JGTRRA cuts rates, increases some deductions and credits.
* The JGTRRA increases the temporary 10% bracket, accelerates rate decreases in the remaining tax brackets and provides some AMT and marriage penalty relief.
* Its incentive provisions lower the top tax rates on capital gains and dividends.
* Business incentives include increased first-year bonus depreciation (50%) and an increased Sec. 179 deduction.
The Jobs and Growth Tax Relief Reconciliation Act of 2003 includes lower income tax, capital gain and dividend rates, some alternative minimum tax and marriage penalty relief and an increase in the child tax credit. For businesses, it expands the first-year bonus depreciation and expense deductions for depreciable property. This article reviews and analyzes these provisions.
To fit into the House-Senate agreed-on budget constraint of a $350 billion tax cut, the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) became a jigsaw puzzle of effective dates, sliding repeals and numerous sunsets. In barely passing the Senate, the bill (without the sunsets) has been estimated to cost approximately $800 billion.
The JGTRRA cuts taxes for individuals, estates and trusts and businesses. Some of the cuts are merely an acceleration of previously enacted changes, while others are new. This article reviews an analyzes the JGTRRA provisions affecting individuals in the following areas:
* Acceleration of tax rate reductions;
* Child tax credit;
* Marriage penalty relief;
* Alternative minimum tax (AMT);
* Capital gains; and
* Dividend tax relief.
The article also discusses the enhanced first-year expense and bonus depreciation deductions for depreciable business property.
Acceleration of Rate Reductions Section 101(a) of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) created a temporary 10% tax bracket. Under the EGTRRA, the first $6,000 of a single individual's taxable income ($10,000 if head of household; $12,000 if married tiling jointly) was taxed at 10%. These amounts were scheduled to increase in 2008, with the 10% bracket expiring in 2011.
Under JGTRRA Section 104, however, the 10% bracket increases for 2003 and 2004, reverts to its current level in 2005 and increases again in 2008. As under the EGTRRA, the 10% bracket disappears in 2011. The changes in the 10% bracket are shown in Exhibit 1 below. (The income tax rates applicable to estates and nongrantor trusts did not include a 10% bracket, so there is no change to the taxation of lower-bracket fiduciaries.)
Exhibit 1: JGTRRA changes to the 10% bracket Single/ married Married filing Head of filing Year separately household jointly 2003(pre-JGTRRA) $6,000 $10,000 $12,000 New law: 2003-2004 $7,000 $10,000 $14,000 2005-2007 $6,000 $10,000 $12,000 2008-2010 $7,000 $10,000 $14,000 2011 Repealed Repealed Repealed Editor's note: Mr. Hegt is the former chair of the AICPA Tax Division's Individual Income Taxation Technical Resource Panel.
This provision will save a single individual (or one married filing separately) a maximum of $50 in 2003 and 2004. It will increase his or her tax by $50 in 2005-2007; the same $50 savings returns in 2008-2010. In 2011, a single person will have a maximum tax increase of $350, as the income taxed at 10% slides into the 15% bracket. For a married couple filing jointly, the corresponding amounts are $100 and $700. Heads of household do not save under this provision. The 15% bracket change is discussed below under marriage penalty relief, as it is not an across-the-board cut.
Under the EGTRRA, the remaining tax rates were scheduled to slowly decrease through 2008, with a return to pre-EGTRRA levels in 2011. JGTRRA Section 105 accelerates these decreases, as shown in Exhibit 2 below.
Exhibit 2: JGTRRA acceleration of rate reductions 2003 (pre-JGTRRA) 27% 30% 35% 38.6% New law: 2003-2010 25% 28% 33% 35% 2011 and later 28% 31% 36% 39.6%
Example 1: At $25,000 of taxable income, a married couple filing jointly will save zero from the JGTRRA rate reductions. At $100,000, the savings are $1,986. At the entry point into the top tax rate ($311,950), the savings are $6,225.
Child Credit Increase and Advance Refunds
Under the EGTRRA, a credit of $600 per child was available to eligible taxpayers. The credit was scheduled to increase to $1,000 by 2010. JGTRRA Section 101 accelerates the increase to $1,000, retroactively to Jan. 1, 2003, for 2003 and 2004 only. The credit will then drop to the EGTRRA level of $700, with an increase to $1,000 again in 2010. To accelerate the benefit of the increased credit, the JGTRRA provides for refund checks ($400 per child) to be mailed to eligible taxpayers no later than Dec. 31, 2003. Eligible taxpayers are those who claimed a child credit on their 2002 return. Any advance credit issued will reduce the 2003 allowable child credit (to no lower than zero).
