Dear Client:

I'm sure you've heard or read about passage of the Jobs and Growth Tax Relief Reconciliation Act of 2003, and the political controversy it has stirred up. Naturally, the first question in your mind is: "how am I affected by this new law?" That's the purpose of this letter. It highlights how the new law will cut your tax bill. It also gives you an idea of the changes that are in store for future years, and why tax and financial planning has become more complex than ever before.

Your income will be taxed at lower rates. For regular tax purposes, the first "slice" of your taxable income is taxed at 10%, and additional slices of taxable income are taxed at progressively higher rates until you reach the maximum rate. The various "slices" of taxable income, and the tax rates each is subject to, are commonly referred to as the "tax brackets." All of the following changes apply retroactively to Jan. 1, 2003:

. . . If you file as a single person or are a married person filing separately from your spouse, the first $7,000 (instead of $6,000) of your taxable income will be taxed at 10%, the lowest tax rate. Because the extra $1,000 was taxed at 15% under prior law, you save a maximum of $50.

. . . If you file a joint return, the first $14,000 (instead of $12,000) of your taxable income will be taxed at 10%, the lowest tax rate. Because the extra $2,000 was taxed at 15% under prior law, you save a maximum of $100.

. . . If you file a joint return, more of your taxable income will be taxed at 15% (instead of winding up in the next highest tax bracket and being taxed at 25%).

. . . The new law reduces all of the tax rates above 15% for all individuals (as well as estates and trusts). The new tax rates above 15% are: 25% (instead of 27%), 28% (instead of 30%), 33% (instead of 35%) and 35%, the top rate (instead of 38.6%).

How much will all of these changes save you? The answer depends on how much taxable income you have and your filing status. For example:

. . . If you are single with $60,000 of taxable income for 2003, your tax bill will be $682 less. If your taxable income is $120,000, you save $1,882.

. . . If you are married, file a joint return and have $60,000 of taxable income for 2003, your tax bill will be $1,286 less. If your taxable income is $120,000, you will save $2,486. The tax savings will be higher if taxable income includes dividends or capital gains (taxed at a lower rate under the new law, see below). Additional tax savings will be realized if the individual is entitled to an enhanced child tax credit.

Wage-earners will get a larger paycheck as a result of these (and other) changes for individuals. New payroll withholding tables are already in effect.

Bigger standard deduction for joint filers.
If you are married, file a joint return, and don't itemize your deductions, your basic standard deduction for 2003 is $9,500, a $1,550 increase.

Bigger alternative minimum tax (AMT) exemptions.
The alternative minimum tax, which is payable only if it exceeds your regular tax bill, is a hazard because many tax breaks ("preferences") allowed for purposes of calculating regular taxes are disallowed for AMT purposes. The "preferences" are added back to regular taxable income, an AMT exemption amount (which phases out at higher income levels) is subtracted, and the balance is subject to an AMT rate of 26% or 28%. The new law makes the AMT less of a problem by increasing the maximum AMT exemption amount to $58,000 for marrieds filing jointly (a $9,000 increase), to $40,250 for unmarried individuals (a $4,500 increase), and to $29,000 for married individuals filing separate returns (a $4,500 increase).

Boosted child tax credit, partially refundable for 2003.
The child tax credit for 2003 is $1,000 per qualifying child (a $400 increase over the prior-law $600 amount). What's more, the increased amount of the child tax credit has been paid "in advance" beginning in mid-July, 2003. This year, a qualifying family with one child will receive an advance payment check from the Treasury for up to $400, and a qualifying family with two children will receive a check for up to $800. The amount of advance payments will be based on a person's 2002 filing status and income, as well as the number of children claimed on the 2002 tax return who will still be under age 17 in 2003. Note that the new law didn't change the income levels at which the child credit starts to phase out ($75,000 for singles, $110,000 for married couples, and $55,000 for marrieds filing separately).

Reduced taxes on capital gains and dividends.
For sales and exchanges (and installment payments received) after May 5, 2003, gains on most capital assets held longer than one year (long term gains) will be taxed a maximum rate of 15% (instead of 20%). From an investment perspective, the lower rates may discourage you from short term trading, since the difference in tax rates between long term and short tern gains has grown. In addition, dividends you receive in 2003 from a domestic corporation (or certain "qualified foreign corporations") are taxed at the same rates that apply to capital gains. In other words, the dividends are taxed at a maximum rate of 15%. These new capital gain and dividend rates apply for both the regular tax and the AMT.

