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25 post-JGTRRA tax planning strategies.

The Jobs and Growth Tax Relief Reconciliation Act of 2003 offers a myriad of planning opportunities. This article presents 25 tax strategies stemming from that legislation, for investments, businesses, gifts and individuals.

The sweeping tax cuts enacted by the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) offered immediate tax relief to individuals and small businesses. (1) The law also reduces taxes significantly for investors, by lowering the rates on earnings from investments (including dividends). It provides major tax incentives to help businesses grow and thrive. However, because many of the new law's benefits are retroactive and all are temporary in nature, tax advisers will have to help clients strategize to minimize taxes. This article presents 25 tax planning tips to accomplish that goal.


1. Take advantage of the rate spread: Because of the 20% spread between the 15% capital gain and 35% ordinary income rates, investors may have to adjust their investment strategy, by changing asset allocations between taxable and retirement accounts. Thus, investors with both types of accounts should examine how their investments are allocated. They may be better off having investment vehicles such as taxable bonds in retirement accounts, because interest is still taxed at ordinary income rates, as are retirement distributions. They should move dividend-paying stocks to taxable accounts, because of the significantly lower dividend tax rates.

2. Use the long-term capital gain rate: Long-term capital gains on sales and exchanges will be taxed at lower rates, so the one-year holding period becomes even more important. Investors should avoid short-term capital gain, as it is taxed as ordinary income.

3. Does the capital gain rate reduction matter?: While the reduction in the capital gain rate is generally beneficial, most investors have significant capital loss carryovers and are unlikely to directly benefit from the rate reductions for the foreseeable future. (The most likely beneficiary is an entrepreneur who sells his or her closely held business or an investor who sells a large amount of low-basis stock.)

4. Concentrate positions and diversify low-basis stock: With the reduced capital gain rate, it may be advantageous to sell and diversify a stock portfolio. This may be the perfect opportunity for investors to sell some low-basis stock that they have been holding for too long, as the tax rate on the gain may never be lower. Many individuals with heavy positions in inherited stock or stock received from the sale of a business or held for a long time should consider the investment implications of such a move.

5. Capitalize on lower dividend tax rates: All other things being equal, the lower tax rate on dividends makes dividend-paying stocks more attractive. The immediacy of a dividend in hand vs. a future potential capital gain is advantageous. Thus, an income deferral (to take advantage of lower rates in future years) may not make sense. No one knows how long the new rates will be in effect and future tax deductions are less attractive at lower marginal rates.

6. Taxable vs. tax-free bonds: The change in tax rates should prompt investors to reconsider whether to invest in taxable or tax-free bonds. An investment in tax-exempt bonds will lose appeal as the after-tax yields on taxable investments increase. While short-term, fixed-income rates are at historic lows, the lower marginal tax rates dictate that tax advisers examine clients' bond and money market accounts, to ensure that they are positioned properly.

7. New 60-day holding period: Under JGTRRA Section 302(a), dividends are deemed "short-term" if the stock was held for less than 60 days (longer for preferred stocks) prior to the ex-dividend date; such a dividend will not qualify for the reduced tax rate. The new law provides flexibility on meeting the 60-day requirement. A taxpayer can own the stock for (1) 60 days before the dividend is paid, (2) 30 days before and after the dividend is paid or (4) 60 days after the dividend is paid. Failure to meet this holding period means that dividends will be taxed at the marginal tax rate. This requirement will prevent investors from actively trading in and out of stocks just to receive tax-advantaged dividend.

8. Change investment strategies on a case-by-case basis: Tax rates are not predictable and the latest tax breaks for investors are not permanent. Under JGTRRA Section 303, the dividend and capital gain rates are effective through 2008. After that, if Congress does not act, taxpayers are back to the old, higher rates. This short tax window should not motivate people to sell stock just for tax reasons. Tax planning should never be done in a vacuum.

9. Examine investment strategies: Investors may want to invest in equities in accounts that are not tax sheltered. They should examine (and perhaps revise) their investment selection and allocation strategies. Basically, there is now an increased incentive to hold dividend-paying and higher-risk/return long-term equity investments outside of tax deferred accounts, and ordinary income, safety-oriented investments (such as taxable bonds, certificates of deposit, treasuries, etc.) in sheltered retirement accounts (with the exception of Roth IRAs, which can avoid tax entirely). The appeal of buying an annuity has definitely declined after the JGTRRA.

