INTRODUCTION 

The main thrust of this paper reviews the provisions of the Jobs and Growth Tax Relief Reconciliation Act of 2003 (the “Act”) affecting federal income tax.  This Act follows earlier tax-related acts in 2001 and 2002.  It is a far-ranging piece of legislation that provides approximately $330 billion in tax cuts and is viewed as the third largest tax cut in history.  The Act’s provisions primarily impact individual taxpayers, although there are some incentives to encourage business spending.  There are changes to income tax rates, capital gains rates, dividends, child tax credits, and the tax penalty on married couples.  Provisions that affect businesses include changes to depreciation on newly acquired business assets.   A few developments in Wisconsin taxation will also be reviewed near the end of this paper.

FEDERAL INCOME TAX DEVELOPMENTS

Ordinary Tax Rate Reductions

The Act accelerates the phase-in of certain marginal tax rate reductions that were enacted in the 2001 Act (EGTRRA).  The rate tables below reflect the accelerated tax rate reductions, the expansion of the 10% tax bracket, and the modification to the 15% tax bracket for married individuals filing joint returns.

The following tables show the tax saved at various levels of taxable income:

10% Tax Bracket

The Act increases the levels of taxable income subject to the 10% individual tax rate, beginning in 2003.

The tax bracket for heads of household does not change. The taxable income levels for the 10% tax bracket for taxpayers other than heads of household are adjusted annually for inflation in 2004, 2009, and 2010.

15% Tax Bracket

Generally, the 15% income tax bracket ends at the same level as under prior law. However, as part of marriage penalty relief, the upper limit of the 15% bracket for married individuals filing jointly is increased, beginning in 2003, to twice that for single taxpayers. For discussion, see Marriage Penalty Relief for 15% Bracket.

Other Tax Rate Reductions for Individuals

The prior-law rates of 27%, 30%, 35%, and 38.6% are reduced to 25%, 28%, 33%, and 35%, respectively, for years beginning in 2003. The tax bracket thresholds for the new rates are the same as under prior law.

In 2011, the rates will return to pre-EGTRRA levels. The tax rate brackets, except for the 10% bracket, will continue to be indexed for inflation

CAPITAL GAINS RATES

The Act establishes a maximum tax rate of 15% on net long-term capital gains for individuals, trusts, and estates.

For capital gains, the 15% maximum tax rate replaces the prior-law general 20% maximum rate (and the 18% rate that would have applied to gains from property that was held for more than five years and whose holding period began after 2000). Thus, an individual's net capital gain will be taxed at a maximum rate of 15% to the extent it is a net gain on assets held more than 12 months.

A lower maximum rate of 5% applies to net long-term capital gains that would otherwise be taxed at a regular income tax rate less than 25% (i.e., gain otherwise taxed in the 10% or 15% income tax brackets). In 2003, under the Act, the 5% rate applies to taxable income of up to $28,400 ($56,800 on a joint return).

In the tax year beginning in 2008, the maximum rate for net long-term capital gains (otherwise eligible for the 5%) rate will be zero. The Act repeals the 10% maximum rate that applies to gains that would otherwise be taxed at a rate below 25% (and the 8% maximum rate on assets held more than five years).

The new maximum rates are effective for gains properly taken into account after May 5, 2003. The prior-law maximum rates apply through May 5, 2003. Generally, the date of an asset's sale or exchange determines which maximum rate applies. Gain from installment sales is recognized on the date a payment is received. In the case of a pass-through entity, the date that gain is accounted for is determined at the entity level.

As under prior law, gains on collectibles and "qualified small business" stock and certain gains on real property are not eligible for the 15% or 5% rates, but are subject to a maximum tax rate of 28% (25% on "unrecaptured section 1250 gain" on real property).

The 15% (and 5%) maximum tax rates also apply in computing alternative minimum tax (AMT). In computing AMT, gain on "qualified small business" stock generally is taxed at approximately 15%.

DIVIDENDS

The Act extends the 15% (or 5%) maximum net long-term capital gains tax rate to dividends received from corporations. The 15% (or 5%) maximum rate applies to dividends received by individuals, trusts, and estates that are included in income in tax years beginning after 2002 and before 2009 (in 2008, a zero rate will apply to dividend income otherwise eligible for the 5% rate).