In certain circumstances, taxpayers could receive an advance payment in excess of the child credit they are entitled to claim.
Example 2: A married couple with two children and modified adjusted gross income (MAGI) of $110,000 claimed a $1,200 child credit in 2002. Under the advance payment provision, the couple will receive an $800 advance child credit payment in 2003. If the couple's MAGI increases to $136,000, the 2003 phaseout rules reduce the credit to $700. However, the $100 excess credit received through the advance payment system will not have to be refunded.
Example 3: The facts are the same as in Example 2, except that the couple's 2003 MAGI increases to $112,000. The child credit will be $1,900. However, as $800 was already refunded, the credit available on the 2003 return will actually be $1,100.
Marriage Penalty Relief
JGTRRA Sections 102 and 103 offer a limited and temporary marriage penalty "fix" For 2003 and 2004, both the standard deduction and the upper limit of the 15% bracket for joint filers have been set at double that of a single taxpayer. After that, both amounts fluctuate for the next seven years, as shown in Exhibit 3 on p. 544.
Exhibit 3: JGTRRA marriage penalty relief Year Standard deduction: Upper-limit 15%: married filing married filing jointly vs. single jointly vs. single 2003 (pre-JGTRRA) 167% 167% New law: 2003-2004 200% 200% 2005 174% 180% 2006 184% 187% 2007 187% 193% 2008 190% 200% 2009-2010 200% 200% 2011 167% 167%
However, the JGTRRA does not address the numerous other Code provisions that create inequities for married couples filing jointly. For example, the relationship of the joint to single upper limits of the remaining tax brackets is not 2:1. Although the joint standard deduction adjustment does not benefit married taxpayers who itemize, many taxpayers who had itemized deductions that were minimally more than the standard deduction may now enjoy the benefit of the increased standard deduction. Married taxpayers (filing jointly) in this position should consider postponing the payment of items that would qualify for itemization in 2004 until 2005, when the joint standard deduction scheduled to decrease.
As with the marriage penalty, JGTRRA Section 106 provides certain minimal temporary relief for the AMT. For 2003 and 2004, single taxpayers and married taxpayers filing separately will see their AMT exemption increase $4,500 to $29,000 and $40,250, respectively. Married taxpayers filing jointly will enjoy a $9,000 increase to $58,000. At the top AMT rate of 28%, this provision will allow savings of $1,260 per taxpayer ($2,520 per couple).
While the increased exemption is designed to relieve middle-class-taxpayers of some of the AMT burden, many other provisions increase the likelihood that the AMT will apply. In 1986, the maximum regular tax rate was 50%; the maximum AMT rate was 20%. With the maximum regular rate dropping to 35% while the AMT rate stays at 28%, a significantly larger number of taxpayers will be subject to the AMT without having large amounts of preferences or deductions.
Example 4: In 2003, a married couple filing jointly has $300,000 of taxable income. Their regular tax liability (assuming no capital gains or qualifying dividends) is $84,445. Their AMT liability (assuming no preferences or adjustments) is $74,460. It takes only $20,304 of preferences and/or adjustments to cause the couple to cross over into the AMT.
Because state and local taxes and miscellaneous itemized deductions are treated as adjustments, any similarly situated taxpayer having itemized deductions in excess of 6.7% of AGI will be subject to the AMT. Given the ever-increasing state and local income and real estate tax burden, it is easy to see that a significant number of taxpayers will end up paying AMT. At $175,000 of taxable income, only $27,500 of adjustments and preferences will cross a taxpayer over into the AMT.
Capital Gain and Dividend Reductions
The centerpiece of the incentive provisions is the lowering of the top tax rates on capital gains and dividends, under JGTRRA Sections 301 and 302. The changes are effective for dividends paid after 2002; capital gain relief applies to transactions completed after May 5, 2003. These reduced rates expire on Dec. 31, 2008.
Capital gains: For taxpayers in the 10% and 15% brackets, the tax rate on long-term capital gains and qualifying dividends is reduced to 5%. In 2008, the 5% rate on dividends only will be reduced to zero. For all other taxpayers, the maximum rate will be 15%. This reduced rate repeals the 18% rate for gains on property held for more than five years. The 25% rate on unrecaptured Sec. 1250 gain, as well as the 28% rate on collectibles and certain small business stock, will continue to apply.
Capital gains eligible for the reduced rate include gains taken into account after May 5, 2003. This would include proceeds collected on installment obligations after that date, even if the initial installment sale occurred earlier. Gains from passthrough entities will be taken into account based on the date of the transaction at the entity level.
