The new law spells relief for nearly all taxpayers. Here's how much you can expect to save.
Whether you love President Bush or hate him, chances are his new tax cut will bring you some savings. Politics aside, the Jobs and Growth Tax Relief Reconciliation Act of 2003, which passed Congress (barely) on May 23, has nothing but good news for taxpayers -- and many of the most important changes are retroactive to Jan. 1 of this year.
As expected, the main beneficiaries are married couples with children, investors, high-income folks and small business. But there's something here for almost everybody. (See the illustrative scenarios at the end of this story.)
In order to placate deficit hawks, all the new breaks were made subject to "sunset rules." So the tax goodies will vaporize in future years unless Congress takes action to extend them. That said, I think most or all of the favorable changes will be with us for some time. After all, members of Congress won't want to expose themselves to charges that they effectively enacted a tax increase by failing to renew expiring breaks. So Congress has painted itself into a corner here -- which is probably exactly what President Bush had in mind all along.
So what's in store for your tax bill? Read on to find out.
Breaks Almost Everyone Can Enjoy
Accelerated Individual Rate Cuts
First and foremost, the individual rate cuts included in the 2001 Bush Tax Cut legislation are accelerated. They now kick in effective on Jan. 1, 2003. Previously, they weren't scheduled to become effective until 2004 and 2006. Revised payroll-tax withholding tables for the second half of this year will reflect the new and improved 2003 rates:
Sunset Rule: Without further action by Congress, rates will revert to 15%, 28%, 31%, 36%, and 39.6% after 2010. The 10% rate would disappear altogether.
Wider 10% Bracket
The 10% rate bracket is widened retroactive to Jan. 1. Specifically, the 10% bracket is expanded by $2,000 for joint filers (from $0-12,000 of taxable income to $0-14,000) and by $1,000 for singles and married individuals who file separately (from $0-6,000 of taxable income to $0-7,000). This means more of your income will now be taxed at the low 10% rate unless you use head-of-household filing status. For heads of households, the 10% bracket covers the first $10,000 of taxable income, same as before.
Sunset Rule: Unless Congress takes further action, these changes would vanish after 2004.
At Long Last: Marriage-Penalty Relief
For years people have griped about having to pay higher taxes just because they got married. The new law doesn't completely eliminate the so-called marriage penalty, but it does deliver meaningful tax savings to joint filers and married persons who file separately from their spouses. Relief comes in the form of expanded 15% brackets and larger standard deduction amounts.
Here's the deal:
Child Credit Is Now $1,000
Effective this year, the tax credit for each under-age-17 dependent child, stepchild, foster child or grandchild is increased to a nice round $1,000 (up from $600). As before, the credit is phased out starting at adjusted gross income (AGI) of $75,000 for singles and $110,000 for joint filers. So, unfortunately, high earners are still ineligible.
If you are eligible, you probably won't have to wait long for your money. In July or August (or so they say), you'll receive a rebate check from the government. Based on information from your 2002 return, you'll be sent up to $400 for each child for whom you claimed a credit last year (provided the kid doesn't turn 17 before the end of this year). An estimated 25 million taxpayers will receive these child-tax-credit rebate checks. So if you haven't yet filed your 2002 return, try to do so ASAP: No return on file means no rebate check for you. Also, if your child was born this year, you'll have to wait and claim your tax credit when you file this year's return.
Sunset Rule: Unless Congress takes further action, the $1,000 credit will last only this year and next. If Congress does nothing, the credit drops to $700 in 2005.
For this year and next, the alternative-minimum-tax (AMT) exemption for joint filers is increased to $58,000 (up from $49,000). The exemption for unmarried persons increases to $40,250 (up from $35,750). The exemption for married-filing-separate status increases to $29,000 (up from $24,500). These larger exemptions are intended to prevent the AMT from eating up most or all of your tax savings from the new law.
Sunset Rule: Unless Congress takes further action, the AMT exemptions for 2005 and beyond will drop back to $45,000, $33,750, and $22,500, respectively.
