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INTRODUCTION
The Tax Jobs & Growth Reconciliation Act was signed into law in May 2003 and provides the third
largest tax cut in history and will certainly have a significant effect on your ultimate income tax liability.
These new rules concerning a wide variety of tax changes affecting individuals, families, investors and
businesses are in addition to the continued phase in of provisions of the Tax Relief Reconciliation Act of 2001
and the Jobs and Growth Tax Relief Reconciliation Act of 2002. The transition rules and current tax
legislation have made the tax code even more complicated. Be sure to review your year end tax planning
with us early enough in the fourth quarter to assure ample time to implement those strategies most important
to your particular situation. What has not changed is the "sunset provision" of the 2001 Act, that dictates
all of the law's provisions will expire after December 31, 2010. In other words, on January 1, 2011 all the
laws revert back to those in effect in 2000.
- Potential Tax Savings Under JGTRRA Table
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Taxable
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Income
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$100,000
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$250,000
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$500,000
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$1,000,000
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$3,000,000
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Filing
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Status
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Married Filing Jointly
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Married Filing Jointly
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Married Filing Jointly
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Married Filing Jointly
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Married Filing Jointly
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2003
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Tax Savings
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$2,176
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$5367
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$13,552
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$31,552
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$103,552
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INDIVIDUAL INCOME TAX RATE REDUCTIONS
Many tax rates have gone down this year, but income reported on a federal income tax return still can be subject
to several effective federal income tax rates. The rates now range from 10 % to 35 % on portfolio, passive and
ordinary income in 2003.
2003 Federal Tax Rate Schedule - Married Filing Jointly Table
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Taxable
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Income
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0
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$ 14,000
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$ 56,800
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$114,650
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$174,700
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$311,950
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Base
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Tax
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0
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$1,400
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$7,820
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$39,096
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$39,096
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$84,389
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Marginal
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Rate
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10 %
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15 %
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25 %
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28 %
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33 %
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35 %
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Many factors determine the tax rate you will pay on each piece of income these include whether:
- It is ordinary income or capital gain income,
- The alternative minimum tax (AMT) applies,
- The income is subject to employment taxes,
- The income is from a tax-deferred retirement account withdrawal, and
- Itemized deduction limitations and personal exemption phase outs apply.
One way to reduce taxes on ordinary income is to wisely time income and deductions. Look further for ideas on how
you might benefit from available strategies.
CAPITAL GAINS & DIVIDENDS
Capital gains and dividend income can be advantageous because they often are subject to lower maximum tax rates.
Beginning this year, net long-term capital gains and corporate dividend income are taxed at 15 % for both regular
tax and AMT:
- Money Market Mutual Funds that are not receiving Corporate Dividends,
- Estate investment Trusts
- Certain Mutual Fund Dividends
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Tax Rates on Capital Gains Table
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Tax Rate
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5 %
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10 %
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14 %
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15 %
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20 %
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25 %
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28 %
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35 %
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Ordinary Income Limit
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$14,000
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$14,000
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N/A
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N/A
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N/A
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N/A
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N/A
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N/A
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Holding Period
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12 Months - Post May 6, 2003 Sales
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12 Months - Pre May 6, 2003 Sales
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5 Years - Qualified Small Business Stock
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12 Months - Post May 6, 2003 Sales
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12 Months - Pre May 6, 2003 Sales
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12 Months - Gain on Depreciable Property
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12 Months - Collectibles
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Held less than 12 Months
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ALTERNATIVE MINIMUM TAX
Ordinary income subject to the AMT is taxed at a maximum rate of 28 %. This rate is lower than the highest regular
tax rate of 35 %, but it typically applies to a higher taxable income base when significant amounts of itemized
deductions and depreciation are taken. The AMT has begun to affect more taxpayers. Many deductions and tax
credits you can use to calculate your regular tax do not apply to the AMT. And some income differences might
trigger or increase your AMT liability rather than reduce it.
EMPLOYMENT TAXES
Social Security and Medicare taxes are assessed on your wages and self employment income. The amount of
income subject to Social Security tax is limited to $87,000 at 6.2 %, but all earned income is subject to
Medicare tax at 1.45 %. If you are considered to be self-employed, your liability doubles, because you also have
to pay the employer portion of these taxes.