Under the EGTRRA, a reduced set of capital gain rates were available for property held for five years, if the acquisition date was after 2000. A taxpayer could elect to treat assets held on Jan. 1, 2001 as sold and reacquired at their fair market value (FMV) on that date. This caused a capital gain to be reported and started a fresh holding period for the special five-year rate With the suspension of the rates in effect on May 5, 2003, through 2008, any long-term capital gain property sold would be taxed at the 5% 15% rate, regardless of the holding period. Hence, in hindsight, a 20% capital gain tax would have been accelerated, with no future benefit. If a taxpayer holds such property beyond 2008, the old capital gain rates return; property held for five years or more would be eligible for the reduced rates.
Dividends: Qualifying dividend generally include those paid by domestic or a foreign corporation incorporated in a country eligible for the benefits of a comprehensive income tax treaty that contains an exchange-of-information program. Until Treasury publishes a list of qualifying treaty countries, any country with an income tax treaty with the U.S. that includes at exchange-of-information program will qualify. The JGTRRA Conference Report specifically highlights Barbados as a country with an exchange-sharing program that does not qualify
The JGTRRA has special rules that limit the amount of qualifying dividends paid by a regulated investment company or a real estate investment trust to the amount of qualifying dividends it receives, unless at least 95% of its income is from qualifying dividends. This will prevent bond funds, money market funds and similar entities from turning interest or other nonqualifying income into qualified dividends.
Under JGTRRA Sections 302(a) and 303, holding periods prevent taxpayers from trafficking in stock immediately prior to ex-dividend dates to collect low-tax-rate dividends and sell the stock at short-term capital loss rates. The new rule disallows qualifying dividend treatment on any dividend paid, if the underlying stock is held by the taxpayer for less than 60 days during the 120-day period before the ex-dividend date.
Dividends received when the taxpayer is holding both a long position, and a short position in a substantially equivalent security, will not be treated as qualified dividends. Also, as part of the unification of the taxation of dividends, the accumulated earnings and personal holding company taxes are reduced to 15%.
To prevent earnings stripping, the JGTRRA provides special treatment for taxpayers selling shares of a company that paid an "extraordinary dividend." Any loss on the sale of stock that has paid an extraordinary dividend will be treated as a long-term loss to the extent of such dividend. Sec. 1059(c) defines an extraordinary dividend as any dividend that exceeds 10% (5% in the case of preferred stock) of the taxpayer's basis in the underlying stock. For stock with a readily ascertainable value, the FMV as of the day before the ex-dividend date can be used in lieu of basis. This election will reduce extraordinary dividend treatment on stock that has appreciated in value from its acquisition.
The dividend tax reduction is accomplished by treating qualifying dividends (for calculation purposes only) as additions to net capital gain for the year. The JGTRRA does not change the character of dividends to long-term capital gains. Thus, although both dividends and long-term capital gains are taxed in the same new regime, dividends cannot be sheltered against capital losses or capital loss carryovers.
Dividends taxed at the reduced rate will not be treated as investment income under Sec. 163. Thus, a taxpayer with potential investment interest limits will have to consider the savings generated by the reduced dividend rate against the cost of disallowance of the current-year investment-interest expense. Just as with long-term capital gain, a taxpayer can elect to forgo the reduced tax rate, and have the dividends taxed as ordinary income (i.e., investment income).
Foreign tax credit: The JGTRRA coordinates dividends with the foreign tax credit, so that an appropriate adjustment is made to the dividend amount deemed to be foreign source. As with long-term capital gain, foreign-source income associated with qualifying dividends is reduced, so that the effective rate on the reduced amount equals the tax rate on ordinary income. Regs. Sec. 1.904-4 requires the reduced-rate foreign-source income to be reduced by a fraction, the numerator of which is the reduced tax rate (15%) and the denominator of which is the maximum tax rate applicable to taxpayers of that type (35% for individuals). Permitting a reduced amount of income in be credited against the full tax amount puts all types of income (e.g., ordinary, capital gains and dividends) on equal footing.
AMT: The same lower rates apply for AMT purposes. However, if a taxpayer has alternative minimum taxable income (AMTI) in the exemption phaseout range ($112,500 if single; $150,000 if joint; and $75,000 if separate), additional income will cause the exemption to phase out and raise the effective AMT rate to 21.5% on qualifying dividends.
Example 5: A single individual has $115,000 of AMTI. An additional $1,000 of dividends would incur a $150 AMT. However, that $1,000 of additional income would decrease the AMT exemption by $250, so that an additional 26% AMT ($65) would also be due.