10. Re-think portfolio strategy: A portfolio should not be "twisted out of shape" to save a few tax dollars. Tax considerations should not be the sole basis for planning strategy. A client's risk tolerance and financial goals are more useful in determining stock and bond allocations. After that, investments should be divided between taxable and tax-deferred/nontaxable accounts, to minimize taxes. A client should not change his or her combination of stocks and bonds simply because of the JGTRRA.

The new law also reinforces another principle of sound investing: holding for the long term, because of the 20% spread between short-term (35%) and long-term gains (15%).The converse is also true: The JGTRRA magnifies the disadvantages of day-trading and other heavy-turnover methods.

11. Take losses now: Capital gain on stock sold before May 6, 2003 is taxed at pre-JGTRRA rates (generally, 20% on long-term investments). Thus, investors should sell stock with long-term capital losses before 2004. They will have to separate pre- and post-May 6, 2003 transactions, then net gains and losses separately for those periods, but can still use net losses from the latter half of 2003 to offset earlier gains.

12. Keep records organized: With the changed capital gain rate as of May 6, 2003, stock-sale records are particularly important. The different rates trigger a heightened need for accurate record-keeping this year.

13. Rethink retirement savings: The new rules make tax sheltered accounts like Sec. 401(k) plans somewhat less appending. There has always been a trade-off with such accounts--in exchange for having investments grow tax deferred, investors paid regular income taxes on withdrawals, rather than capital gain rates. Now, the gap between regular rates and those for dividends and capital gains will be even greater, at least until the next round of tax changes. (The JGTRRA also makes variable annuities and nondeductible IRAs even less attractive than before, because they offer no pretax deferral and no tax breaks at withdrawal.)

14. Do not abandon Sec. 401(k) plans entirely: The main advantage of retirement accounts--tax deferral--continues to make such accounts a good deal for investors. The strategy remains the same as before: investors should put funds in a Sec. 401(k) plan first (and take advantage of any employer match). Next, if eligible, they should set up a Roth IRA, then invest in a taxable account.

15. Change investment strategy: Clients need to rethink which assets to hold ill taxable accounts and which in tax-deferred accounts. Specifically, taxpayers will want more equities in taxable accounts (to take advantage of the lower capital gain and dividend rates) and more taxable bonds in tax-advantaged accounts (sheltering those payouts from tax until withdrawal). Tax-free municipal bonds, of course, should remain in a taxable account.

16. Gear portfolio toward dividend-paying stocks: Clients might want to shift some investments from interest-earning to dividend-paying vehicles. Clients will likely want to sell non-dividend-paying stocks, which might trigger capital gain. The real issue going forward is whether dividend-paying stocks will outperform over the long term--and the effect investors' newfound fondness for dividends will have in such an uncertain and volatile market. Dividends are cash in hand, and cannot be manipulated the way earnings can. Given the scandals of the past few years, there is an extra appeal to dividends, with or without the rate cut.

17. Consider dividend-paying preferred stocks: Some tax advisers believe that clients should hold preferred, rather than common, stock, because it is less volatile and investors receive dividends before common stockholders do. But not all preferred stock dividends are eligible for the new tax rate, because some pay interest income. Clients need to assess carefully each company's preferred stock.


18. Consider the small business depreciation incentive: Dramatically enhanced expensing of assets purchased in 2003 (up to $100,000) and increased bonus depreciation (50% of the cost of property acquired after May 5, 2003), under JGTRRA Sections 201(a) and 202, have a significant effect on business decisions to buy equipment, computers, etc. This also comes into play when evaluating rental real estate.


19. Gift now: While tax-free gifts are capped at $11,000 per donor, per donee for 2003, a gift of stock given early in the year can grow more rapidly for the donee, as long as the stock market rises. If stock is gifted to a low-bracket taxpayer (e.g., a child or a grandchild), it is likely to be taxed at only a 5% capital gain rate when sold, as long as the child is not in a tax bracket higher than 15%. In 2008 only, the 5% capital gain rate drops to zero, making that an excellent year for the low-bracket taxpayer to sell the stock.

