Roth IRA Advisor E-News

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1 ACCUMULATE WEALTH AND REDUCE TAXES June 2003 by James Lange, CPA, Esq. Pittsburgh, Pennsylvania On May 28, 2003, President Bush signed the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). The act includes: Reduced income tax rates Reduced tax on qualifying dividends Reduced capital gains tax Increased child care credit Mild alternative minimum tax relief Faster depreciation for small business Marriage penalty relief Revised tax brackets resulting in less tax A whole lot more The Bottom Line For most of my clients, the most important changes will be the changes in the income tax rates and the income tax brackets. Of less importance will be the break on tax dividends and capital gains because most of my clients have the majority of their investments inside IRAs and retirement plans. The current legislation does not have any direct impact on IRAs and retirement plans. Presumably, the impact will be felt in the increased value of your stocks, even if still in your IRA or retirement plan. For your convenience, we will be sending out an update of our Tax Reference Card with all the new income tax rates and tax brackets. You might want to recalculate your anticipated liability under JGTRRA and consider lowering your withholdings or estimated tax payments. You should, however, consider that there is also an adjustment to the withholding tables that will reduce the amount of tax withheld. We start with logical Action Points in response to the new legislation, move to the big picture and conclude with a short description of the changes. The source for much of this information comes from: CCH Tax Briefings, Special Report Tax I also want to alert you to a special radio broadcast at 7:30 p.m., Eastern Standard Time, June 11, 2003 on KQV 1410 AM (in the Pittsburgh area). I will be the guest of Ron Weiss on the Ar- 1

2 thur Lestrange Financial Forum. KQV also streams its broadcasts on the web at There are more particulars on the broadcast at the end of this newsletter. Action Points Charlie Smith, Chief Investment Officer of Fort Pitt Capital Group, comments on the impact of JGTRRA from an investment viewpoint. Everything in the investment world happens at the margin. This is a marginal change, not a sea change. At the margin, it makes stocks more attractive than bonds. We are not at the point, however, where the change in the tax law should drive the investment decision. Taxpayers should recalculate their anticipated liability with the new laws and consider lowering their withholdings or estimated tax payments. It is time to get married! There are no more excuses you ve waited long enough to avoid the marriage penalty. The change in the tax brackets and the increase in itemized deductions effectively eliminate the marriage penalty. Retirement plan, IRA and Roth IRAs owners: stay the course. We have run numbers and determined, even with the reduced taxes and the special dividend rate reduction, our timehonored advice to pay taxes later continues to apply. The most important exception to this rule stands as well: the Roth IRA and the Roth IRA conversion. If you are currently taking distributions, you will enjoy some of the benefits of this tax act. Traditional C corporation owners have even a higher incentive to switch to LLC or Subchapter S status. Profitable small businesses owners can enjoy greater depreciation benefits and if needed, should consider purchasing qualifying equipment. The real truth is the resulting tax code now has constantly changing income tax rates, income tax brackets, and other shifting provisions. These constant changes along with the uncertainty of the sunset provisions create massive uncertainty, and seriously hinder everyone s ability to do effective planning. The Big Picture This was one of the most contentious pieces of tax legislation ever passed. The House voted in favor, the Senate voted with the Vice President casting the tie-breaking vote. Both the House and the Senate voted primarily on party lines. The Committee that hammered out the differences between the House and Senate came up with a bill that was signed by President Bush on May 28 th. If you are one of fortunate 184,000 taxpayers making more than $1M per year, you can expect to see an average tax savings of $93,500 in If you are one of roughly 8,000,000 low and middle-income taxpayers, you will receive no benefits from the new legislation. Half of all households in the nation either will receive no tax cut or will get a tax cut of $100 or less. 2

3 The enormity of the change is difficult to comprehend. The $350 billion dollar number is misleading. Though billed as a $350 billion dollar cut, its true impact is far greater due to the sunset provisions. The technique, also employed widely under EGTRRA (Economic Growth Tax Relief Reconciliation Act of 2001), the first major tax cut signed by President Bush, is to make sweeping changes, but make the changes temporary. At the end of the term, the sunset provisions return the law to where it was before the changes. This sunset provision allows the master number-crunchers to cap the tax cut, while knowing that once the public becomes accustomed to the changes, future Congresses will find it difficult to fail to extend the many benefits of this bill. The total costs of the two most recent tax law acts, EGTRRA and JGTRRA, if extended beyond 2010, will be between $430 billion and $2.7 trillion by the year 2013, depending on which source you believe. JGTRRA is certainly not the first legislation to employ the sunset provision gimmick. Nonetheless, depending on which figures you believe and the specific way you define the terms, the magnitude of gimmicks in this legislation and President Bush's earlier tax cut (EGTRRA) exceeds that of prior administrations by a factor of 20 or more. One source for this newsletter, Center on Budget and Policy Priorities found at a group that obviously doesn t support the legislation as written. Opposing viewpoints are found at the Republican National Committee s web site, Among the winners are tax attorneys at the corporate level and income tax preparers at the individual level, courtesy of the enormous complications inherent in the JGTRRA. Producers of tax preparation software such as Turbo Tax or Tax Cuts should also get a boost as it will be harder and harder for individual self preparers to complete their tax return without the aid of computer software. Existing self-preparers using computer software may expect additional complications, but many of the changes will be seamless, and you will still be able to prepare your return. Short Descriptions of the Changes Capital Gains Reductions Capital gains rates fall from 20% to15% for higher income earners for qualifying property sold between May 6, 2003 through December 31, For lower income taxpayers, the current 10% rate falls to 5%. In 2008, there will be a zero percent capital gains for lower income taxpayers. Then, on January 1, 2009, the sunset provisions spring to life (maybe) and capital gains taxes will increase to prior levels. The big difference between the highest tax rate of 35% and the highest capital gains rate of 15% makes tax planning even more important. The five-year holding period created by EG- TRRA is effectively repealed. Reduced Taxation on Dividends Dividend income from a qualifying corporation will be taxed at a maximum rate of 15% for most taxpayers. Lower income individuals will pay tax on dividends at 5%. Many dividends will not qualify for the lower 15% rate. You can expect to see controversy and litigation over which dividends will qualify for special treatment and which will not. 3

