Highlights of Recent Tax Legislation
By Stewart Berger and Ben J. Bogdanowicz
Congress, after much debate, passed the Jobs and Growth Tax Relief Reconciliation Act of 2003, which contains major tax cuts for individual and business taxpayers. The legislation was signed into law by President Bush on May 28, 2003.
Tax rate reduction. The 2003 Tax Act accelerates the rate cuts that were enacted by the 2001 Economic Growth and Tax Relief Act. The highest rate for 2003 was 38.6%. The tax brackets under the 2003 Tax Act are 10%, 15%, 25%, 28%, 33%, and 35%. These tax rates, which are retroactive to January 1, 2003, are temporary and expire in 2011, at which point the 2000 tax rates return with a top bracket of 39.6%.
Marriage penalty relief. In the past, working married couples could face a higher combined tax on their joint income than they would if both were single. The act increases the 2003 standard deduction for joint filers from $7,950 to $9,500, and expands the upper limit of the 15% tax bracket from $47,450 to $56,800. These amounts are that of single taxpayers.
There will still be situations in which the marriage penalty will apply, such as with middle- and upper-income two-earner couples who make comparable salaries.
Child tax credit increase. Taxpayers with qualifying children under age 17 will receive an increased child care credit, from $600 to $1,000 per child. Taxpayers who qualified for the credit on their 2002 tax return received a check this past summer as an advance payment of the increased credit. Parents, stepparents, foster parents, or grandparents may qualify for the increased credit. It is refundable to the extent of 10% (15% in 2005 and thereafter) of the taxpayer’s earned income in excess of $10,500. The advance payment checks (up to $400 per child) were mailed July 25, 2003, based on information contained in the taxpayer's 2002 tax return.
The amount of the advance child tax credit will affect the computation of the child tax credit for the 2003 tax return. Taxpayers must reduce the claimed 2003 child tax credit by the advance payment received. The child tax credit begins to phase out for upper-income parents whose modified adjusted gross income exceeds $110,000 for joint filers, $75,000 for singles, or $55,000 for married couples filing separately.
Alternative minimum tax relief. The reduction in tax rates may expose a taxpayer to a greater risk of being subjected to the alternative minimum tax (AMT). Currently, AMT rates are 26% of the first $175,000 ($87,500 for married individuals filing separately) of alternative minimum taxable income in excess of an exemption amount, plus 28% of the remaining AMT income.
In order to partially relieve this exposure to the AMT, Congress has increased the exemption amounts for 2003 and 2004. The exemption amount rises from $49,000 to $58,000 for married couples filing joint tax returns. For single taxpayers, the exemption rises from $35,750 to $40,250. The exemption for married couples filing separately rises from $24,500 to $29,000.
As under prior law, the exemption is phased out by 25% of the amount by which an individual's AMT income exceeds $150,000 in the case of married individuals filing a joint return and surviving spouses, $112,500 for single individuals, or $75,000 in the case of married individuals filing separately or an estate or trust. The AMT income at which exemptions are completely phased out are as follows:
Capital gains tax rate reduction. The 2003 Tax Act reduces the capital gains rate for capital assets sold and installment sale payments received by May 6, 2003, and thereafter from 20% to 15%. Long-term capital gains that were taxed at a maximum rate of 10% under prior law (for individuals in a 10% or 15% tax bracket) will be taxed at a maximum rate of 5%.
The new reduced rates apply to assets held for more than one year, as well as to the AMT. Higher rates still apply to certain types of capital assets, like collectibles. The rates are temporary, and will revert to the pre–May 6, 2003, rates for tax years beginning after December 31, 2008.
Reduced taxes on dividends. Under the act, dividends received by an individual taxpayer may be taxed at the rate of 15% (5% for taxpayers in the 15% or 10% bracket). These rates apply to years beginning after 2002. In 2009, dividends will be taxed at the prior law’s ordinary income tax rates.
In order to benefit from the lower rate, a taxpayer must have owned a stock for at least 60 days of a 120-day period, beginning 60 days before the ex-dividend date. The reduced dividend rate cannot be used to offset dividends against investment interest expense for purposes of calculating the limit on the investment interest deduction. If a taxpayer elects to offset investment interest expense, the dividend income will be taxed at ordinary income tax rates.
Dividends received from a foreign corporation qualify for the lower rate only if the entity is one that has its stock traded on an established U.S. securities market, is subject to a tax treaty that meets certain qualifications, or is incorporated in a U.S. possession. IRC section 1246(b) foreign investment companies, IRC section 1297 passive foreign investment companies (PFIC), and IRC section 552 foreign personal holding companies (FPHC) do not qualify.
