It may be “itty-bitty” but it presages a monumental shift in tax policy. In case you haven't noticed, the “investor class” has arrived big time as a major political force. Maybe it has something to do with the fact that more than one-half of the voters now have some stake in the stock market.

Granted the new law does not go all the way, as President Bush had originally proposed. Yet, six months ago there was nary a tax advisor in the land who was willing to bet on enactment of any significant reduction in the double taxation of dividends. A feature of the tax system for decades, experts had long been content with just trying to plan around the inequity.

The new law

Any dividends from domestic corporations and qualified foreign corporations received between 1/1/03 and 12/31/08 will be taxed at capital gains rather than ordinary income rates.

And simultaneously the tax rate on capital gains is reduced from the current 10% and 20% rates to 5% and 15%, for assets held more than one year. This applies to gains between 5/6/03 and 12/31/08. Even with the concurrent reduction in maximum marginal brackets on ordinary income, this is a huge tax reduction, particularly for taxpayers in the upper brackets.

Comments:

• Dividends from mutual funds investing in debt instruments (e.g. bond funds, money market funds, etc.) won't qualify.
• You can elect out of the reduced rates if you want your dividend income to be included in your investment income for purposes of deducting unused investment interest.
• You will have to give your 1099-DIV even closer scrutiny than in 2002, when there were 12 boxes for different types of dividends.

Increase in child credit

Under the new act this credit jumps to $1,000 this year from $600 under current law. This change is limited to 2003 and 2004 only. For this year the increased amount will be converted to refund checks to be mailed out to taxpayers in July.

Upper-income taxpayers, generally those with Adjusted Gross Income over $75,000 single and $110,000 joint, will get a reduced credit or no credit at all.

Marriage penalty reduced

The new act accelerates the reduction in the marriage penalty, to provide additional relief in 2003.

Comment:

Joint filers, where both spouses earn reasonably high salaries, will continue to pay higher taxes than if they had not married in the first place.

Acceleration of income tax rate reduction

The new act also provides that the phased-in 2001 tax act reductions in marginal tax brackets are accelerated from 2006 to 2003.

As adjusted for inflation, the federal tax brackets for the foreseeable future are as follows:

Alternative minimum tax

The exemption amount is raised from $49,000 to $58,000 for joint and from $35,750 to $40,250 for single taxpayers. This change is in effect for 2003 and 2004 only.

Expensing election/depreciation increases

Small businesses adding property and equipment in 2003, 2004 and 2005 will be able to expense in the first year up to $100,000 of applicable cost. Amounts paid for off-the-shelf software are specifically eligible for this expense. A new 50% bonus depreciation rule goes into effect for property acquired after 5/5/03 and before 1/1/05.

This newsletter article has been prepared by Tom Jacobsen. It is not intended to be a complete treatise on the subjects discussed. Please seek professional advice before acting on any information contained herein.

Tom Jacobsen is a certified public accountant (CPA) with a practice in Marin County. He is a member of the JCEF Marin/Sonoma County Legal & Tax Professional Subcommittee, a group of professional advisors that meets regularly to discuss tax and estate planning developments and strategies that may prove useful to the advisors' clients, as well as the general and Jewish communities. This article on the new tax act signed into law on May 28, 2003 emphasizes many of the new law's provisions concerning taxation of investment income.

The opinions and information expressed are those of the author. The JCEF does not provide legal advice.