The Act does not change the definition of a dividend (i.e., generally a distribution with respect to a corporation's stock from its earnings and profits), and all the tax rules defining "stock" are taken into account.

Dividends paid on both common and preferred stock qualify. However, a dividend generally is not eligible for the 15% (or 5%) rate if the stock is held for 60 days or less. More specifically, the stock must be held for more than 60 days during the 120-day period beginning 60 days before the date the stock becomes ex-dividend with respect to the dividend; a longer holding period may apply to certain preferred stock dividends or if the shareholder's risk of loss is protected. Also, a dividend is not eligible for the lower rates if the shareholder has an obligation to make related payments on certain other property -- for example in a short sale.

The reduced rate applies to dividends from a:

• Domestic corporation
• Foreign corporation if its stock is readily tradable on an established U.S. securities market
• Foreign corporation that is incorporated in a possession of the United States
• Foreign corporation that is eligible for benefits under a comprehensive income tax treaty with the United States which the Secretary determines is satisfactory for this purpose, and that includes an exchange of information program

Notwithstanding these rules, the reduced rate does not apply to dividends paid by a foreign corporation that in the current or preceding tax year was a foreign investment company, a passive foreign investment company, or a foreign holding company.

Under prior law, U.S. taxpayers receiving dividends from foreign corporations could be allowed a credit for foreign taxes paid on such dividends. The Act reduces the foreign tax credit allowed against U.S. taxes imposed on dividends eligible for the reduced rate.

Special Rules

Dividends from an entity (including a farmers' cooperative) that is tax-exempt in the year of the distribution, or the prior year, do not qualify. Amounts characterized as "dividends" on deposits from certain financial institutions and dividends paid on certain employer securities in a retirement plan are not eligible for the 15% (or 5%) maximum rate.

In limited circumstances, dividends received from regulated investment companies (RICs), such as mutual funds, and real estate investment trusts (REITs) may be eligible for the 15% (or 5%) rate when taken into income by a non-corporate shareholder. If less than 95% of certain gross income of the RIC or REIT consists of qualifying dividend income, the entity must designate the amount of its dividends to which the shareholder can apply the 15% (or 5%) maximum rate. Dividends received by a RIC or REIT before 2003 but distributed to its shareholders in 2003 or later are not eligible for the reduced rate.

The Act provides that if an individual receives an extraordinary dividend, any loss on the underlying stock is treated as a long-term capital loss to the extent of the dividend. An extraordinary dividend is, generally, one whose amount exceeds 10% of the shareholder's basis in the stock.

As under the prior-law maximum rate provisions for capital gains, dividends are not eligible for the 15% (or 5%) rate to the extent the taxpayer elects to treat them as investment income for purposes of determining the deductible amount of investment interest expense.

The 15% (and 5%) maximum tax rates also apply in computing alternative minimum tax (AMT).

Even though they may be taxed at a lower rate, dividends and capital gains are still "counted" in computing adjusted gross income (AGI). Thus, they are taken into account in determining the reductions in itemized deductions and personal exemptions, and limitations and phase outs of various personal tax credits, exclusions, and deductions.

Corporate-Level Changes

The Act does not change the treatment of dividends received by corporations. A corporation is eligible for a deduction equal to 70%, 80%, or 100% of certain dividends received from other corporations, depending on the source and ownership interest in the payor. However, the Act reduces the accumulated earnings tax and personal holding company tax imposed on certain corporate earnings to 15%, and repeals the collapsible corporation rules, effective for tax years beginning after 2002.

Effective Date

The changes to the maximum tax rate on dividends apply for tax years beginning after 2002 and before 2009. Thus, in 2009, the law reverts to a maximum rate of 35% on dividends.

CHILD TAX CREDIT

The Act increases the child tax credit to $1,000 per child for 2003 and 2004. Under prior law, it was $600 for 2001 through 2004, and $700 in 2005.

The increase in the credit in 2003 ($400 per child) will be paid to taxpayers during 2003 in the form of an advance refund. Most taxpayers automatically will receive a check based on filing status and income shown on their 2002 returns.