Dividends received from a regulated investment company or real estate investment trust qualify for the lower rate to the extent they represent pass-throughs of qualified dividends. Dividends received by an S corporation are not considered dividends but a distribution of previously taxed earnings. Dividends received by a shareholder prior to an S election may qualify for the reduced dividend tax rate. Under the act, the accumulated earnings and the personal holding company taxes are reduced to 15%.
Bonus depreciation. Under the 2003 Tax Act, bonus depreciation was increased from 30% to 50% for qualified assets acquired after May 5, 2003, and placed in service before January 1, 2005. Property that met the requirements for the 30% bonus will qualify for the 50% rate.
If a binding contract was in effect before May 6, 2003, the property will not qualify for the 50% bonus depreciation. If property qualifies for the 50% bonus depreciation, a taxpayer can instead elect the 30% rate. It may be beneficial to elect out, depending on a taxpayer’s ability to absorb the bonus depreciation.
Increased expensing for capital investment. The 2003 Tax Act increases the IRC section 179 write-off of qualifying tangible depreciable property from $25,000 to $100,000. The amount of property placed in service, used to compute the phase-out, is increased from $200,000 to $400,000. The increased expensing amount applies to property placed in service for the years 2003, 2004, and 2005. The election to expense may be revoked by the taxpayer on an amended return without permission from the IRS. The dollar limitations are to be indexed for years beginning in 2003. Off-the-shelf computer software is included as qualified property, subject to IRC section 179.
New York State Tax Changes
On May 15, 2003, the New York State Legislature, over the veto of Governor George Pataki, enacted legislation which provides for a variety of tax increases.
Personal income tax. The New York State Legislature passed a three-year temporary personal income tax increase for the years 2003, 2004, and 2005. The rate increases are as follows:
The 7.5% rate will be reduced to 7.375% in 2004 and 7.25% in 2005 (4.175% and 4.05% for New York City). For 2003 estimated taxes, taxpayers relying on the prior year’s safe harbor must recompute 2002 taxes using 2003 rates. Penalties will be waived for the April 15, 2003, installment.
Federal bonus depreciation. For corporate franchise and personal income tax returns, New York has decoupled from IRC section 179 expensing of the acquisition of sport utility vehicles for purchases made after 2002. The state also decoupled itself from federal bonus depreciation for purchases of applicable property placed in service on or after June 1, 2003, except with respect to qualified Resurgence Zone Property and qualified New York Liberty Zone property.
Nonresident withholding/estimated tax payments. Partnerships, LLCs, and S corporations having income from New York sources are required to make estimated tax payments for taxable years after 2002 on behalf of partners, members, and shareholders that are nonresident individuals or C corporations with respect to their pro rata share of such income. The highest tax rate is to be used for purposes of computing the estimated payment. A $300 per owner de minimis exception applies; exceptions also exist for certain group returns.
In November 2003, section 658 of the New York State Tax Law, which required S corporations and partnerships to make estimated tax payments on behalf of their nonresident shareholders and partners, was amended.
Each nonresident shareholder or partner must now file Form CT-2658-E or IT-2658E, an exemption certificate, with the corporation or partnership. The exemption certificate states that the nonresident shareholder or partner will comply with estimated tax provisions of New York State. The form does not have to be filed with the New York State Tax Department.
The estimated tax payment made by the entity on September 15, 2003, should be claimed as estimated taxes by the nonresident when the tax return is prepared.
Sales tax increases. Effective June 1, 2003, the New York sales tax and use tax rate has increased from 4% to 4.25%. The increase in sales and use tax is temporary and reverts back to 4% on June 1, 2005. Effective June 4, 2003, the New York City rate has increased to 4.375%, resulting in a combined state and local rate of 8.625%.
The state and local sales and use tax exemption on clothing and footwear for items sold under $100 has been eliminated from June 1, 2003, to May 31, 2004, and replaced with two one-week exemption periods in January and September.
LLC filing fees. The filing fees for LLCs and LLPs are increased from $50 to $100 per member, with a minimum fee of $500 (previously $325) and a maximum fee of $25,000 (previously $10,000). A single-member LLC, which previously was exempt from paying filing fees, will now have a filing fee of $100. These filing fees are applicable for tax years 2003 and 2004. The filing fees must be paid within 30 days after the last day of the taxable year, not by the return due date.
Edwin B. Morris, CPA
Rosenberg Neuwirth & Kuchner
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