Jobs and Growth Tax Relief Reconciliation Act of 2003

August 19, 2003 Published Work
Connecticut Bar Association Newsletter, July 2003

On May 28, 2003, President Bush signed into law the "Jobs and Growth Tax Relief Reconciliation Act of 2003" (the "Act"). Although not as large as the $726 billion tax cut originally proposed by the Bush Administration, the $350 billion Act is still the third largest tax cut in history and contains many aspects and variations of the President's original proposal. The Bush Administration and Congress are hopeful that the Act will provide a much needed stimulus to capital investments by businesses and will further boost the struggling economy by putting more income back into the hands of individuals.
The Act contains immediate income tax relief for individuals, investors and businesses, although the tax cuts are currently scheduled to expire (i.e., "sunset") beginning in 2011, with many provisions scheduled to expire over the next two or three years. The Act encourages capital investments by business of all sizes by providing for a 50 percent bonus depreciation deduction for certain tangible personal property placed in service during 2003 through 2005 and especially benefits small businesses who are the beneficiaries of a $100,000 first-year expense deduction for certain property placed in service during 2003 through 2005. Individuals and investors will also benefit by the Act's reduction in marginal income tax rates, the reduced tax rate on most long-term capital gains and dividends, and from the "marriage penalty" relief provided by the Act. The Act also increases the child tax credit from $600 to $1,000 per "qualifying child" for 2003 and 2004 and, beginning in July of this year, many taxpayers will receive advance payment checks (up to $400 per "qualifying child") with respect to the increased 2003 child tax credit.

Tax Breaks for Businesses
  • "Bonus" Depreciation & Increased First-Year Small Business Expensing.
Bonus Depreciation. In 2002, Congress enacted Section 168(k) of the Internal Revenue Code (the "Code") allowing a taxpayer to elect to take an additional 30 percent "bonus" first-year depreciation deduction (in addition to the regular depreciation deduction for the taxable year) for purchases of "qualified property" placed-in-service during the year. The Act increases the first-year bonus depreciation deduction to 50 percent of the adjusted basis of "qualified property" (again, in addition to the regular depreciation deduction for the taxable year) for electing taxpayers. Taxpayers may elect on an asset class basis to claim either the 30 percent or 50 percent bonus first-year depreciation, or may elect not to claim bonus first-year depreciation at all. For taxpayers electing either the 30 percent or 50 percent bonus depreciation, regular depreciation is calculated in the first and subsequent years under the general MACRS rules, with the property's cost less the applicable first-year bonus depreciation (and, as discussed below, any Code Section 179 expense deduction) as the property's adjusted basis. We note that not all states allow for bonus depreciation when determining state taxable income.

For purposes of bonus depreciation, "qualified property" generally consists of new depreciable, tangible personal property (including certain computer software and leasehold improvements to non-residential real property) that has a recovery period for depreciation purposes of 20 years or less and with which the original use of the property commenced with the taxpayer after May 5, 2003 and before January 1, 2005. Property does not qualify for 50 percent bonus depreciation if the property has been repaired or reconstructed or if a binding written sales contract to purchase the property was in effect prior to May 6, 2003. In order to conform the so-called "luxury automobile" depreciation limits to the new 50 percent bonus depreciation, the Act raises the bonus depreciation amount that may be deducted for certain business automobiles to $7,650 (plus the normal depreciation amount). Luxury SUVs, trucks and other automobiles weighing 6,000 pounds or more are eligible for the 50 percent bonus depreciation, provided that the business use of the automobile is greater than 50 percent of its total use. Bonus depreciation does not apply where the business use of the automobile is not greater than 50 percent of its total use.
First-Year Expensing. The Act also increases the first-year expensing limitation under Code Section 179 for small business taxpayers electing to take an expense deduction from $25,000 to $100,000 for "qualified property" placed in service during the taxable year. The increased Code Section 179 expense limitation applies to "qualified property" placed in service for taxable years beginning in 2003, 2004 and 2005 (the $100,000 limitation will be indexed for inflation in 2004 and 2005) and will revert back to its pre-Act limitation of $25,000 for taxable years beginning in 2006 and thereafter. For purposes of the Code Section 179 expensing deduction, "qualified property" continues to be defined as new or used depreciable, tangible personal property that is purchased for use in the active conduct of a trade or business and includes "off-the-shelf" computer software placed in service during taxable years beginning in 2003, 2004 or 2005.
The Act raises the phase-out threshold for the Code Section 179 deduction to $400,000 (from $200,000) of "qualifying property" placed in service by the taxpayer during the year. Accordingly, if the aggregate cost of qualifying property placed in service during the year exceeds $400,000, the taxpayer must reduce the Code Section 179 expense deduction dollar-for-dollar by the cost of qualifying property placed in service during the taxable year exceeding $400,000. If the taxpayer places in service during the taxable year qualifying property costing more the $500,000, the taxpayer is not permitted to take a first-year expense deduction under Code Section 179, although the taxpayer will still be entitled to bonus depreciation to the extent that the property placed in service during the taxable year so qualifies. The Act provides that taxpayers may now make or revoke a Code Section 179 election on an amended tax return without securing the IRS' prior approval.
A Code Section 179 expense deduction may be taken in conjunction with a bonus depreciation deduction provided that the property qualifies under both provisions. However, not all property will qualify for both the 50 percent bonus depreciation and the $100,000 first-year expense deduction. In particular, the 50 percent bonus depreciation is permitted only for new property and there is no dollar limitation with respect to the amount of property placed in service during the taxable year, while a Code Section 179 deduction is permitted for new or used property and is subject to a dollar limitation with respect to property placed in service during the taxable year.

