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Tax Bill Gives, Then Takes Away To Balance Tax Cuts, Budget Concerns, Says CCH

(RIVERWOODS, ILL., May 23, 2003) – The just-passed Jobs and Growth Tax Relief Reconciliation Act of 2003, due to be signed into law next week by President Bush, will benefit almost everyone who pays taxes, although some groups will see much more effect than others, according to CCH INCORPORATED (CCH), a leading provider of tax law information and software. Traditional families with children and investors will gain the most, single taxpayers with no capital gains or dividends the least, although no one should be worse off under the new law. Owners of small businesses will receive tax incentives to purchase more equipment, although the degree to which they will take advantage of them is open to question.

Timing is a theme running throughout the new law, which amends some 25 sections of the Internal Revenue Code. Some provisions will take full effect, then recede with passing years, then build back again, like a tide. Others will "sunset" and disappear from the tax code at some date unless a future law extends their life. The limited duration of many key provisions lowers the cost of the Act, striking a balance between the aggressive tax-cutting originally proposed by President Bush and congressional concerns about budget deficits.

A major component of Bush’s original plan was the elimination of income tax on shareholder dividends. In the compromise that emerged in Congress, taxes will be lowered on both capital gains and dividends. For 2003 through 2008, both will be taxed at 15 percent for taxpayers in what will be the 25-percent and higher brackets. For those in the 10- and 15-percent brackets, capital gains and dividends will be taxed at 5 percent in 2003 through 2007, then at 0 percent in 2008. (For capital gains, the rates will apply to transactions on or after May 6, 2003.)

"The change in the treatment of dividends is striking," said Mark Luscombe, an attorney, CPA and CCH principal tax analyst. "Currently, a dollar of capital gains receives favorable tax treatment, while a dollar of dividends is taxed as ordinary income. The equality of treatment under the new law may change people’s investment preferences and even the decisions of corporations on whether they will pay dividends."

In 2009, the lower rates "sunset" and the tax on capital gains will revert to their current 20 percent and 10 percent rates.

"This will undoubtedly be portrayed by some as a ‘tax increase’ when it looms closer on the horizon," Luscombe noted. "Of course, much of our current tax law is already due to ‘sunset’ after 2010, with dozens of tax rules being rolled back to their 2001 versions."

At the low end of the income scale, relatively few tax returns report any dividends in the first place. On year 2000 returns, only one taxpayer in seven with income under $20,000 reported any dividends, and only 20 percent of returns with income of less than $75,000 showed any dividends. By contrast, 87 percent of returns with $200,000 or more in income reported dividends. Although many people hold stocks in their 401(k) and other retirement accounts, the dividends from them are not taxed now and therefore would not be affected by the plan.

But those individuals who do receive dividends report significant amounts, given their income levels. Taxpayers with less than $20,000 in income who have dividends report an average dividend income of $1,385, while those with incomes between $50,000 and $75,000 who have dividend income report an average of $2,914. But taxpayers with little income already pay little in tax on their dividend income, and would pay even less under the proposed rate reductions, so their direct savings from the elimination of dividend taxation will be relatively modest.

"It is undoubtedly those with tens of thousands of dollars in dividend income – who, not surprisingly, tend to have a lot of income, period – who will benefit the most, and most directly, from this element in the new law," Luscombe said.

The Act will benefit a wide range of individuals by speeding up provisions in 2001 tax legislation that were due to take effect between 2004 and 2010. The benefits will be spread around, but high-income taxpayers, married couples and especially married couples with children who qualify for the child credit will benefit the most.

An expansion of the 10-percent bracket will reduce taxes for anyone currently above the 10-percent bracket except someone filing as head of household who currently has income taxed above 10 percent. There is additional rate relief for those in the 27-percent and higher brackets. This relief will begin immediately and remain in effect through 2010.

Married taxpayers will see a significant expansion of the amount of income included in the 15-percent tax bracket as part of the "marriage penalty relief" in the 2001 tax bill that is being fast-forwarded to 2003. The top end of their 15-percent bracket rises from $47,450 under current law for 2003 to $56,800 – twice that of single taxpayers. The size of the standard deduction for those filing jointly also increases, so that it, too, will be double that of a single taxpayer. For 2003, the increase is from $7,950 to $9,500.

But this amount of relief will be short-lived. In 2005, the top of the 15 percent bracket will be only 180 percent of the single-taxpayer amount, while the standard deduction will be only 174 percent of the standard deduction for single filers. Then both percentages will increase over a number of years until they once again equal 200 percent of the single amounts.

An increase in the child credit from $600 to $1,000 for 2003 and 2004 will have an especially large effect for low- and moderate-income taxpayers, since the credit wipes out taxes dollar-for-dollar and can even be refundable.

"Many families with moderate incomes will find that their federal tax obligation will shrink to zero, or a very modest amount, once all the provisions are added together, and a greater number of low-income families should receive a check, rather than a tax bill," Luscombe observed.

In fact, the Treasury plans to mail refund checks this summer to parents who would appear to be eligible to claim the credit on their 2003 taxes.

But the credit will shrink to $700 for 2005 through 2008 before rising to $800 in 2009 and $1,000 in 2010.

"As with the dividend and capital gains provisions, there will probably be a lot of talk about ‘tax increases’ for married couples and families with children in 2005, even though the ‘increase’ will simply be a reversion to current law," Luscombe noted.

Single taxpayers without children or investment income will benefit much less dramatically under the new law. Although most of them also will see their taxes trimmed through rate reductions, the Act has nothing for them that compares with the dramatic tax-lowering provisions affecting married couples and families with children.

"The provisions favoring families are already part of the law, but accelerating the provisions will make that pro-family bias even more evident," Luscombe said.

The Act has two measures designed to encourage business spending on new equipment. One is an increase in the amount that small businesses can "expense," or immediately write off, from $25,000 to $100,000. The threshold at which the expensing amount is reduced is changed from $200,000 to $400,000. Businesses can also make use of "bonus" depreciation of 50 percent on qualifying equipment purchased on or after May 6 of this year through the end of 2004. These provisions can have a measurable impact on the bottom line, but CCH small business analyst Paul Gada, JD, believes they will depend on other factors to have full effect.

"Business owners generally don’t incur expenses just so they can take a tax deduction. They are likely to spend only when they’re fairly confident that the expenditure will lead to more sales and profits. Making it easier to deduct expenditures for equipment may stimulate the economy, but a stronger economy may itself be the key factor that encourages businesses to spend," Gada said.

"Business owners also will directly benefit from the reduction in marginal tax rates, since their business income will be taxed at those rates if they operate as sole proprietors, partnerships, or similar "flow-through" types of entities," he added.

Additional information on the new law, including taxpayer scenarios and how the plan changes tax brackets and rates can be found at cch.com/tax2003.

CCH INCORPORATED, headquartered in Riverwoods, Ill., was founded in 1913 and has served four generations of business professionals and their clients. The company produces more than 700 electronic and print products for the tax, legal, securities, insurance, human resources, health care and small business markets. CCH is a Wolters Kluwer company. The CCH tax and accounting destination site can be accessed at tax.cchgroup.com.

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2003 Tax Legislation: Law, Explanation and Analysis; 2003: Tax Legislation: Explanation and Analysis; 2003: Tax Legislation: Highlights. Contact Leslie Bonacum, 847-267-7153 or mediahelp@cch.com; or Neil Allen, 847-267-2179, allenn@cch.com.