New Tax Law with Reduced Rates Offers Opportunities
Income, Dividends, Capital Gains, Business Investments, 401(k)s, All Winners
The decline in income tax rates and other changes wrought by the Jobs and Growth Tax Relief Reconciliation Act of 2003 (referred to here as JGTRRA), which was signed into law on May 28, 2003, introduce a number of tax planning opportunities that merit consideration. Retroactive to January 1, 2003, JGTRRA reduced the 38.6-percent income tax bracket to 35 percent; the 35-percent bracket to 33 percent; the 30-percent bracket to 28 percent; the 27-percent bracket to 25 percent; and expanded the 10-percent bracket, although this latter change applies for the years 2003 and 2004 only.
Also effective January 1, 2003, JGTRRA reduced tax rates on most dividends from the taxpayer’s marginal rate to 15 percent for most taxpayers. Taxpayers in the 10-percent and 15-percent brackets are subject
to a still lower 5-percent tax rate on dividends. These reduced tax rates on dividends are scheduled to expire at the end of 2008. JGTRRA also reduced taxes on capital gains, although unlike other changes, these reductions are not retroactive to the beginning of the year. Effective May 6, 2003, the capital gains rate for assets held longer than one year, other than real estate and collectibles, is reduced from 20 percent to 15 percent for most non-corporate taxpayers. The rate is reduced from 10 percent to 5 percent for taxpayers in the 10-percent and 15-percent tax brackets. These changes also expire
at the end of 2008.
For self-employed individuals or those with significant investment income, one means of accelerating the benefit of these rate changes is to adjust this year’s estimated income tax payments in conformance with the lower rates. State income tax payments should also be reviewed. For those who conduct business in corporate form, the temporarily reduced tax rate on dividends may also present a unique opportunity to distribute corporate profits to shareholders for minimal tax cost. Likewise, for those individuals holding substantially appreciated assets, now may be the time to sell and take profits while capital gains tax rates are at historic lows.
With all of these changes and reductions in the regular tax rate, alternate minimum tax (AMT) consequences must not be ignored. Taxpayers who plan to avail themselves of these new incentives should prepare a 2003 tax projection to make certain that their actions do not trigger unanticipated AMT consequences.
Bearing in mind especially that the reduced capital gains tax rates are not retroactive, investors should consider generating capital losses sufficient to offset capital gains for the year. Once gains have been offset, capital losses can shield up to $3,000 of ordinary income, as well.
The preferential tax rates for dividends as compared to interest income, although temporary, may suggest a change in your investment portfolio. Likewise, since dividends will, for a time, be taxed at the same rate as capital gains, this may be an appropriate time to take a second look at stocks that pay substantial dividends as compared to stock of companies that reinvest profits with an eye to increasing share price. You should make an appointment to discuss the implications of JGTRRA with your investment adviser.
Business owners may find that now is the time to make needed investments in equipment or other depreciable property to take advantage of JGTRRA’s increase in first-year “bonus depreciation” from 30 percent to 50 percent for qualifying property. The additional bonus depreciation generally applies to property placed in service after May 5, 2003, but before January 1, 2005 (January 1, 2006, in the case of long-term production property). Another incentive to new business investment is the increase in the Section 179 deduction. That section now permits as much as $100,000 annually of depreciable personal property placed in service during the tax year to be deducted as a current expense rather than depreciated over the useful life of the property. Before JGTRRA, the Section 179 deduction had been limited to $25,000 annually. The increase applies to property placed in service in 2003, 2004 or 2005. The amount of property for which the deduction can be taken is reduced as depreciable property placed in service during the tax year exceeds $400,000.
Although JGTRRA did not make significant changes affecting retirement accounts, do not overlook making contributions to qualified retirement plans, including elective deferrals to 401(k)s or to an IRA if you meet eligibility requirements. In addition, note that higher contribution limits apply for persons age 50 or older.