Observations: The Act dramatically increases the bonus depreciation and business expense deductions for businesses, especially small business taxpayers. The increased Code Section 179 expense deduction encourages taxpayers to maximize their tax savings by hand-picking qualified property against which to apply the $100,000 first-year expense deduction. In choosing such property, taxpayers should apply the expense deduction against qualified property with the longest recovery period in order to accelerate to the greatest extent possible the cost recovery of such property.

  • Corporate Estimated Taxes
The Act postpones the due date of the third quarter corporate estimated tax payment from September 15, 2003 until October 1, 2003.

Individual Income Tax Relief
  • Reduction of Marginal Income Tax Rates
The Act accelerates the reductions in the marginal income tax rates that were previously scheduled to occur in 2004 and 2006. Retroactive to January 1, 2003, the marginal income tax rates above the 15 percent tax bracket are 25 percent, 28 percent, 33 percent and 35 percent (from 27 percent, 30 percent, 35 percent and 38.6 percent, respectively). The rates are currently scheduled to sunset and revert back to the pre-2001 rates (28 percent, 31 percent, 36 percent and 39.6 percent) beginning on January 1, 2011. The Act also accelerates the increase to the taxable income level of the 10 percent income tax bracket for the 2003 and 2004 taxable years. The IRS has released updated income tax withholding schedules for employers and wage earners should expect to see an increase in their paychecks beginning no later than this July.

Observations: Since the marginal income tax rate reductions are retroactive to January 1, 2003, wage earners are encouraged to reduce (by filing with their employers a new Form W-4) the amounts that they have withheld from their paychecks to best take into account the prospective and retroactive nature of the rate reductions. Sole proprietors and taxpayers conducting business through pass-through entities such as partnerships, LLCs and S Corporations will also benefit from the marginal rate reductions. Taxpayers making estimated tax payments for 2003 may wish to adjust the amount of such payments to take into account the reduced marginal income tax rates, as well as the reduced dividend and long-term capital gain rates (discussed below).

  • Alternative Minimum Tax ("AMT") Relief
The Act increases the maximum AMT exemption amount to (i) $58,000 (from $49,000) for married taxpayers filing a joint return or for a surviving spouse, (ii) $40,250 (from $35,750) for unmarried taxpayers, and (iii) $29,000 (from $24,500) for married taxpayers filing a separate return. The increase in the AMT exemption amount applies to the 2003 and 2004 taxable years and, for taxable years beginning in 2005 and thereafter, the AMT exemption amount will revert back to its pre-Act amount.
  • Marriage Penalty Relief

For 2003 and 2004, the Act increases the amount of the standard deduction for married taxpayers filing jointly ($9,500 for 2003) to twice the standard deduction amount of single taxpayers. Beginning in 2005, the standard deduction for married taxpayers filing jointly will return to its pre-Act amount of 174 percent of the standard deduction for single taxpayers and will then gradually rise to double the amount for single taxpayers by 2009.

The Act also expands the maximum taxable income level for the 15 percent tax bracket for married taxpayers filing joint returns to twice the width of the bracket for single taxpayers for 2003 and 2004. Beginning in 2005, the maximum taxable income level for the 15 percent tax bracket will revert to its pre-Act amount of 180 percent of the level for single taxpayers.