Under the Jobs Creation and Worker Assistance Act of 2002, Section 101(b), eligible property acquired and placed in service after Sept. 10, 2001 and before Sept. 11, 2004, is eligible for a 30% first-year bonus depreciation deduction. Tiffs bonus is in addition to the deduction allowed under Sec. 179 and regular depreciation. JGTRRA Section 201(a) increases this bonus allowance to 50% for property acquired after May 5, 2003, if it is placed in service before 2006. Property whose acquisition was subject to a binding contract prior to May 6, 2003, and self-constructed property whose construction commenced prior to that date, are not eligible for 50% bonus depreciation. However, if the property otherwise qualified for 30% bonus depreciation, that would still be available.
A taxpayer may elect, on a class-by-class basis, not to claim 50% bonus depreciation. In its place, it can elect 30% or no bonus depredation.
JGTRRA Section 201(a) increases the first-year depreciation limit ($3,060) on luxury automobiles by $7,650, to $10,710, to reflect the 50% bonus allowance. At 30%, the first-year increase was $4,650. Both amounts reflect the luxury-automobile threshold value of $15,300.
As with the 30% bonus allowance, only modified accelerated cost recovery system (MACRS) property with a recovery period of less than 20 years, off-the-shelf computer software subject to a 36 month write-off (1) and certain commercial-building qualified leasehold improvements are eligible for 50% bonus depreciation.
In addition to increased bonus depreciation, JGTRRA Section 202 amends Sec. 179 to allow an increased deduction and phaseout threshold. For tax years beginning 2003-2005, the amount of property eligible for current expensing increases to $100,000 per year (indexed for inflation in 2004 and 2005). For tax years beginning after 2005, the maximum deduction returns to $25,000.
In addition, the JGTRRA expands the definition of eligible property to include off-the-shelf software. Off the-shelf software is computer soft ware that is readily available for purchase by the general public, subject to a nonexclusive license and not substantially modified.
Prior to the JGTRRA, the Sec. 179 deduction was phased out, dollar-for-dollar, to the extent that the taxpayer acquired property eligible for the deduction in excess of $200,000. For years beginning in 2003-2005, the $200,000 amount is increased to $400,000. Thus, a taxpayer acquiring $400,000 in eligible property would be allowed a $100,000 current expensing deduction. If the amount of property acquired increased by $50,000 to 5450,000, the expensing allowance would be reduced to $50,000.
Exhibit 4 below shows how these changes combine to allow a substantial deduction for property acquired during the eligibility period. Assuming a taxpayer makes no elections to limit allowable deductions, the taxpayer can deduct the percentages shown in Exhibit 4 for five-year or seven-year MACRS property, based on claiming the maximum bonus, Sec. 179 and MACRS depreciation.
Exhibit 4: JGTRRA maximum first-year depreciation and expense deduction Five-year MACRS Seven-year MACRS Property cost property property $150,000 87% 86% $200,000 80% 79% $250,000 76% 74% $300,000 73% 71% $400,000 70% 68%
Corporate Estimated Taxes
In an effort to conform the JGTRRA to budgetary restrictions (which require revenue neutrality in years 1, 5 and 10), 25% of corporate estimated tax payments normally due on Sept. 15, 2003, are postponed to Oct. 1, 2003, by JGTRRA Section 501.
The JGTRRA is as interesting for the provisions that did not get enacted as for the provisions that survived. The conference process revolved stripping all revenue-raisers from the bill, so that the resulting law was strictly a tax reducing economic stimulus package. Some of the "cutting room floor" items are a window into the future of tax reform. For example, the Senate bill included language designed to increase disclosure and reporting of tax-shelter transactions through a more strict and expensive penalty regime. In addition, the Senate defined the concept of economic substance, for purposes of determining whether deductions and credits associated with a transaction would be allowable. The proposed definition would have required (1) the transaction to change the taxpayer's economic position in a meaningful way (besides income taxes); and (2) the taxpayer to show substantial nontax purposes for entering into the transaction. In addition, the Senate bill would have repealed the earned-income exclusion and housing deductions available to U.S. persons working overseas.
The JGTRRA reduces taxes in many ways. However, most of the changes are temporary or are accelerations of previous provisions. In addition, revenue-raisers were stripped from the bill. Tax advisers should keep an eye on various bills working their way through Congress to determine when these issues will be attached to the appropriate bill for enactment.
(1) For further discussion, see Witner and Krumweide, "Purchasing, Leasing and Developing Software (Parts I and II)," 34 The Tax Adviser 404 (July 2003) and 34 The Tax Adviser 486 (August 2003).
Ronald B. Hegt, CPA
Hays & Company LLP
New York, NY
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|Title Annotation:||Jobs and Growth Tax Relief Reconciliation Act of 2003|
|Author:||Hegt, Ronald B.|
|Publication:||The Tax Adviser|
|Date:||Sep 1, 2003|
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