The impact of this provision can be seen in an individual who sells the home that he purchased many years ago for $500,000 for $2 million, a gain of $1.5 million ($2,000,000 - $500,000). Assuming that he can exclude $250,000 under the exclusion for the sale of a principal residence, he must pay a tax on capital gains on $1,250,000 ($1,500,000 - $250,000). If he sold it after May 5, 2003, he would pay a tax of $187,500 (15% of $1,250,000). If he had sold it earlier in the year, say Jan. 1, 2003, he would pay a tax of $250,000 (20% of $1,250,000). The savings because of the 2003 Jobs and Growth Act would be $62,500.

The 5% drop in the capital gains rates under the 2003 Jobs and Growth Act is more than the 3.6% drop in the top individual rate under the 2003 Jobs and Growth Act and the 2% drop in other individual rates. Thus, the advantage of long-term capital gains over other types of taxable income is even greater for high earners than it was before.

Reduced rates won't apply after 2008.

A word of caution should also be mentioned. While these reduced rates for capital gains and dividends can result in considerable tax savings, in devising a long-term investment strategy it is important to remember that these rates aren't permanent. They are scheduled to "sunset" (i.e., no longer apply) after 2008.

For Business:

Quadrupled maximum annual expensing amount. A business that buys machinery and equipment generally deducts its cost over a number of years via depreciation. The expensing election permits a business or practice to expense (that is, deduct immediately rather than depreciate over several years) a certain amount of the cost of tangible depreciable personal property purchased and placed in service during the year. Under the Jobs and Growth Act, effective for tax years beginning in 2003 through 2005, the maximum annual expensing amount is $100,000. That's four times the prior-law $25,000 ceiling. Additionally, the maximum annual expensing amount begins to phase out dollar-for-dollar only where the business or practice places in service during the tax year expensing-eligible property in excess of $400,000. (Under prior law, the expensing amount phased out dollar-for-dollar where the taxpayer placed in service during the tax year expensing-eligible property in excess of $200,000.)

Results. These major expensing liberalizations mean that most small businesses, and even those of moderate-size with modest capital equipment needs, will be able to claim a full deduction for the cost of their business machinery and equipment, thereby reducing their effective cost for the assets. Additionally, the ability to currently deduct the entire cost of qualifying property makes purchasing (as opposed to leasing) a more attractive option than it was under prior law.

Bonus first-year depreciation allowance. The 2003 Jobs and Growth Act gives enterprises a 50% bonus first-year depreciation deduction for most capital assets (other than buildings) acquired new after May 5, 2003 and before 2005 (there can't be a written binding contract for the asset's acquisition in effect before May 6, 2003). Qualifying new capital assets generally must be placed in service before 2005 (before 2006 for certain longer-lived property). Under prior law, extra first-year depreciation took the form of a 30% bonus writeoff for most new capital assets (other than buildings) acquired after Sept. 10, 2001, and before Sept. 11, 2004, and placed in service before 2005 (before 2006, for certain property).

Results: The bonus 50% first-year writeoff means that an enterprise can recover more of the cost of a business asset in the year it is placed in service.

What qualifies. Bonus first-year depreciation applies to:

. . . most types of new, nonrealty assets, such as business machines, computers, most types of computer software, many types of production equipment, trucks, trailers, and business furniture; and

. . . qualified leasehold improvements which, in general, are interior improvements made under a lease to commercial property (such as an office building or warehouse), and placed in service more than three years after the building was first placed in service. Certain structural improvements don't qualify, and neither do expansions.

New business autos. The so-called "luxury auto"dollar caps limit the combined regular depreciation and expensing deduction that may be claimed for a business auto. Under the 2003 Jobs and Growth Act, the luxury auto dollar cap for the year a new business auto is placed in service is increased by $7,650 for a passenger auto that's otherwise eligible for bonus 50% first-year depreciation. For 2003, this will result in an allowable first-year writeoff of about $10,710 (the final figure hasn't yet been released by the IRS). The passenger auto must be used more than 50% for business. The extra first-year allowance is reduced for autos treated as used for personal as well as business driving.

What the future holds in store.

Unfortunately, to meet budget constraints many of the tax breaks in the new law are not permanent. For example, unless Congress changes the rules again, the new tax breaks for marrieds filing jointly (more income taxed in the 15% tax bracket instead of a higher tax bracket, and larger basic standard deduction) are slated to be watered down after 2004, the AMT exemption amounts will drop after 2004, and the maximum child tax credit also will drop after 2004. What's more, the reduced tax rates for capital gains and dividends will only last through the end of 2008. This will make it much harder for all of us to plan for the long haul.

Our first step should be to examine the new law's immediate effect on you, your family, and your investments, and then come up with a game plan for the future. Please call my office to set up an appointment.

Very truly yours,

Ken