  • Accelerated Increase in Child Tax Credit
The Act increases the child tax credit to $1,000 (from $600) per "qualifying child" in 2003 and 2004, accelerating the scheduled phase-in of the increase that was previously to have occurred between 2005 and 2009. For 2003, the increased amount of the child tax credit (up to $400 per "qualifying child") will be paid in advance by the IRS to taxpayers who claimed the credit on their 2002 federal income tax return (based on information provided in the 2002 return) with respect to each child who will not reach age 17 by December 31, 2003. The child tax credit will revert to its pre-Act amount beginning in 2005, which means that the child tax credit will be $700 in 2005 through 2008, $800 in 2009, $1,000 in 2010 and $500 for taxable years beginning after 2010.

Observations: The IRS will begin mailing the advance payments in July 2003 and hopes to have all advance payments distributed to qualifying taxpayers no later than October 2003 (with no advance payments being made after December 31, 2003). Taxpayers who receive an advance payment will reduce the child tax credit taken on their 2003 federal income tax return by the amount of the advance payment received. Taxpayers to whom a qualifying child is born during 2003 will be entitled to the full $1,000 child tax credit for 2003 to the extent that they so qualify. The Act did not change the income levels at which the child tax credit starts to phase-out ($75,000 for unmarried taxpayers, $110,000 for married taxpayers filing a joint return and $55,000 for married taxpayers filing separate returns).

The House and Senate has each passed a bill that would expand eligibility for the new $1,000 child tax credit to low-income taxpayers, although the bills differ as to whether low-income taxpayers would receive advance payment checks. Under current law, many low-income families pay too little in taxes to qualify for the child tax credit. The bills would also raise the phase-out amount for married taxpayers filing joint returns from $110,000 to $150,000 ($75,000 for married taxpayers filing joint returns), although when such an increase would occur varies between the current House and Senate bills. The two bills also differ with respect to the sources of funding for the increased scope of the child tax credit.

Tax Breaks for Investors
  • Reduction of Long-Term Capital Gains & Dividends Rates
Capital Gains. The Act lowers the long-term capital gains rate from 20 percent to 15 percent and from 10 percent to 5 percent for lower-income taxpayers (i.e., taxpayers in the 10 or 15 percent tax bracket). The reduced long-term capital gains rates are effective for sales or exchanges of most capital assets (e.g., stocks, bonds and other securities) occurring on or after May 6, 2003 and on or before December 31, 2008, which were held by the taxpayer for more than one year prior to their disposition. The higher capital gains rates still apply to sales of collectibles (taxed at 28 percent) and to unrecaptured depreciation on certain sales of real property (taxed at 25 percent). The Act also did not change the 28 percent capital gains rate that applies to 50 percent of the gain from the sale or exchange of "qualified small business stock" held by the taxpayer for more than five years (the other 50 percent not being subject to taxation). The 5 percent long-term capital gains rate for lower-income taxpayers drops to zero percent for the 2008 taxable year. Beginning on January 1, 2009, the pre-Act maximum long-term capital gains rate of 20 percent (10 percent for lower-income taxpayers) will return. The 15 percent maximum long-term capital gains rate also applies for AMT purposes. Additionally, as under current law, short-term capital gains (i.e., sales or exchanges of capital assets held one year or less) are subject to tax at the taxpayer's marginal income tax rate, which as discussed above is currently a maximum rate of 35 percent for taxable years through 2010. Deductions of capital losses against ordinary income also continue to be limited to $3,000 per year for individual taxpayers.
Dividends. The Act also provides that "qualified dividend income" will be taxed at a rate of 15 percent for dividends received by the taxpayer between January 1, 2003 and December 31, 2008. Dividends received by lower-income taxpayers will be taxed at a rate of 5 percent for dividends received between January 1, 2003 and December 31, 2007, with dividends received in 2008 not being subject to tax. Dividends not qualifying for the 15 percent tax rate will continue to be taxed at the taxpayer's marginal income tax rate. The 15 percent dividend rate also applies for AMT purposes
In order to be subject to the reduced 15 percent tax on "qualified dividend income," the security with respect to which the dividend is paid must have been held for more than 60 days during the 120-day period beginning 60 days prior to the ex-dividend date. Additionally, as is the case for long-term capital gains, dividends that qualify for the 15 percent rate are not treated as investment income for purposes of calculating a taxpayer's deductible investment interest under Code Section 163, unless the taxpayer elects to have the dividend income taxed at the taxpayer's marginal rate. Beginning on January 1, 2009, the pre-Act taxation of dividends return and dividends will be taxed as at the taxpayer's marginal income tax rate.

