NEW TAX LAW

by W. King Copler

As you are likely aware, Congress recently passed the Jobs and Growth Tax Relief Reconciliation Act of 2003 ("the 2003 Act").  This legislation, reputedly the third largest tax cut in history, is wide-ranging in scope, impact and complexity.  With our clients in mind, we reviewed the 2003 Act and in this letter outline the following significant features.

INDIVIDUAL TAXPAYERS

Tax Brackets
The expansion of the individual rate brackets is the most significant provision of the 2003 Act with respect to the majority of individual taxpayers.  Under the Act, the addition of a 10% rate bracket is accelerated to 2003.  The 10% bracket was originally scheduled to appear in 2006, under The Economic Growth and Tax Relief Reconciliation Act of 2001 ("the 2001 Relief Act").  Similarly, the 2003 Act accelerates to 2003 scheduled reductions in the higher tax brackets.  For example, in 2003, taxpayers in the highest rate bracket will be taxed at 35% rather than 38.6%.  Taxpayers in the second highest rate bracket will be taxed at 33%, rather than 35%.

Keep in mind, however, that these changes are scheduled to disappear in 2011 due to a "sunset provision" under the 2001 Relief Act which calls for a return to pre 2001 rates in 2011.  Further, even the provisions scheduled to take effect in 2006-2008 are vulnerable to future changes depending on the performance of the economy and the overall outcome of the 2004 elections.

The 2003 Act also increases the standard deduction as well as the size of the 15% rate bracket for joint filers, thereby alleviating the marriage penalty to some degree.  The amount of the Child Tax Credit is also increased, from $600 to $1,000 per child, for 2003 only.  Subject to phaseout for higher income taxpayers, those who listed dependent children on their 2002 tax returns will receive $400 per child this year as an advance payment of the increased credit.

Reductions in Taxes on Dividends and Capital Gains
The 2003 Act lowers taxes on dividends and capital gains, thereby providing significant tax savings, particularly for investors.  These changes are not permanent, however, and, barring additional Congressional action to extend them, they will not apply after 2008.

Under the Act the 10% and 20% rates on adjusted net capital gains are reduced to 5% and 15%, respectively, for both regular tax and the alternative minimum tax (AMT) on sales and exchanges (or installment payments received) between May 6, 2003 and January 1, 2009.  Additionally, in 2008, the 5% rate will be reduced to zero.  The lower rates apply to sales of capital assets held more than one year.  Because this 5% drop in the capital gains rate is more than the 3.6% drop in the top individual rate, and the 2% drop in other individual rates under the 2003 Act, the advantage of long-term capital gains over other types of taxable income is even greater for high earners than it was before.  Note, however, that there is no cut in the 28% capital gains rate affecting collectibles and certain small business stock or the 25% rate affecting gains representing depreciation claimed on MACRS realty.

Dividends received by individual shareholders from domestic corporations in 2003 through 2008 will be treated as adjusted net capital gain, rather than ordinary income, for purposes of applying the capital gains rate.  As a result, dividends received in these years will also be taxed at the 5% and 15% rates, with the 5% rate dropping to zero in 2008.

BUSINESSES AND CORPORATIONS

The 2003 Act offers two temporary tax breaks designed to encourage immediate investment by businesses in equipment and other capital assets.

First, the Act liberalizes the small business expensing election, which allows certain businesses to immediately deduct a certain amount of tangible depreciable personal property purchased and placed in service during the taxable year.  All of the following expensing changes are effective for tax years beginning after 2002 and before 2006:

• The maximum annual expensing amount for depreciable assets is raised from $25,000 to $100,000. 
• The maximum annual expensing amount is reduced (but not below 0) by the amount by which the cost of qualifying property placed in service during the tax year exceeds $400,000, an increase from the previous level of $200,000.
• The above increased dollar amounts will be inflation-indexed for tax years beginning after 2003.
• Off-the-shelf computer software is made eligible for expensing.
• Taxpayer revocation of expensing elections will no longer require IRS consent.

The second tax break, which is applicable to all businesses, increases and extends bonus first year depreciation.  Prior law applied an additional first year depreciation allowance to the non-expensed portion of qualified property (including most new MACRS property) so long as:

• Its original use with the taxpayer began after September 10, 2001;
• The taxpayer acquired the asset after September 10, 2001, and before September 11, 2004; and
• The taxpayer placed the asset in service before 2005, or before 2006 for certain property with longer production periods.

Under the 2003 Act, the bonus first-year depreciation is raised to 50% for property acquired after May 5, 2003 and placed in service before January 1, 2004.  Taxpayers may now elect, on a class-by-class basis, to claim 30% bonus first year depreciation, rather than 50%.  Alternatively, taxpayers may elect not to claim bonus first year depreciation at all.  These options would be advantageous when a taxpayer has nearly expired net operating losses, or anticipates moving into a higher tax bracket in future years.

Note that there are still no AMT depreciation adjustments for the final recovery period of qualified property that was recovered using either 30% or 50% bonus first year depreciation.

The final significant change for corporations defers for 15 days 25% of the third quarterly installment of estimated tax payments for taxable years ending at the end of September, 2003 through May 31, 2004. 

Please keep in mind that we have described only the highlights of the most important changes in the new law and that, as with any endeavor, generalizations involving taxation may be dangerous.  If you have any questions or concerns, please do not hesitate to contact any member of our tax and estate preservation group.

© 2003 Chambliss, Bahner & Stophel, P.C.

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