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In this section we present you with short newsletters containing
timely and useful information. |
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What the New 2003 Tax Act Means To Individual Taxpayers |
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For individual taxpayers, the new Tax Act signed into law in May
2003 means lower tax rates, tax relief for dividends, capital gains,
and much more, including up to a $400 check for each qualifying
child. This Special Alert will give you the big picture and the
details you need to know. |
Lower Income Tax Brackets and Reduced Rates on Capital Gains and
Dividends
The most significant change in the new tax law is the reduction of
tax rates – for ordinary income, capital gains, and dividend income.
The January 1, 2003 effective date for rate reductions on ordinary
income is an unexpected break for many taxpayers, but it may
complicate some carefully planned transactions for others. New
capital gain rates introduce one more variable to investment
decisions, may adversely affect transactions that straddle the May 6
effective date, and call into question decisions made in 2001
regarding five-year property. The fact that cuts are “temporary”
makes financial planning more tax sensitive than ever. The years
ahead may well be referred to as “a roller coaster of change.”
Capital gains
The maximum tax rate on net long-term capital gains (other than from
collectibles or “unrecaptured” depreciation on real property)
immediately falls five percentage points to 15-percent, down from
20-percent, while the 10-percent rate for lower-income taxpayers
falls to five percent, both effective for sales and exchanges (and
payments received) on or after May 6, 2003 through December 31,
2007. (The 15-percent rate continues unchanged in 2008 as well).
Those lower rates apply for both regular tax and AMT purposes. In
2008, the five percent rate for low-income taxpayers drops to zero,
the 15-percent rate remains the same for all other taxpayers, and on
January 1, 2009, the pre-2003 rates of 20 and 10 percent return.
Long-term capital gain from collectibles remains subject to a
28-percent maximum rate, and unrecaptured “Sec. 1250 gain” is
subject to a 25-percent maximum rate. Deduction of capital losses
against individual ordinary income continues to be limited to $3,000
per year, and losses carried forward will not be adjusted to reflect
the higher tax rate in effect when they were incurred.
There is a clear planning opportunity for taxpayers with appreciated
assets and children who will be over age 13 (and exempt from the
“kiddie” tax) in 2008. If the child will also be in the lowest, or
10-percent, regular tax bracket, gain from sale of appreciated
assets won't be taxed at all!
Special rates for property held for five years or more were
effectively repealed as of May 6, 2003, and no special rate is
available again until 2009 when the old 20 and 10 percent regular
capital gains rates are scheduled to return.
Dividends
Dividend income received by an individual shareholder from a
domestic or qualified foreign corporation will be taxed at a maximum
rate of 15 percent for most taxpayers. Lower income individuals may
pay tax on all or part of their dividends at a new rate of five
percent. The 15 percent rate is effective for dividends received in
tax years beginning after 2002 and ending after December 31, 2008.
The five-percent rate ends one year earlier, but falls to zero for
2008. There are no special rates for dividend income after 2009. As
if the complexity created by different effective and sunset dates
for dividend tax relief wasn't enough, exactly what is a qualifying
dividend for purposes of the lower rates will require detailed
regulations and be the subject of new controversies. There are some
highly technical exceptions and special rules that are described
below. Feel free to call and ask questions about them or skip this
part of the newsletter and continue on to the section discussing
"Individual Marginal Rates."
Exceptions and Special Rules
These sources of dividend income are specifically excluded from
“qualified dividend Income:”
Distributions from farm cooperatives and other “not-for-profit”
entities;
“Dividends” paid by Mutual Savings Banks;
Dividends on employer securities paid to a qualified retirement
plan;
Dividends subject to limitation by IRC Sec. 246(c) because they are
paid on stock acquired and disposed of within 45 days of a dividend
payment date.
Dividends will be treated as “investment income” to the extent you
so elect. Dividends generated by regulated investment companies will
be taxed at the maximum rate for individuals. The qualified dividend
rules apply to dividends received by a regulated investment company
if a gross-income test is met. Distributions from a REIT are not
considered dividends, provided certain requirements are met. Both
the Tax on excess accumulated earnings of a C, or regular,
corporation and the tax on Personal Holding Company income are
reduced to 15 percent by the Act . . . a significant relief
provision for mature C corporations.
A “qualified foreign corporation” is an entity incorporated within a
U.S. possession or that is eligible for the benefits of a
comprehensive U.S. tax treaty. Dividends paid by a foreign
corporation that is not “qualified” may still be eligible for the
lower rates if stock of that corporation is traded on an established
U.S. equities market.
Under the old law, a taxpayer in the highest tax bracket, receiving
$100,000 in dividend income, would pay $38,600 in tax. Under the new
law, the same dividend income, taxed at 15 percent, results in a
$15,000 tax liability, a reduction of $23,600 or 61 percent.
Reductions for lower income taxpayers are less dramatic. A taxpayer
in the 10 percent bracket, receiving $1000 of dividend income, would
have paid $100 in tax. The rate reduction, to 5 percent, will save
50 percent, but that's only $50.
Dividend tax relief may have a positive influence on stock values
for publicly traded companies. The low rate on dividends also makes
stocks more competitive with tax-free bonds. We will be pleased to
assist you in evaluating your investment goals and reevaluating your
portfolio allocations in light of the changed after-tax return now
provided by stock dividends.
Closely held corporations frequently make S elections to avoid
double taxation of corporate earnings. The impact of double taxation
is lower now, but still can be a significant number. Corporate
income tax rates have not been reduced. Therefore, closely held
corporations should probably continue to take advantage of the S
election to pass through income at lower rates. We can also assist
you in calculating the best form of entity for your business to
assure the lowest overall tax burden.
Individual Marginal Rates
The 2003 Act accelerates individual rate reductions that were
scheduled for 2006 and later. Rates above 15-percent all fall at
least two percentage points, while the highest rate, formerly
38.6-percent, falls to 35-percent. All reductions are effective
January 1, 2003 … but they are still subject to their original
sunset provision that restores rates to 15, 28, 31, 36 and
39.6-percent after 2010.
Because the rate cuts are effective from January 1, you can reduce
the amounts that will be withheld from your paycheck for the balance
of the year to reflect the full year rate cut. If you are making
quarterly estimates, you should review those to assure that you are
not overpaying your obligation.
Expanded 10-percent bracket
In addition to accelerating rate cuts, the 2003 Act increases the
amount of income covered by the 10-percent bracket through 2005. For
single filers, the 10-percent bracket threshold increases from
$6,000 to $7,000. For married couples filing jointly, that threshold
increases from $12,000 to $14,000. Here, again, is where the roller
coaster appears. The 2002 rate thresholds of $6,000 and $12,000
apply in 2006 but the $7,000 and $14,000 levels, return in 2008. The
10-percent bracket amount for heads of households remains at
$10,000, but is subject to inflation adjustments starting in 2004.
On May 28, the IRS issued new percentage method withholding rate
tables for the balance of 2003. They should go into effect by the
third week in June. The 10-percent bracket increase applies to all
taxpayers so a single filer paying taxes at a marginal rate above
the 10-percent bracket will realize
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