For purposes of the Act, "qualified dividend income" includes dividends received by individuals, trusts, or estates from (i) domestic corporations, (ii) "qualified foreign corporations," or (iii) non-qualified foreign corporations whose stock is traded on an established U.S. equities market. A "qualified foreign corporation" is an entity incorporated in any U.S. possession and generally includes any entity incorporated in a country with which the United States has entered into a comprehensive income tax treaty. A "qualified foreign corporation" does not include a foreign personal holding company, a foreign investment company, or a passive foreign investment company (a "PFIC"). The Act also provides that most dividends received from real estate investment trusts ("REITs") are not eligible for the 15 percent tax rate and will be taxed at the taxpayer's marginal income tax rate (this is the case as the income of a REITs is generally not subject to corporate taxation). The accumulated earnings tax under Code Section 531 and the personal holding company tax under Code Section 541 are reduced under the Act to 15 percent of accumulated taxable income and undistributed personal holding company income, respectively. The Treasury department is expected to issue guidance regarding the definitions of "qualified dividend income" and "qualified foreign corporation" for purposes of the Act.

Observations: With the spread between the maximum marginal tax rate for ordinary income (35 percent) and the tax rate for long-term capital gains and qualifying dividends (15 percent) now being 20 percent, recognizing long-term capital gains or dividend income rather than ordinary income becomes even more valuable to taxpayers in higher tax brackets. Therefore, taxpayers may want to reconsider the current allocation of their portfolio assets between interest bearing assets such as bonds and CDs and dividend paying stocks. For example, unless the interest rate on tax-exempt municipal bonds rise to take into effect the reduced tax on dividends, tax-exempt municipal bonds may prove less appealing to investors, although investors residing in states with high personal income tax rates may still favor tax-exempt municipal bonds over dividend paying equities. Taxpayers may also want to consider adjusting the assets held both inside and outside of their tax-exempt or tax-deferred retirement plans.

Under the Act, taxpayers borrowing money to fund their investments may find that less of their investment interest expense is deductible. This is due to the fact that any dividends subject to the 15 percent tax rate will not treated as investment income against which investment interest expense may be deducted, unless the taxpayer elects to have the dividend income taxed at the taxpayer's marginal rate. In some cases, owners of S corporations (with accumulated earnings and profits) and closely-held C corporations may take advantage of the reduced dividend rate under the Act by paying dividends and other non-wage distributions to their employee-shareholders, rather than taxable wage compensation subject to tax at ordinary income tax rates as well as FICA and other employment taxes.
Additionally, with the reduced tax rate for long-term capital gains and dividends, taxpayers may wish to consider using Uniform Transfer to Minors Act ("UTMA") or Uniform Gift to Minors Act ("UGMA") custodial accounts as an alternative to (or in conjunction with) state-sponsored 529 college-savings plans as a way to save for college. In particular, taxpayers with appreciated securities may want to consider transferring some or all of such appreciated securities to a custodial account established for their children who are age 14 or older or who will be age 14 or older (and exempt from the "kiddie" tax) when the securities are sold (securities may not be transferred to a 529 plan). Assuming that the securities are sold prior to 2009 and that the child is in the 10 or 15 percent tax bracket when the securities are sold, any long-term capital gains recognized on the sale will be taxed at only 5 percent (zero percent for sales during 2008), compared to the 15 percent tax on such income that would be paid by the parent.
However, besides tax planning, there are other important considerations when choosing between a 529 plan and a custodial account. For instance, withdrawals of gains from a 529 plan are tax-free only if they are used to pay "qualified tuition costs," while withdrawals may be made from custodial accounts for any purchase that benefits the child, such as a the purchase of a computer, travel or educational costs. Also, parents retain complete control over assets in a 529 plan for as long as such assets are in the plan and may generally switch the plan beneficiary, while with custodial accounts parents lose control of the account assets once the child reaches a certain age (usually age 18 or 21 depending on state law). We note that contributions to 529 plans and custodial accounts are generally subject to gift tax for contributions of more than $11,000 annually ($22,000 for married taxpayers), although each parent may generally contribute $55,000 to a 529 plan with no gift tax consequences provided as no other gifts are made to the child over the next five years.

State Relief
  • Temporary State Fiscal Relief Fund
The Act provides relief to States by establishing a temporary fund to provide $10 billion divided among the States to be used for essential government services, as well as providing an additional $10 billion to the States for Medicaid.