For example, a married couple filing a joint return with two eligible dependent children and adjusted gross income in 2002 below the threshold (in this example, $110,000) will receive a check in 2003 for $800. The Act directs the IRS to issue refund checks before October 1, 2003. Taxpayers who receive an advance refund will need to reduce the amount of the child credit allowed on their 2003 return by the amount of the refund (but will not be required to refund any excess over their actual 2003 credit).

MARRIAGE PENALTY RELIEF FOR 15% BRACKET

Under prior law, except for the highest tax bracket, the tax rate bracket breakpoints for married couples filing joint returns were 167% of the rate bracket breakpoints for single individuals.  The 2003 Act increased the size of the 15% regular income tax rate bracket for joint returns to equal twice the 15% regular income tax rate bracket for single returns for tax years 2003 and 2004.  For taxable years beginning after 2004, the applicable percentages revert to those allowed under prior law, with a phased in increase.  Like many other provisions under the Act, in 2011, the breakpoint would revert back to 167% resulting in the same marriage penalty as we had in the past.  The brackets above 15% are not changed by this provision, so there is still a marriage penalty for taxpayers in the higher brackets.

For 2003 and 2004, the upper limit of the 15% income tax bracket for married individuals filing jointly is increased to twice that for a single taxpayer. For 2003, the 15% tax bracket for married couples is increased from $47,450 to $56,800.

 STANDARD DEDUCTION MARRIAGE PENALTY RELIEF

The 2003 Act accelerates the increase in the basic standard deduction for married taxpayers filing a joint return to 200% of the basic standard deduction for single individuals for 2003 and 2004.  For taxable years beginning after 2004, the relationship between the standard deduction for joint filers and single filers reverts to prior law.  The increase standard deduction provides no benefit for married taxpayers who have itemized deductions that exceed the increased standard deduction. The standard deduction (for all taxpayers) will continue to be indexed for inflation in future years.

CHANGES AFFECTING BUSINESSES

SPECIAL DEPRECIATION ALLOWANCE FOR CERTAIN PROPERTY

The 2002 Act provided for 30% bonus (increased first-year depreciation) on qualifying property purchased after September 10, 2001.  The 2003 Act increased the additional first-year depreciation from 30% to 50% for assets purchased after May 5, 2003, and before January 1, 2005.  To qualify for the 50% bonus depreciation, the following four requirements must be met: 

1.                 Assets must be property to which MACRS (Modified Accelerated Cost Recovery System) applies for depreciation purposes with a class life of 20 years or less, computer software that can be purchased off-the-shelf, or qualified leasehold improvements.

2.         Original use of the property must begin after May 5, 2003

3.         Purchase or a binding contract must occur after May 5, 2003

4.         The property must be placed into service before January 1, 2005.

Listed property used 50% or less in trade or business does not qualify for the bonus depreciation.

       Example:

Depreciation deductions that a taxpayer may take each tax year on an investment of $1,000 in qualified property, for 5-year property, assuming a half-year convention applies, are as follows:

The 2003 Act also increases the first-year Section 280F limitation on the amount of depreciation deductions allowed with respect to certain passenger automobiles by $7,650 (in lieu of the $4,600 provided under 30% bonus depreciation). 

Taxpayers may elect out of the of both additional first year depreciation provisions.  They can also choose between 30% or 50% additional depreciation for assets purchased after May 5, 2003 and before January 1, 2005.  This gives taxpayers a great deal of flexibility in tax planning.

INCREASED SECTION 179 EXPENSING

The Act raises the limit on the amount of tangible personal property a taxpayer may elect to expense -- rather than depreciate -- each year under section 179 to $100,000 a year, for property placed in service in a tax year beginning in 2003 through 2005. This limit is indexed for inflation for property placed in service in tax years beginning in 2004 and 2005. The limit reverts to $25,000 for property placed in service in tax years beginning after 2005.

The Act also raises the threshold at which the $100,000 limitation begins to phase out, so that a taxpayer that places more than $400,000 of section 179 tangible personal property in service in a tax year beginning in 2003 will have a reduced limitation (phased out entirely when such investment reaches $500,000). The $400,000 threshold also is indexed for inflation in tax years beginning in 2004 and 2005, but reverts to the prior-law threshold of $200,000 for property placed in service in tax years beginning after 2005.

