qualifying property acquired after May 5, 2003 and before January 1, 2005. Planning Alert! Even if you acquire the property after May 5, 2003, it will not qualify for the 50% deduction if the purchase was pursuant to a binding written contract in effect before May 6, 2003 (although it may qualify for the 30% bonus depreciation).
This 50% bonus depreciation deduction is, instead of, not in addition to, the 30% deduction. Planning Alert! To qualify for this deduction, you must satisfy various requirements summarized below.
Qualifying Property. Like the 30% deduction, the 50% deduction generally applies only to MACRS property that has a MACRS depreciation period of 20 years or less. The following is a partial list of the types of property that could qualify for this deduction:
"Used Property" Generally Does Not Qualify for the Bonus Depreciation. You will qualify for the additional 50% depreciation deduction only if your business is the first taxpayer to actually use the qualified property. If your business purchases "used property," it will generally not qualify for the 50% (or 30%) deduction. Moreover, "factory reconditioned" or "rebuilt" machinery or equipment will not qualify for the deduction. Tax Tip. If your business incurs capital expenditures to recondition, rebuild, or refurbish qualifying property it acquires (or already owns), the capital expenditures will qualify for the new 50% deduction.
Example. Let's say that on June 1, 2003, your business purchased $20,000 of used equipment. You then incur a $5,000 capitalized expenditure to recondition the equipment. The original $20,000 purchase price would not qualify for the additional first year depreciation, but the $5,000 capitalized expenditure should qualify. Planning Alert! Special rules apply if your business participates in certain sale-leaseback arrangements of otherwise qualified property.
You May "Elect Out" of the 50% First Year Depreciation. If a business purchases qualifying property, it has the option to elect out of the additional first year depreciation altogether (or it may opt for the 30% depreciation deduction rather than the 50% deduction). These elections may be made for any class of property for any taxable year. Tax Tip. In certain situations, you might decide to elect out of this 50% deduction if you determine you will get a greater tax benefit by deferring depreciation deductions to later years using regular MACRS depreciation. For example, your business might anticipate paying tax at a much higher rate in later years and decide to defer the depreciation deductions by forgoing all additional first year depreciation or by selecting the 30% rather than the 50% deduction. Planning Alert! Careful calculations should be made before deciding to elect out of the new additional first year depreciation. For example, electing out of both the 30% and the 50% additional depreciation deductions, may have alternative minimum tax consequences.
Like-kind Exchanges and Involuntary Conversions. The 2003 Act Committee Reports clarify that the entire depreciable basis of qualifying property acquired in a like-kind exchange or an involuntary conversion qualifies for the first year 30% or 50% depreciation deduction. IRS had indicated that the 30% deduction only applied to the "boot" paid to acquire the new asset. If you failed to take this deduction, please call our office and we will help you determine whether you can take the deduction on an amended return, or by applying for a change in accounting method.
Additional First Year Depreciation on Passenger Automobiles. The maximum annual depreciation for passenger automobiles used in a business is capped at certain dollar amounts. For example, for 2001 and 2002, the maximum first year depreciation on a business automobile was originally capped at $3,060. Under last year's tax legislation, for passenger automobiles purchased after September 10, 2001, the first year depreciation cap was increased by $4,600 if the additional 30% depreciation was taken for the auto. Consequently, the maximum first year depreciation on a qualifying passenger automobile placed in service after September 10, 2001 was $7,660 ($3,060 plus $4,600). Under the 2003 Act, for business automobiles purchased after May 5, 2003 and before January 1, 2005, and for which the 50% bonus depreciation is taken, the first-year depreciation limitation is increased by $7,650 (rather than $4,600). Therefore, the 2003 depreciation limit for these automobiles is $10,710. For qualifying electric vehicles, the first year depreciation cap is increased to $32,130. Tax Tip. Trucks and vans used in a business are exempt from these "passenger auto" depreciation limitations if the "gross vehicle weight" exceeds 6,000 pounds (e.g., a full size pickup; a full size van; or a sport utility vehicle, including an: Expedition, Range Rover, Tahoe, Durango, Suburban, etc.). These vehicles may qualify for the full §179 deduction (discussed below), the increased 50% first year depreciation deduction, and the regular MACRS depreciation deduction.
§179 Deduction Increased to $100,000. For 2002, you could take an up-front deduction of up to $24,000 for the cost of qualifying §179 property (e.g., machinery, equipment, furniture, fixtures, etc.). This deduction was phased out dollar for dollar to the extent the total purchases of §179 property exceeded $200,000 for the year. For tax years beginning in 2003, 2004, and 2005, the 2003 Act increases the §179 deduction to $100,000 (and the phase-out level begins at $400,000, not $200,000). The deduction will be reduced to $25,000 for tax years beginning after 2005.
The following are several observations about the §179 deduction:
Personal Holding Company Tax Reduced from 38.6% to 15%. If more than 50% of a regular, C corporation is owned by five or fewer individuals during the last half of the tax year, the corporation could be subject to a "personal holding company" penalty tax (in addition to the regular corporate tax) if the company has excessive personal holding company income. There is excessive personal holding company income if 60% or more of its ordinary adjusted gross income is from interest, dividends, specified levels of rents, royalties, or income from certain personal service contracts. Effective for tax years beginning after 2002 and before January 1, 2009, the 2003 Act reduces the personal holding company tax rate on personal holding company (PHC) income from 38.6% to 15%.