PHASEOUT OF DEDUCTIONS
Personal Exemptions - You begin to lose a portion of your $3,050 personal and dependent exemption in 2003 as
your Adjusted Gross Income exceeds:
- $209,250 if you are married filing jointly
- $139,500 if you are single
- $104,625 if you are married filing separately
- $174,400 if you are head of household.
Reduction of itemized deductions- You must reduce your itemized deductions by 3 % of your AGI if your
AGI exceeds $139,500 ($69,750 if married filing seperately). But, the reduction cannot exceed 80% of these
deductions.
RETIREMENT ACCOUNTS
Retirement Plan Still Makes Sense
JGTRRA did not address retirement plans, but as a result of EGTRRA, you can increase your annual
contributions to many types of retirement plans. The main benefit of investing in most retirement plans
is that contributions typically are excluded from current taxable income and grow tax-deferred until
withdrawn. Some plans do not exclude your contributions but instead exclude your withdrawals. Either way,
you can have more available for retirement - or for your heirs.
Take advantage of plans available to you
Numerous retirement savings vehicles are available, with varying contribution limits, distribution rules and tax
treatments. Whether you can contribute to a specific type of plan depends on a variety of factors, including your
income, whether you are a business owner (or self-employed) or an employee, and what other retirement plans
to which you contribute. Typically, Keogh plans help small business owners save for retirement while reducing
taxes through deductible contributions and tax-deferred growth. These plans to which usually take one of two forms:
- 1. Qualified defined-contribution plan - This plan can be a qualified profit-sahring plan, qualified
- money-purchase pension plan, or both. The maximum Keogh plan contribution is the lesser of $40,000
- or 100% of your compensation. You now need only the profit-sharing plan to contribute the maximum.
- Because a money-purchase plan requires annual contributions in accordance with the plans formula, you
- should generally eliminate the plan by termination or merger to avoid the mandatory contribution and the
- separate annual filing requirement.
- 2. Qualified defined-benefit plan - This plan sets a future pension benefit and then actuarially calculates
- the contributions needed to attain the projected future benefit may exceed $40,000 based on your age and
- either your annual desired benefit or the maximum allowable benefit. The maximum annual benefit is $160,000
- or 100% of earned income, if less, is subject to a reduction of benefits will begin before age 62 and an increase
- if benefits will begin after age 65.
Whether you choose a defined-contribution or a defined-benefit plan, if you want to deduct contributions on your
2003 tax return, your Keogh plan must exist on Dec. 31, 2003. You then can make deductible profit-sharing plan
contributions as late as the due date of your 2003 income tax return, including extensions- October 12, 2004.
Be careful: Loans or the use of plan assets as security can disqualify a Keogh plan if made to or used for the benefit
of a sole proprietor or partner who is a more than 10% owner or an S corporation shareholder who is more than a 5%
owner. But these restrictions will not apply if the non owner participates are also offered the loans.
Establish a SEP after year end
Under a simplified Employee Pension (SEP) plan, you as the employer, make contributions to an employee IRA
increasing $1,000 annually until it reaches $15,000 in 2006. The maximum allowable SEP contribution is $40,000
annually, the same as a Keogh plan.
One advantage of a SEP is that you can establish it after Dec. 31, 2003, and deduct contributions on your 2003
tax returns even if made in 2004, as long as they are made by the due date of the 2003 tax return, including extensions.
Defer Salary with 401(k), 403(b) or 457 Plan
A 401(k) plan is a salary deferral plan that allows you as an employee, to elect to have a portion of your compensation
paid to a qualified trust under an employer-sponsered qualified deferred-compensation plan. The maximum employee
elective contribution for 2003 is $12,000. Both 403(b) and 457 plans contain similar provisions to 401(k) plans.
A 403(b) plan is for employees of public schools or tax-exempt educational, charitable and religious organizations.
A 457 plan is set up for employees of state and local governments and any other tax-exempt organization other than
a governmental unit or chuch organization.
Simplify with a SIMPLE
An employer with 100 or fewer employees who received at least $5,000 of compensation in the preceding year can
establish a Savings Incentive Match Plan for Employees (SIMPLE) as long as it generally doesn’t maintain any other
employer- sponsered retirement plan. A SIMPLE can take the form of an IRA or a 401(k) plan. Both plans allow
employees to contribute up to $8,000 (increasing $1,000 in2005) with the employer required to match that amount,
up to a maximum of 3 % of the employee’s compensation, subject to limitation. A 1 % match is permitted in two
years out of every five years.