4 Small Business Provisions Profitable business owners should plan for greater equipment purchases if that is the right move for your business. Section 179 property, specific property for which a business can purchase and depreciate 100% of the cost in the first year, increases from $25,000 to $100,000. In addition bonus depreciation will increase from 30% to 50% for qualifying property. Please note that only businesses purchasing more than $25,000 of qualifying equipment will receive any additional depreciation benefits. Child Tax Credit The new law boosts the credit from $600 to $1,000 per child for 2003 and 2004 for certain taxpayers. From , the credit will be $700, but then back to $1,000 in Based on your 2002 return, the IRS is planning on sending checks to taxpayers with children. The check will be $400 per eligible child. Please note that even though the law increases the credit from $600 to $1,000, the checks qualifying families can expect to receive is for $400. Qualifying taxpayers can request the additional $600 when they file their return. In order to qualify for the credit, taxpayers must fall within certain income guidelines. These guidelines were fiercely disputed and are the subject of the front-page story of the New York Times. The New York Times and the Center for Policy and Budget Priorities claimed that the income limitations on the new tax act unfairly excluded working poor taxpayers with children. The Wall Street Journal s editorial page disputed the claim. Just yesterday, June 5, 2003, (after I thought this newsletter was done), the Senate responded to widespread criticism by passing a new resolution changing the income limitations on the child tax credit. I will describe both the law as it stands today and provide a brief summary of the Senate resolution. It should be noted, however, that even though the Senate passed the new resolution 94-2, the Senate resolution is not law because it did not pass the House, nor is it signed by the President. What is relatively certain is that we will see additional changes in the limitations of which families will qualify for the child tax credit. The proposed changes increases eligibility for the child tax credit both on the low and high income ranges. First, the law as signed by President Bush is the current law. Before we get into the income limitations, let s do an easy example where the income limitation doesn t apply. A married couple with income of $60,000 has two children. Under pre JGTRRA law, the credit would be calculated as follows: 2 children times $600 or $1,200. Under post JGTRRA, the couple would receive the additional $400 credit per child for a total of $2,000. The IRS will mail this couple a check for $800 and they can claim the additional $1,200 when they file their tax return, IRS Form The child tax credit for married filing jointly is currently limited to 10% of your earned income above $10,500 or $600, whichever is lower. Thus many minimum wage earners will not enjoy any increase in the increased child tax credit and minimal, if any, income tax relief. 4

5 A married couple with earned income of $20,000 has two children. $20,000- $10,500=$9,500 times 10% = $950 or $475 per child. The limitation is the lower of the $475 or $600. Both under pre and post JGTRRA, the couple falls short of the limitation of $600 per child. Thus the current change in the tax law expanding the credit from $600 to $1,000 doesn t help or hurt this couple. The law as proposed in the Senate resolution would increase the limitation to 15% of your earned income in excess of $10,500 or $1,000 whichever is lower. New calculation: $20,000-$10,500=$9,500 times 15% = $1,425. The new proposed limitation of $1,425 would give this couple an additional $475 tax break. The Senate resolution also increases the income eligibility limit for married individuals on the upper income limits. The income eligibility limit for married couples will remain at $110,000 until 2008 when the limit will increase to $115,000. The limit will then remain at $115,000 until 2010 when the limit will increase to $150,000. For a detailed analysis of the phase-outs and political commentary on how even the Senate resolution is regressive, please see Marriage Penalty Income tax rates are decreased for married couples. The standard deduction for married taxpayers is increased from $7,950 to $9,500. For most of our readers, this change will not have any impact because you are currently itemizing your deductions. As with most of the provisions, this relief is only temporary. From a tax standpoint, it is probably wise for those individuals living together to get married now but consider getting divorced in 2005, depending on how much money you make and what happens with the sunset provisions. Things to Look Forward To Schedule of Tax Rates and Other Information to Follow We will be following up this with a separate containing the new rates and old rates as well other important tax information. It is an update of the extremely popular Jim Lange s Tax Reference Card. Upcoming Availability of Cutting Edge IRA Strategies CDs and Tapes On another note, we are excited about our recent workshop, Pay Taxes Later: Cutting Edge IRA Strategies. We taped that session as well as a series of related workshops and will be making CDs and tapes available to our readers. The workshops have information with the potential to significantly increase your financial security and if followed, almost certainly will have an enormous impact on the quality of life for your family after you are gone. The workshops are based on a lifetime of experience and research, and my most valuable recommendations have stood the test of peer review. We will be sending out a pre-release special in the next several weeks. I hope you will take advantage of it. 5