How to reap maximum
dollars from new tax act

business builder taxes

Earlier this spring, President Bush signed into law the third-largest tax cut in United States history. The 2003 Tax Act promised to save tax dollars for nearly every individual and business this year and over the next several years. But how exactly will this new tax cut put dollars back into your pocket?

Instead of taking you through a lengthy analysis of this new tax law, this article will use three sample taxpayers to walk through the new tax implications.  Moreover, this article will show each taxpayer how to receive the maximum benefits from this tax cut.

Sample taxpayer 1:  The entrepreneur

Profile: This entrepreneur is a self-employed owner of a small or medium-sized business (sole proprietorship, corporation or limited liability company).

Changes for this business taxpayer:

• Increase in the amount of property additions that a business can elect to expense.  With the new tax act the amount of qualified property that taxpayers such as the entrepreneur can now elect to expense has increased from $25,000 to $100,000.

Qualified property includes trucks and sport utility vehicles over 6,000 pounds.

• Increase in the first year “bonus” depreciation for assets purchased after May 5, 2003.  Last year, businesses were given a 30 percent depreciation bonus for newly acquired assets and the 2003 Tax Act increases this to a whopping 50 percent for assets acquired between May 6, 2003, and Dec. 31, 2004. This bonus is in addition to regular first-year depreciation.

Sample taxpayer 2:  The executive

Profile: The executive is a highly compensated individual with moderate to high levels of investment income and capital gains.

Changes for this individual taxpayer:

• Lower individual marginal tax rates retroactive to the beginning of this year.  For example, the 38.6 percent marginal tax rate drops to 35.6 percent. This could translate to more than $3,000 in federal tax savings on $100,000 of marginal taxable income.
• Lower taxes paid on dividend income. The executive will pay a maximum federal rate of 15 percent on dividend income instead of the former ordinary income treatment of up to 35.6 percent.  For taxpayers such as the executive, the effective federal tax on dividend income (including dividend income from many mutual funds) has been cut by more than half.
• Lower taxes paid on capital gain income. The federal tax rate on capital gains drops from 20 percent to 15 percent for transactions on or after May 6, 2003.

The reduced rates on dividend income and capital gains along with the temporary nature of these reductions call for the immediate revisions of many taxpayers’ investment strategies.  Unfortunately, the executive taxpayer in this example does not qualify for child tax credits due to income level.

Sample taxpayer 3:  Middle-class family

Profile: $90,000 combined family income, two kids, and low to moderate investment income.

Changes for this individual taxpayer:

• Lower individual marginal tax rates retroactive to the beginning of 2003.  For example, the 27 percent marginal tax rate drops to 25 percent.  Taxpayers will see an immediate impact as withholding rate tables were changed in July 2003 and were designed to encompass lower rates for the full calendar year.
• Increase in the child tax credit from $600 to $1,000 per child. Taxpayers like this one will see an immediate impact as $400 per child rebate checks are mailed to all eligible recipients during 2003, with future year credits being claimed on individual tax returns.
• Lower taxes paid on dividend income. Taxpayers will pay a maximum federal rate of 15 percent while lower-income taxpayers will pay tax on dividends at a new rate of 5 percent.
• Marriage penalty relief.  The tax act immediately raises the standard deduction for married filing jointly to twice the standard deduction for single taxpayers for 2003 and 2004.

Maximizing savings

The 2003 Tax Act provides you with several changes that will “just happen,” such as marginal rate reduction and child tax credit increases.  The new tax law also provides numerous planning opportunities that will achieve tax savings only if acted upon:

• Consider dividend income (now taxed at a lower rate) instead of ordinary income. Individual investors may consider rebalancing their portfolios while certain corporate shareholders may re-characterize ordinary income (wages/consulting fees/interest) to dividend income.
• Consider current year equipment additions to take advantage of “bonus” depreciation or the new limit on full depreciation of qualified property.  The new $100,000 per year limit is only applicable to years 2003, 2004 and 2005.  After these three years, it is scheduled to revert back to its former $25,000 per year limit.  Qualified property includes standard business equipment but also includes SUVs over 6,000 pounds and certain types of business property improvements.
• Consider initiating capital gain transactions (for lower rates).
• Consider modifying fourth quarter estimated tax payments or decreasing salary withholdings to reflect decreased tax rates and also to account for any proactive tax actions taken such as those described above.
• Reconsider “C Corp” status.  With corporate tax rates no longer a bargain compared to individual tax rates, operating as an “S Corp” or LLC may make more tax sense to get favorable pass-through entity treatment.

Of course, no action should be taken without a thorough understanding of the tax law and consultation with your tax professional.