Jobs and Growth Tax Relief Act 2003

To: NAPFA members

From: Government Affairs Task Force

Re: Bush Economic Stimulus Plan

Date: June 3, 2003

Dear Members,

 All of you are aware that President Bush signed the "Jobs and Growth Tax Relief Reconciliation Act of 2003" last week. The bill came together in the House-Senate conference more rapidly than expected, as the House basically acceded to the Senate’s demands so that an agreement could be reached. The law will result in tax cuts of about $330 billion. Officially, those tax cuts are spread out over the next 10 years, but the reality is that they come heavily front-loaded; most of the breaks are in the first two to five years, and then they expire.   

In this final memo on the tax package, we will try to identify some details that might be meaningful to you and your clients. At the end of this memo, we have included a generic press release that you can modify and distribute to your local media outlets.  It is likely that the tax package will be of interest to your local media for the rest of 2003, so you have numerous opportunities to share your knowledge with the public on this matter.

 Key provisions in the bill.

 1. Income Taxes

a.       Acceleration of federal income tax rate cuts for middle- and upper-income taxpayers. Tax cuts scheduled for 2004 and 2006 have been made effective for the 2003 tax year through 2009. Comparison of past and current rates for 2003:  

 b.      Increased child credit. Rises from $600/year to $1,000/year per child. As with the income tax, this is retroactive to cover the 2003 tax year. However, the $1,000 deduction is only for 2003-2004, before falling to $700 in 2005 and then gradually rising again. (People at upper and lower ends of income scale are excluded, though Congress is now considering a bill to make all lower-income taxpayers eligible for the child credit.)

c.       Marriage penalty relief. For the years 2003 and 2004 only, the “marriage penalty” has been reduced by giving married couples twice the standard deduction for individuals.

d.      Alternative Minimum Tax (AMT) exemption, married taxpayers. The AMT exemption for married taxpayers filing joint returns (and surviving spouses) rises to $58,000. Again, this is for 2003 and 2004 only.

e.       AMT exemption, unmarried. Rises to $40,250 for 2003 and 2004 only.

f.        The deduction for capital losses against ordinary income remains at $3,000 per person per year.

 2. Capital Gains Taxes

Prior to passage of the new tax package, there were two capital gains tax rates in effect on assets held for more than one year. For taxpayers in the 10% or 15% income tax range, the capital gains rate was 10%. For all other taxpayers, it was 20%.

 a.       Under the new package, the capital gains rate for lower-income-tax people (10% or 15%) will drop to 5%, effective May 6, 2003 . For the year 2008, those people will have a capital gains rate of 0%. Rates return to the old, higher levels in 2009.

b.      Other taxpayers will see their capital gains rate drop from the current 20% to 15%, effective May 6. The 15% rate will be in effect through the end of 2008, at which point they are scheduled to return to 20%.

 3. Dividend Relief

Dividends are taxed at the same rate as capital gains.  The rule applies for the same time period May 6, 2003 through Dec. 31, 2008 , as with capital gains.

 4. Business Tax Relief

a.       Section 179 expensing. Increases a business’s ability to expense investments for the years 2003, 2004, and 2005. Rises to $100,000/year from the current level of $25,000/year.

b.      Special depreciation allowance. Higher first-year depreciation equal to 50% of the adjusted basis of qualified property. Qualified property is defined as property that was eligible for the 30% depreciation in the Job Creation and Workers Assistance Act of 2002.

 What Is the Reaction in Washington , D.C. ?

Politically, President Bush won a significant victory. Although the tax cuts are on their face less than half of what Bush originally sought ($726 billion), they are nonetheless substantial reductions. They represent the third-largest tax cut in U.S. history.  And if the provisions are extended beyond the terms in the legislation—which most observers think will happen—they could cumulatively reach more than $800 billion.

Moreover, the legislation addresses areas in which it was thought that a tax cut was a political non-starter, such as dividends.  Here’s how the National Review, a conservative weekly, sees things:

Congress has just enacted the most pro-growth tax cut since 1981. The 1986 tax reform reduced tax rates but also included tax increases on capital. The 1997 tax cut focused narrowly on capital gains. The 2001 tax cut reduced tax rates, but did so over a painfully extended period. President Bush's latest tax cut, on the other hand, cut tax rates, taxes on dividends, and taxes on capital gains—immediately. Not only did Bush get most of what he wanted from Congress; the capital-gains provision was an improvement on his original proposal.

 Another victory for President Bush is that the bill did not contain any “revenue offsets,” which is the government’s current euphemism for tax increases.  During the conference meetings between the House and Senate, it was reported that the final package would contain measures to increase corporate taxes in a few ways or to tax overseas income earned by American citizens.  These tax increases were supposed to offset additional tax-relief provisions that many members of Congress favored.  House Republicans, however, defeated that idea.

 Not surprisingly, liberal members of Congress continue to criticize the tax program. They point towards the current federal budget deficit and upcoming problems with Social Security and Medicare as requiring more federal spending, not less.  And they are especially critical of the precedent of enacting major tax cuts during a deficit period. 

