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The Tax Prophet Newsletter Issue #2, June 2003

In This Issue:
Capital Gains Cut
Dividend Tax Rate
Reduced Tax Brackets
Small Business Breaks
Gifts to Children

President Bush Signs the Jobs and Growth Tax Relief Reconciliation Act of 2003

 
Introduction President Bush signed into law the Jobs and Growth Tax Relief and Reconciliation Act of 2003, a combination of cuts in the capital gains tax rate, a new 15% tax rate on dividends and a lowering of tax brackets, all designed to stimulate the lagging economy. Here are the highlights:



Capital Gains Cut The maximum federal rate for long-term capital gains is 15%, down from 20%. Whether the financially-strapped states will follow suit is doubtful. Unfortunately, there is no relief for those with large capital losses. Taxpayers in the 10% to 15% tax brackets pay capital gains taxes at 5%.



New Dividend Tax Rate Corporate dividends will be taxed at 15%. While this provision is designed to encourage corporations to pay their profits to shareholders, rather than retain them, corporate tax planning, especially for small, closely-held companies, has just become a lot more complex. Prior to this change, the tax law was consistent - dividend treatment meant a second tax on earnings. Corporations pay tax on their income, then individuals pay tax when they receive dividends.

Now that dividend treatment is no longer a scourge (in many cases, the 15% tax will approximate payroll taxes for compensation), corporations with retained earnings now can disgorge those earnings with minimal tax consequences. Going forward, the corporate tax rate for the first $50,000 in pre-tax income is 15% and the dividend rate is 15% for a combined tax rate of 30%. The highest individual tax rate is 35% so in many instances, there is a lower overall tax if corporate earnings are paid out as dividends rather than as compensation to corporate shareholders.



Reduction in Tax Brackets The tax-bracket reduction set for 2006 has been accelerated to 2003. The average is a 2 percentage point drop, although the highest tax bracket dropped from 38.5% to 35% (a 3.5 percentage point change). The change will lower everyone's regular taxable income and will subject more taxpayer's to the alternative minimum tax (AMT).



Alternative Minimum Tax

The AMT exemption has been increased from $35,750 to $40,250 for single filers and from $49,000 to $58,000 for joint filers.

Planning Note: Those with Incentive Stock Options may want to exercise just enough options to fall below these new exemption amounts. Because the AMT calculation is so complex, use a software tax program or consult with a tax professional to determine the maximum amount of options that may be exercised without triggering the AMT.

The spread between ordinary income tax on non-qualified stock options of 35% compared to the AMT of 28% is just 7 percentage points. With non-qualified stock options, there is withholding of taxes at 28% so the employee is at risk as to 8% if the stock collapses. In contrast, the employee who exercises an ISO is at risk as to 28% if the stock value evaporates since there is no required withholding when an ISO is exercised.



10% Income Tax Bracket

The 10% income tax bracket is now applies to the first $7,000 of income for single filers ($14,000 for joint filers). Planning Note: Shifting income to children over age 14 is, once again, a valuable planning tool.



Small Businesses Equipment Expensing

Small businesses may expense up to $100,000 in equipment in the year of purchase, up from $24,000, effective for acquisitions after December 31, 2002. Also, the phase-out for this exemption begins at $400,000 of equipment purchased (up from $200,000). Thus, a small business may invest in $400,000 of equipment and take full advantage of the $100,000 deduction in the year of purchase. In addition, for equipment placed into service between May 5, 2003 and January 1, 2005, taxpayers may claim a 50% bonus depreciation.

Note: Vehicles weighing more than 6,000 pounds (i.e. Hummers and other heavy SUVs) qualify as equipment and may be expensed in the year of purchase; however, look for Congress to close this loophole.



Gifts of Appreciated Assets

Example: A parent or grandparent gifts stock worth $11,000 to a child. Parent's basis in the stock is $1,000. If a parent sold the stock, the federal tax would be $1,500 under the new long-term capital gains rate. If a child (who inherits a carryover basis - the donor's basis in the stock) sells the stock, the tax is 5% or $500 - a tax savings of $1,000. Note: the 5% rate applies while the taxpayer is in the 10% or 15% bracket, which means that if the child has no other income, the 5% rate applies to the first $29,150 of gains, per year.





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All contents copyright © 1995-2003 Robert L. Sommers, attorney-at-law. All rights reserved. This internet site provides information of a general nature for educational purposes only and is not intended to be legal or tax advice. This information has not been updated to reflect subsequent changes in the law, if any. Your particular facts and circumstances, and changes in the law, must be considered when applying U.S. tax law. You should always consult with a competent tax professional licensed in your state with respect to your particular situation. The Tax Prophet® is a registered trademark of Robert L. Sommers.