The New Tax Law- Only The Beginning?

Earlier this year, Congress and President Bush reached an historic agreement known as the "Jobs and Growth Tax Relief Reconciliation Act of 2003" (2003 Tax Act). The new law contains important changes to our federal tax system. The cuts in both the dividend tax and the capital gains tax create new incentives to pay dividends and secure capital gains.

But much more is in the Washington air. By the end of 2003, Congress may well enact new tax proposals aimed at "charitable giving" incentives and create an entirely new system of U.S. international tax. Only time will tell if and how these new reforms will unfold.

In a bold and somewhat unexpected move, the 2003 Tax Act lowers the tax rates on capital gains. The new lower rates are 5% (zero in 2008) and 15%, depending on your normal tax bracket.

The new provision contains a generous effective date applying to sales and exchanges (and payments received) on or after May 6, 2003. Thus, installment payments received after May 6, 2003, are eligible for the lower rate, even though the sale triggering these payments was closed before May of 2003.

These lower rates apply to the sale of assets held more than one year and the Act repeals the special reduced rates for property held for five years. With this complex tax overhaul, taxpayers can expect a complicated 2003 tax return.

The 2003 Tax Act also provides dividend tax relief. Under the new Act, dividends received by an individual shareholder from domestic and qualified foreign corporations are generally taxed at the same rates that apply to capital gains. In other words, dividends are taxed at rates of 5% (zero in 2008) and 15%. This provision applies to dividends received in taxable years beginning after 2002 and before 2009.

To be eligible for the lower rate, the underlying stock must be held for certain periods. These holding-period requirements are complicated and can be found in the definition of "qualified dividend income."

The 2003 Tax Act also creates new incentives for business expenditures. The Act provides an additional first-year depreciation deduction equal to 50% of the adjusted basis of qualified property. Qualified property is generally defined in the same manner as for purposes of the 30% additional first-year depreciation deduction provided by the Job Creation and Workers Assistance Act of 2002.

In general, in order to qualify for the 50% additional depreciation deduction, the property must be acquired after May 5, 2003, and before January 1, 2005. But property does not qualify if the taxpayer had signed a binding written contract for the acquisition before May 6, 2003. Property for which the 50% additional first-year depreciation deduction is claimed is not eligible for the 30% additional first-year depreciation deduction. The provision is effective for taxable years ending after May 5, 2003.

Increase in Section 179 Expensing. The 2003 Tax Act also increases the popular Section 179 expense deduction. Under the Act, the maximum dollar amount that may be deducted under Section 179 is increased to $100,000 for property placed in service in taxable years beginning in 2003, 2004, and 2005. In addition, Congress has eased the restrictions on this deduction by increasing the phase-out amount to $400,000 for property placed in service in taxable years beginning in 2003, 2004, and 2005. In other words, Congress increased the deductible amount and eased the phase-out limitations that can reduce the deduction. The provision also expands the deductions for off-the-shelf computer software placed in service in 2003, 2004, or 2005. The provision also contains a generous election rule permitting taxpayers to make or revoke expensing elections on amended returns. The provision is effective for taxable years beginning after December 31, 2002.

After years of rhetoric denouncing the marriage penalty tax, Congress finally enacted relief. The 2003 Tax Act provides that the basic standard deduction amount for married joint filers is twice the basic standard deduction amount for single individuals. The provision is effective for taxable years beginning after December 31, 2002, and before January 1, 2005.

Expansion of the 15% Rate Bracket for Married Joint Filers. The 2003 Tax Act expands the size of the 15% regular income tax rate bracket for married taxpayers filing joint returns to twice the width of the 15% regular income tax rate bracket for single returns. The provision is effective for taxable years beginning after December 31, 2002, and before January 1, 2005.

Ten Percent Regular Income Tax Rate. The 2003 Tax Act accelerates the expansion of those taxpayers eligible for the 10% taxable income rate. Thus, for 2003, the taxable income level for the 10% regular income tax rate bracket for single individuals is increased from $6,000 to $7,000, and for married taxpayers filing joint returns from $12,000 to $14,000 for 2004.

Reduction of Other Regular Income Tax Rates. The 2003 Tax Act accelerates the reductions in the regular income tax rates previously scheduled for 2004 and 2006. Thus, after 2003, the regular income tax rates in excess of the 15% bracket are 25%, 28%, 33%, and 35%.

Earlier this spring, Congress boldly enacted new and historic tax cuts for dividends and capital gains. The new rates are 15%, or for those taxpayers in the lower tax bracket, only 5%.

But these historic changes will not be the final changes to our tax system. New tax reforms for both charitable gifting incentives and international taxation could be enacted by year end. Bolder changes in other areas (such as estate and gift tax) could follow in the next few years. As with previous significant tax reforms, Congress could fundamentally alter the tax-law landscape rewarding those taxpayers who anticipate and plan for new tax-law changes.