The Texas Giant
Some folks absolutely love roller coasters while some of us are just a little bit skittish about placing our lives in the hands of engineers and ride operators we never met. Some of us downright hate roller coasters, but whether you like it or not, this decade you will be riding a roller coaster the size of The Texas Giant soon and it’s all free - sort of.
On May 23, 2003, the United States Congress, along with support from President Bush, did the impossible - it reduced taxes, increased spending and managed to make life more complex for us all. Then again, Congress is noted for doing the impossible. The instruments they chose as their magic wands are affectionately known as "sunset provisions" and with them they crafted the Jobs and Growth Tax Relief Reconciliation Act of 2003 ("JGTRRA" or the "Act" ).
This magic Act reduces the tax burden on the American public approximately $330 billion and increases spending by approximately $20 billion. As one possibly unintended effect, the Act also guarantees the jobs of scores of computer programmers. Therefore, it can’t properly be labeled solely as the Tax Preparers’ Full Employment Act of 2003.
What follows is a quick summation of the major provisions of the Act
Income tax rate reductions previously planned for 2006 will be accelerated and take effect on January 1, 2003. The following table illustrates the differences:
2003 rates before JGTRRA - 10, 15, 27, 30, 35, 38.6%
2003 rates after JGTRRA - 10, 15, 25, 28, 33, 35%
From a practical standpoint, what this means for the typical taxpayer is the monthly paycheck will be a bit larger or, for those who pay quarterly estimates, the estimate payments can be reduced a bit. You could also elect to make no changes to withholdings and have a bigger refund at year-end. These rates will sunset in 2010.
In addition to the accelerated rate reductions, the 10% bracket will be increased to $7,000 for single filers and $14,000 for married couples filing jointly. The old thresholds of $6,000 for singles and $12,000 for married couples filing jointly return in 2006, but don’t worry, the higher thresholds return in 2007 - just another dip in the roller coaster ride folks.
The Child Tax Credit was slated to gradually increase to $1,000 by 2010, but that has now changed - temporarily. The new law retroactively increases the credit to $1,000 as of January 1, 2003 and it remains at that level until 2004. Then, you get to ride the roller coaster down to $700 in 2005 with a gradual increase back up to $1,000 by 2010.
To get immediate economic impact from the new law, Congress elected to give you an advance payment of $400 per eligible child this summer. Don’t worry, though, anything you receive as an advance payment will reduce the amount of credit you get on your 2003 return. To be eligible for the advance payment, you must have filed your 2002 return and paid the liability in full. The payments are expected to begin in July. All tolled, the change in the Child Tax Credit is expected to reduce tax revenues by $32.5 billion through 2013.
Marriage penalty relief is finally here. If you have been singing the tax wedding bell blues, sing no more because in 2003, the standard deduction and income included in the 15% tax bracket for married couples will be exactly double those for single filers. These tax reductions are effective for 2003 and 2004 only. In 2005 the doubling disappears and the standard deduction and income in the 15% bracket are only 180% of the single amounts. Just a slight dip there folks.
Alternative Minimum Taxes ("AMT" ) were not eliminated this go around, and they likely will never be since they make up a large portion of the U.S. Treasury’s receipts. Instead, the income exempt from taxation under the AMT will increase by $4,500 for single filers and $9,000 for married taxpayers filing jointly over current levels, but only for 2003 and 2004. After that, the pre-2001 amounts come back ($33,750 for single filers and $45,000 for those filing married filing joint). Are you beginning to feel the jolts of the roller coaster ride?
So far, we have discussed only the issues expected to affect most middle-income taxpayers in one way or another. The total reduction in taxes from these changes is approximately $171.5 billion and we haven’t even hit the most controversial changes.
Dividends and Capital Gains
Until now, dividends were taxed as ordinary income at whatever your top rate was. So, if you were in the 38.6% bracket, some or all of your dividends were taxed at 38.6%. With the new law, the top tax rate for dividends will be 15% for taxpayers in the 25% or higher bracket. This change is effective through 2008. Taxpayers in the 10% and 15% brackets will see their top rate on dividends reduced to 5% through 2007 and zero percent in 2008. In 2009, the top rate for dividends will return to whatever your top tax bracket is.
Similar provisions apply to long-term capital gains from sales transactions entered into and payments received on or after May 6, 2003. The new rates mirror the rates for dividends. There is no advantage under the new law for holding assets over 5 years until the roller coaster dips in 2009. At that point, the current 20%/10% rates as well as the 18%/8% rates for assets held 5 years or longer will return.
There are numerous exceptions to the dividend and capital gain rules, so don’t automatically assume you have stumbled onto a bonanza. The dividend rules can be very tricky and there will be numerous questions on capital gains also.
The combined revenue reduction to the dividend and capital gain provisions in the new law is estimated to be $148.3 billion.
Business Investment Incentives
The main point of JGTRRA is to stimulate the economy and create jobs. The tax reductions previously discussed are designed to 1) get people spending to create a need for products and services (i.e. jobs) and 2) give people incentives to invest their money in businesses that will create those jobs.
JGTRRA increases the amount that businesses can expense immediately under Code Section 179 when purchasing long-lived assets. Previously, businesses could expense up to $25,000 in qualifying assets unless their total additions exceeded $200,000 at which point the $25,000 began to phaseout. The new law allows an expensing election of up to $100,000 with a phaseout to begin at $400,000. This provision is effective as of January 1, 2003, but don’t worry, it will sunset after 2005 and the old $25,000 maximum expense and $200,000 phaseout threshold rear their ugly heads again.
Additionally, prior to the new law, off the shelf computer software did not qualify for the expensing election. This law changes that and allows for the expensing of computer software as a Code Section 179 asset.
As part of the 2002 tax law changes, Congress allowed 30% bonus depreciation on all new (as in new from the factory) equipment placed in service through 2004. This special bonus depreciation has now been increased to 50% and will sunset in 2004.
If you are taking advantage of these tax savings, you are in for a big roller coaster dip in 2005. Not only will the amount of Code Section 179 expense you can take be reduced to $25,000, the amount of depreciation you can take will go back to pre-September 11 levels. Forget about roller coasters, this is more like falling off a cliff.
Because these changes basically deal with the timing of your depreciation and expense deductions rather than the actual amount, their effect on tax revenue is not that significant, weighing in at only $10.2 billion. However, as many business owners will attest, the deduction in early years is a powerful incentive to buy today.
One Last Dip
One thing to remember about the preceding changes, they are all subject either to their own sunset provisions or those of the 2001 tax act. Accordingly, on January 1, 2011, forget everything we just said.
No, this isn’t totally serious, but it is close. If the tax law has no more changes between now an then, all the rate reductions and most other changes enacted since 2001 are slated to sunset and we will return to pre-2001 law. Don’t bank on it though, the President and Congress have a history of making changes annually.
Coming to the End of the Ride
If we have done our math right, the total reduction in taxes should be approximately $330 billion and we are coming to the end of our roller coaster ride. There is no doubt the changes in JGTRRA will be significant to many. That’s why the time is now for you to plan the rest of the year to minimize your 2003 and beyond tax burden. Give us a call and we can discuss how you can use the new law to your advantage.
Don’t forget to keep our troops in your hearts and have a great and profitable June.