Accumulated Earnings Tax Reduced from 38.6% to 15%. If a regular, C corporation has accumulated earnings exceeding its reasonable business needs, it could be subject to a corporate accumulated earnings penalty tax, in addition to the regular corporate tax. However, a corporation can generally accumulate $250,000 ($150,000 for personal service corporations) of earnings before this penalty tax is triggered. Effective for tax years beginning after 2002 and before January 1, 2009, the Act reduces the accumulated earnings tax rate from 38.6% to 15%. Tax Tip. Your corporation can accumulate an unlimited amount of earnings to the extent it can establish reasonable business needs for the accumulation. Earnings may be retained for bona fide business expansion, replacement of plant buildings and equipment, acquisition of another business enterprise through purchase of stock or assets, retirement of bona fide business debt, maintaining necessary working capital for business needs, and others. Planning Alert! Proper documentation is vital to defeating an IRS assessment of the accumulated earnings tax. If your corporation is accumulating earnings, be sure to document the business reasons for the accumulations through corporate minutes, memoranda, and business studies. Your documentation should occur contemporaneously with the accumulation if possible.
25% of Corporate Estimated Tax Payments for September Delayed. The 2003 Act provides that 25% of any corporate estimated tax payments that would otherwise be due in September, 2003 will not be due until October 1, 2003. The purpose of this provision is to shift revenue from the fiscal year of the federal government ending September 30, 2003 to the year ending September 30, 2004.
"Collapsible Corporation" Rules Repealed–Finally! Effective for tax years beginning after December 31, 2002, the obscure and horribly complex "collapsible corporation" rules were repealed by this tax legislation.
In a bold move to help bolster Wall Street, Congress slashed the tax rates for individuals on dividends paid on stock and, somewhat unexpectedly, reduced the individual tax rates for most long-term capital gains. The capital gains rate reduction was generally unexpected because President Bush had not included capital gains tax relief in his original economic stimulus proposals. These rate reductions do not apply to capital gains or dividends received by C corporations.
Long-Term Capital Gains Tax Reduced. The new law generally reduces the tax rate on long-term capital gains from 20% to 15% for individual taxpayers above the 15% tax bracket. The new 15% rate applies only to capital gains "properly taken into account" after May 5, 2003. For pass-through entities (e.g., S corporations, partnerships, LLCs, etc.), the determination of when capital gains are "properly taken into account" is made at the entity level. If the long-term capital gains would otherwise be taxed in the 10% or 15% tax bracket, the long-term capital gain rate is reduced from 10% to 5% from May 6, 2003 through 2007. For 2008 only, the tax rate on qualifying long-term capital gains for taxpayers who would otherwise be in the 10% or 15% tax bracket is zero. Also, the 18% and 8% rates for assets held more than five years are repealed. All these rate changes sunset after 2008, and on January 1, 2009 the tax rates on long-term capital gains revert back to 20%, 10%, 18% or 8%. The following is a summary of the changes in the long-term capital gains rates:
| Long-Term |
Capital Gains Rates: 2002 through |
5/05/03 After 5/05/03 |
through 2007 2008 |
After 2008 | General |
In 10% or 15% |
Bracket |
The following are important points to keep in mind regarding these new rate reductions for long-term capital gains:
Maximum Tax on Dividends Reduced from 38.6% to 15%. The crown jewel of President Bush's tax relief proposal was the elimination of the double taxation of corporate dividends. His proposal would have exempted dividends from individual income tax to the extent they were paid from taxable corporate earnings. By contrast, the Senate would have exempted all dividends from income tax even if they were paid from corporate earnings that had never been taxed. The final bill adopted neither President Bush's proposal nor the Senate proposal. Instead, the final legislation largely adopted the House proposal which taxes dividends (whether or not paid out of taxable corporate earnings) at a maximum rate of 15%. The new legislation provides that dividends paid to individuals in 2003 through 2008 will be taxed at a maximum rate of 15%. For 2003 through 2007, the rate is 5% for taxpayers who would otherwise be in the 10% or 15% ordinary income tax bracket. For 2008 only, the tax rate on dividends for taxpayers who would otherwise be in the 10% or 15% tax bracket is zero. After 2008, dividends will no longer qualify for these special rates and will once again be taxed at the regular individual tax rates. The reduced tax rate on dividends applies for both regular and alternative minimum tax purposes. The following is a summary of the changes to the tax rate for dividends:
| Tax Rates for |
Dividends: 2002 |
2003-2007 |
2008 |
After 2008 | Brackets |
Above 15% 10% or 15% |
Bracket |
The following are things to keep in mind concerning the new rules for taxing dividends:
AMT Relief for "Qualified Small-Business Stock". If you sell "qualified small-business stock," you can exclude 50% of the gain from your gross income. The remaining 50% of the gain is taxed at a maximum rate of 28% for regular tax purposes. Qualified small-business stock is generally stock of a C corporation that: 1) operates a "qualified business," 2) meets certain active business requirements, and 3) owns assets at the time the stock is issued of $50 million or less. Also, the stock must be issued to you after August 10, 1993, and must be held for more than five years before the sale. Prior to May 6, 2003, 42% of the "excluded" gain was added back into income in calculating the alternative minimum tax. Under the new law, if you sell qualified small-business stock after May 5, 2003 and before 2009, only 7% (not 42%) of the excluded gain is included in your "alternative minimum taxable income." Therefore, it is now less likely that a sale of "qualified small-business stock" will trigger the alternative minimum tax.
There were several tax proposals that did not make it into the final legislation. The following are some of the more publicized proposals that were dropped from the final tax bill:
Tax Tip. Although the above proposals did not make it into the final tax legislation, it is clear that these proposed changes (particularly those providing tax relief) will probably be high on the list for consideration if Congress considers another tax bill later in 2003 or in future years.