 Moreover, Republicans are committed to continuing their tax-cutting programs, especially those cuts that are due to expire at the end of 2004 or 2008. Here’s a statement from Sen. Kay Bailey Hutchison (R-Texas) that sums up that attitude: “What we certainly hope to do is not to sunset these tax cuts…but instead to allow these to go forward. We will pass legislation to do it.”

 What Does the Tax Bill Mean to Your Clients?

 Your clients will see real reductions in their tax burdens. The table below, prepared by Deloitte and Touche, gives a sense of the scale of tax breaks for single and married people at different income levels:  

Single, no children

Household Income¹      2003 tax old law           2003 tax new law²        Individual savings

 $41,000                       $5,221                         $5,010                         $211

$63,000                       $8,426                         $7,875                         $551

$170,000                     $34,845                       $32,102                       $2,743

$530,000                     $144,380                     $131,542                     $12,838

Married, two children under 17

Household Income¹      2003 tax old law           2003 tax new law²        Family’s savings

 $41,000                       $1,303                         $95                              $1,208

$63,000                       $3,547                         $2,447                         $1,100

$170,000                     $27,901                       $24,753                       $3,148

$530,000                     $138,859                     $125,417                     $13,442

 ¹Assumes varying amounts of dividends and capital-gains income, from $1,000 for households making $41,000, to $30,000 for households making $530,000. Estimates based generally on IRS data.

²Most provisions take effect for tax year 2003; some child tax credits will be paid this year.

 Source: Deloitte & Touche

 More money in your clients’ pockets is the good news.  The bad news is that the complexity of their (and your) investment decisions and tax preparation will be increased, especially if you do tax work.  For example, the IRS predicts that 6 million more taxpayers will have to file Schedule D for the tax year 2003 because of the capital gains provisions, and the agency has not yet even adjusted Schedule D or other forms to reflect the new laws.

 Unfortunately, because the bill has so many aspects that are temporary, it raises the atmosphere of uncertainty for your recommendations.  Even if it is a good possibility that a “temporary” tax break will be made permanent, it is by no means certain, and it would be irresponsible to make recommendations based solely on that assumption.

 Another good aspect of much of the tax package is that taking advantage of the reduced rates in many aspects does not require that a person or family changes its actions in any way.  In other words, these are new reductions that simply will come into existence. For example, most of your clients will see some relief in marginal rates, and some of your married clients will benefit because of new “marriage penalty” provisions. Parents with children will get a larger child credit.

 However, there are other provisions in the tax package that would require a change in behavior to realize the benefits of the new laws.  Here are a few ways that you might wish to adjust your recommendations to your clients, or at least communicate the impact of the new laws:

 1.      Capital gains, part 1.  The spread between the long-term capital gains rates and the taxes on ordinary income increases for high-income taxpayers. At the highest income tax rate, the spread was formerly 18.6% (38.6% minus 20%), but it now is 20% (35% minus 20%).  Thus, it’s even more beneficial to shift income into long-term capital gains when possible.

2.      Capital gains, part 2.  Shifting appreciated assets to children also has become more attractive.  At its most extreme, in the year 2008 when the 10% income-tax bracket incurs no capital gains tax, a client could transfer appreciated assets to eligible children (i.e., over age 13 and exempt from the so-called “kiddie tax”), and they would pay no tax.  This might be a good way to fund a college-savings program.

3.      Dividend taxes. Most, but not all, dividends are covered by the new lower rates. For example, REIT dividends do not enjoy the lower rate, and neither do dividends from companies that have not yet “paid” taxes on them.  The provisions are too complex to address in this memo, but IRS Code Sections 246(c), 404(k), 501, 521, and 591 help identify which types of dividends qualify for the lower rates.

4.      Child tax credit. To jump-start the economy, the IRS will mail checks to people eligible for the children’s tax credit this summer ($400 per eligible child).  People who are making estimated payments can reduce their payments by the amount to which they are entitled.  Maybe you should counsel your clients about how to invest that windfall.  People who have children or adopt children in 2003 will not receive an early refund, but they will be credited for the higher amount when they file their 2003 taxes.  Note that these tax breaks are still phased out, based on adjusted gross income.

5.      Marriage penalty. Doubling the standard deduction for married couples filing jointly (from $4,750 to $9,500) could make it better for some married couples who have itemized their deductions to instead take the standard deduction.  But advisors should be careful to note if the state in which their client is filing requires that the state and federal filings are the same (either itemized or standard). 

6.      AMT.  The time that the AMT affects large numbers of your clients is drawing nearer.  The new tax bill gives some temporary relief by raising the AMT exemption to $40,250 for a single filer (up from $35,750) and to $58,000 for joint filers (from $49,000).  This is only a two-year provision, and indicative of how Congress is avoiding addressing the AMT’s potentially huge impact in a few years.

7.      Irrevocable trusts.  Trusts are governed by fairly restrictive rules that, at times, result in distribution of assets to people in the highest income brackets. The alternative was to distribute the assets to a younger generation who might be in a lower tax bracket.  But the point of the trust might have been to keep that younger generation from having too much money too soon.  With the new lower tax rates on dividends and capital gains, distribution of trust assets can be made with significantly less tax implications.