20. Shift income (and/or assets) to lower-bracket family members: As stated above, a gift of stock to a low-bracket taxpayer could result in a 5% capital gain rate on sale. However, if the stock is sold before the year the child turns age 14, the kiddie tax will tax the gain at the parents' rate.


21. Beware of the AMT: Although the JGTRRA made only minor changes to the alternative minimum tax (AMT) exemption, the effect is great. Because clients pay the higher of the AMT or regular tax, most items that reduce regular tax have the potential to pull a client into the AMT or increase an existing AMT burden. Many more taxpayers will now have to incorporate AMT planning in their usual tax planning.

22. Assess itemized deductions: For clients with itemized deductions close to the standard deduction, a tax adviser could suggest that they itemize every other year, particularly because the married filing jointly standard deduction is $9,500 for 2003. For instance, a taxpayer could donate to charity in January and December of the same year, then skip donating the following year. Or a client could subscribe for two years, rather than one, to an investment periodical.

23. Adjust now for income phaseouts: Tax advisers should ensure that clients do not disqualify themselves from tax benefits such as the child credit, education credits and rolling fun& over to a Roth IRA, by earning "excess" income. If a client is thinking of selling a capital asset, and the additional income will disqualify him or her from taking a credit, he or she may want to wait until next year to sell, to preserve the tax advantage.

24. Focus on lower income tax rates in coming years: Clients might consider accelerating taxable sums before rates potentially increase again in 2011 (under JGTRRA Section 104), especially executives in transition (e.g., retiring or changing jobs). Also, they might consider exercising stock options or receiving deferred compensation. However, these actions may result in larger state taxes, which could trigger the AMT.

25. Take advantage of lower rates: If a client can control income timing to take advantage of the "bracket game" by deferring or accelerating income and deductions, the decrease in personal income tax rates means that he or she will have less tax deducted from his or her paycheck. Perhaps these excess funds can be used for deductible IRAs, stock options, Sec. 529 plans and/or other savings vehicles.


Careful planning is needed to make the most of the JGTRRA's tax relief in specific client situations, especially due to the law's retroactive effective dates and the temporary duration of many of its provisions.

The JGTRRA should result in tax savings for almost every taxpayer. Taxpayers who qualify for the expanded child tax credit should realize significant tax savings. Those in high marginal brackets or with substantial dividend income will also likely be pleased with the new law.

CPAs will need to look at current transactions, as well as those planned, to evaluate how the JGTRRA will affect their clients. In addition, the JGTRRA may also allow for new personal and/or business or investment opportunities.

The only way to completely understand the new law's effects on a client's situation is to review its provisions in detail. CPAs should help clients understand how the JGTRRA affects their planning strategies, whether by weighing the new capital gain and dividend rates or planning an early gift of stock.

The major beneficiaries of the rate reductions and credit and expensing increases are higher-income individuals, particularly those collecting dividends and with capital gains outside retirement or other sheltered accounts, qualifying families with dependent children under age 17 and businesses that will acquire significant qualifying depreciable assets in the next couple of years.

Sunset, phaseout and other eligibility qualifications, coupled with the AMT, make the law even more complicated than in the past. Because many current reductions decrease (or disappear entirely) over time, long-term planning is uncertain.


* CPAs should help clients understand how the JGTRRA affects their planning strategies.

* The JGTRRA's 60-day holding period prevents investors from actively trading in out of stocks just to receive tax-advantage dividends.

* A portfolio should not be "twisted out of shape" just to save a few tax dollars.

Editor's note: Ms. Bernstein is the co-author of Investment Advisory, Relationships: Managing Client Expectation in an Uncertain Market (AICPA, 2003).

(1) For a detailed discussion of the JGTRRA's provisions, see Hegt, "JGTRRA Cuts Rates, Increases Some Deductions and Credits," 34 The Tax Adviser 542 (September 2003).

Phyllis Bernstein, CPA


Phyllis Bernstein Consulting, Inc.

New York, NY

For more information about this article, contact Ms. Bernstein at
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Title Annotation:Jobs and Growth Tax Relief Reconciliation Act of 2003
Author:Bernstein, Phyllis
Publication:The Tax Adviser
Date:Dec 1, 2003
Previous Article:Mass. related-member interest or intangible expenses.
Next Article:Reporting common foreign transactions of U.S. clients.

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