Traditional IRA
Perhaps the most widely known retirement plan, a traditional IRA allows deductible contribution and tax-deferred
growth. As with the various qualified retirement plans, withdrawals (including your contribution amounts) are subject
to ordinary income tax. The maximum deductible contribution is $3,00 for 2003, increasing to $4,000 for 2005 and
to $5,000 for 2008 through 2010. But contributions for 2003 must be made by April 15, 2004, even if the date for
filing your tax return is extended.
Pay no Taxes on Roth IRA Distributions
The Roth IRA offers many advantages over a traditional IRA. For starters, though contributions are not deductible,
qualified distributions are tax-free – so you never pay any tax on the earnings – as long as the IRA has been open five
years and the distribution is made after age 59 1/2 (with only a few exceptions) Pre-age 59 1/2 and other nonqualified
distributions are treated first as a nontaxable return of your contributions, so nonqualified distributions that do not
exceed contributions are not taxed. But on amounts that exceed accumulated contributions, you’re subject to regular
income tax plus an additional 10% penalty on the nonqualified distributions. The tax-free distributions alone make
ROTH IRAs more advantageous than traditional IRAs in most cases, but the benefits don’t stop there. Another Roth
IRA difference is that original account owners are not required to take distributions beginning at age 70 1/2 – or ever.
Also unlike traditional IRAs, you can continue to contribute to a Roth IRA after you reach age 70 1/2, as long as you
have sufficient earned income.
And Roth IRA contributions (up to $3,000 less contributions to any other IRAs) can be made even if your
AGI is too high for a traditional IRA and you are covered by an employer-sponsored plan, as long as your AGI
does not exceed:
- $ 150,000 if you are married filling jointly, or
- $ 95,000 if you are single or head of household
ESTATE AND GIFT TAXES
Planning
The maximum tax rate assessed on gifts, bequests and generation-skipping transfers (GSTs) drops to 49% for 2003.
The gift tax exemption amount remains $ 1 million. The estate tax exemption is also $1 million for 2003, but it will
increase to $1.5 million for 2004. The GST Tax exemption amount has increased to $1.12 million for 2003 and will also
increase to $1.5 million for 2004. Further reductions are scheduled until 2010 (see Chart), when gift taxes are to be
assessed based on a gradtuated rate table with rates hanging from 18% to 35%. Also at that time, the estate and GST
taxes will disappear. But transfer taxes will return to 2001 rates in 2011 if no further legislation is passed.
If the estate tax is eventually repealed, the income taxes paid by your beneficiaries could increase and the estate
planning proces could be more complicated. One key provision of the planned estate tax repeal requires that the basis
step-up on assets aquired from a decedent will be treated as if the transfer were a gift. This means that your basis will
carry over to your beneficiaries, requiring them to pay capital gains taxes when they sell any appreciated assets they
inherited. A limited basis step-up will allow an aggregate basis of $1.3 million – $4.3 million if at least $3 million is
tansferred to a surviving spouse. And you can increase this allowable basis.
Make annual exclusion gifts. The annual exclusion allows you to make tax-free gifts up to $11,000 per year, per
individual ($22,000 if you are married and use a gift-splitting election), in 2003.
Mitigate medical and education costs. You can directly pay unlimited tuition and medical expenses free of gift
taxes to any person. This exclusion is in addition to the annual $11,000 gift exclusion and includes health insurance
premiums and tuition payments for nursery school through graduate school.
Trust strategies. Transfer future appreciation out of your estate at an immaterial, if any, gift tax cost by creating a
trust, such as a grantor retained annuity trust (GRAT). Also determine whether you can remove life insurance
proceeds from your estate by using an irrevocable life insurance trust (ILIT). Or diversify your portfolio with a
charitable trust to combine estate planning with your charitable desires.
Form a family vehicle. You can transfer a portion of your asset ownership to your beneficiaries by creating a family
limited partnership.
- Estate and Gift Transfer Tax Rates, Exemptions and Credits Under EGTRRA Table
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Estate Gift
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2003
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2004
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2005
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2006
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2007
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2008
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2009
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2010
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2011
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Gift
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49 %
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48 %
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47 %
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46 %
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45 %
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45 %
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45 %
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35 %
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