Big Breaks for Investors
Qualified Dividends Now Taxed at 15% or Less
As you know, dividends have always been taxed as "ordinary income." That meant you paid your regular tax rate, which could be as high as 35% (formerly 38.6%).
That was then. Effective for all of 2003 through the end of 2008, qualified dividends from domestic corporations and qualified foreign corporations will be taxed at the same low rates as long-term capital gains. And those rates have been reduced, too (see below). Bottom line: The maximum rate on qualified dividends is now only 15%. And if you're in the 10% or 15% rate bracket (see the table above), your dividends will be taxed at only 5%. (For 2008, the rate will be 0%, but just for that one year.)
Here's the catch. To be eligible for the reduced rates on qualified dividend income, you must hold the stock on which the dividends are paid for more than 60 days during the 120-day period that begins 60 days before the ex-dividend date (the last date on which shareholders of record are entitled to receive the upcoming dividend). In other words, when you own shares only for a short time around the ex-dividend date, your dividend income will be taxed at your regular rate (up to 35%).
One more thing: The new low rates don't apply to dividends received in tax-deferred retirement accounts (traditional IRAs, 401(k) accounts, SEP and Keogh accounts, and the like). Dividends accumulated in these accounts will still be taxed at your regular rate (up to 35%) when withdrawn as cash distributions.
Sunset Rule: Unless Congress takes further action, dividends received after 2008 will once again be taxed at your regular rate.
Long-Term Capital Gains Now Taxed at 15% or Less
More good news for those who invest in taxable accounts: Long-term capital gains from sales on or after May 6, 2003, will be taxed at no more than 15% (down from 20%). If you're in the 10% or 15% bracket, you'll pay only 5% on long-term gains from sales on or after the magic May 6 date (0% in 2008, but only for that one year). However, it's not all peaches and cream.
Business Tax Breaks, Too
Section 179 Instant Depreciation Write-Off Increased to $100,000
For most businesses, the very best part of the new law is a huge increase in the Section 179 first-year depreciation allowance. This break allows you to instantly deduct 100% of the cost of most new and used business assets (other than real estate). However, the Section 179 deduction was limited to only $25,000. Under the new law, the annual allowance for 2003, 2004 and 2005 is increased to a whopping $100,000.
Bottom line: Most small businesses can now deduct the entire cost of their business equipment additions in Year One.
The new law also makes computer software eligible for the Section 179 allowance, which means 100% of cost can be deducted in Year One. (Previously, it generally had to be written off over 36 months.)
Sunset Rule: The Section 179 changes will vanish after 2005 unless Congress takes further action. If Congress does nothing, the Section 179 allowance will revert to $25,000 for 2006 and beyond.
Another First-Year Depreciation Break
The 2002 tax legislation introduced a first-year bonus depreciation deduction equal to 30% of the cost of qualifying new (not used) assets. This year's law kicks the bonus depreciation concept up a notch.
For qualifying assets acquired on or after May 6, 2003, and before 2005 (and placed in service before 2005), 50% of cost can be written off as depreciation in Year One. The remaining half is then written off over the years under the "standard" depreciation guidelines. Qualifying assets acquired before May 6, 2003, are still eligible for the 30% first-year bonus depreciation break. Remember: Both of these bonus depreciation breaks are available only for new assets.
Sunset Rule: Bonus depreciation will vanish after 2004 unless Congress takes further action.
More First-Year Depreciation for Business Vehicles, Too
If you use a car for business, you're painfully aware of the stingy depreciation rules. Previously, the maximum first-year depreciation write-off for a new (not used) vehicle placed in service during 2003 was $7,660.
Good news: The new 50% bonus depreciation rule has the favorable side effect of increasing the maximum first-year write-off to $10,710 for new (not used) vehicles acquired on or after May 6, 2003. For new autos acquired during 2003 but before May 6, the maximum first-year depreciation deduction remains at $7,660 (thanks to the 30% bonus depreciation rule). For used vehicles placed in service during 2003, the maximum first-year depreciation deduction is only $3,060.
Sunset Rule: Bonus depreciation will vanish after 2004 unless Congress takes further action.
Illustrative 2003 Scenarios: The New Law Compared With Previous Law