Off-the-Shelf Software

The Act makes off-the-shelf computer software eligible for the expensing election. Off-the-shelf software is computer software that:

• Is readily available for purchase by the general public
• Is subject to a non-exclusive license, and
• Has not been substantially modified

Such purchased software otherwise is amortized, generally, over a 36-month period, and would be eligible for bonus depreciation. Investment in such software is counted in determining the phase out of the $100,000 expensing limitation.

The Act also permits taxpayers to make or revoke a section 179 election on an amended return for the year the asset was placed in service, without obtaining the consent of the IRS. However, any revocation of an earlier election is irrevocable.

WISCONSIN TAX DEVELOPMENTS

Wisconsin follows the Internal Revenue Code as of December 31, 2002; therefore, there may be some adjustments required on a taxpayers Wisconsin Schedule I to adjust Federal AGI to the amounts allowable for Wisconsin tax purposes.  Some notable differences include a Wisconsin limit of $25,000 for Section 179 expensing, no 30% or 50% bonus depreciation, depreciation limits on automobiles of $3,060, and prevention from using the installment sale method.

Under current law, multistate businesses generally determine the amount of net income attributable to Wisconsin using a three-factor formula.  The sales factor represents 50% of the formula and the property and payroll factors each represent 25% of the formula.  Insurance companies use an apportionment formula based on the average of a premiums factor and a payroll factor.  A transition will take place so that for taxable years after December 31, 2007, the apportionment formula will be composed 100% on the sales factor.  For insurance companies, the formula will be composed of the premiums factor.

The state is beginning to require some large out-of-state companies that sell products to Wisconsin to register and remit sales tax or use tax to Wisconsin.  In an effort to pressure companies into registering and collecting the tax, the Wisconsin Department of Administration and certain designated purchasing agents, agencies, and authorities may not contract for the purchase of materials, supplies, equipment, or contractual services with companies that fail to register.  This provision will apply generally to Fortune 500 type companies initially, but may be expanded later on in an effort to collect more revenue.

The state, counties, and municipalities of Wisconsin continue to look for additional revenue and sales tax continues to be a focus.  Following the lead of many other counties, Wood County adopted a  % sales tax that went into effect in January of 2004.

Taxpayers should be aware that for deaths after September 30, 2002 there is a Wisconsin estate tax exemption equivalent of $675,000 which may create tax liability for estates that would not be subject to federal estate tax.  The federal estate tax exemption equivalent rose from $1 million in 2003 to $1.5 million for 2004 and 2005.  Taxpayers that have an estate valued above $675,000 should have their estate plan reviewed to ensure it is consistent with the recent changes in Federal and Wisconsin estate tax laws. 

CONCLUSION

The 2003 Act provides reduced income tax liability, particularly for individuals.  One concern with the new legislation lies with its automatic sunset provisions.  Without an act of Congress, many of the Act’s favorable individual taxpayer provisions would end after 2004; the dividend and capital gains tax reductions would end after 2008; and the individual tax rate cuts would expire after 2010 – with those rates then reverting to the higher levels applicable before July 1, 2001.  Many politicians consider that unlikely to occur because it might be viewed as a tax increase.  Others; however, believe it will largely depend on the state of the economy. 

My intent is to provide a general understanding of the Act’s provisions.  It has been necessary to omit certain content that may be important to you or another taxpayer.  As such, I recommend that you contact your accountant and/or attorney for additional information that may be relevant to you and to fully understand how the changes may affect your particular circumstances.

REFERENCES

“2001 Act” refers to the Economic Growth and Tax Relief Reconciliation Act of 2001. 

“2002 Act” refers to the Job Creation and Worker Assistance Act of 2002. 

Grant Thornton, The Jobs and Growth Tax Relief Reconciliation Act of 2003. 

Kleinrock’s TaxExpert, Total Tax Office, July 2003. 

KPMG, The Jobs and Growth Tax Relief Reconciliation Act of 2003. 

“Section” refers to the Internal Revenue Code of 1986, as amended. 

Wisconsin Tax Update, Wisconsin Department of Revenue, 2003 CLEW Tax Workshop.