What Might the New Tax Laws Do for You? Deric C. Bowden, MBA According to the U.S. Treasury department, the newly enacted Jobs and Growth Tax Relief Reconciliation Act of 2003 will give 91 million Americans an average tax cut of $1,126 in 2003. That's great news for many taxpayers, but the new changes are designed to serve as more than just a tax cut. (Source: U.S. Treasury news release, May 22, 2003.) As the bill's name implies, the tax relief act is also an economic stimulus package intended to spur jobs and economic growth and generate sweeping changes in the way companies behave and Americans invest. Removing Certain Tax Consequences For investors, one of the centerpieces of the new act is a reduction in the taxes that shareholders pay on corporate dividends and long-term capital gains. Under previous tax laws, corporate dividends were essentially taxed twice. Companies paid federal tax when they earned the money used to pay dividends, and shareholders paid regular income taxes on the same money when dividends were distributed. Long-term capital gains were taxed at their own rate - generally at 10% for taxpayers in the lowest tax brackets (10% and 15%) and 20% for those in higher tax brackets. Under the new rules, both qualifying dividends and long-term capital gains are taxed at significantly lower rates - 5% for those in the 10% and 15% brackets, and 15% for those in the higher brackets. So, under the new law, if you're in the 15% tax bracket and receive a qualifying corporate dividend of $100, you'll owe $5 in federal income taxes. Previously, you would have owed $15, or three times as much, because the old rules required dividends to be taxed at your regular income tax rate. Putting the Focus on Long-Term Investing By making dividend-paying stocks more attractive, lawmakers are hoping to draw reluctant investors back into the market. In theory, if investors seek out the growth potential of dividend-paying stocks, publicly traded corporations will be pressured to pay dividends. With more companies paying dividends, investors, in turn, might start to rely on more of a long-term investment philosophy - one in which shareholders stay in the market to benefit from predictable returns on their investments, which can be realized in the form of dividends. Promoting Stronger Corporate Solvency Lawmakers also hope that changes to the dividend tax rules will lead to reforms in the way corporations conduct themselves. The intent is to put more of an emphasis on responsible corporate governance, so companies are focused less on the potential economic benefits of short-term increases in stock price. "It's hard to pay dividends unless you've actually got cash flow," said President Bush at a White House signing ceremony for the tax relief bill. "The days when people could say, 'Invest with me because the sky's the limit,' will be changed by dividend policy. It's hard to promote the sky being the limit and pay dividends unless you're actually profitable and have cash flow." In order to pay dividends, companies need to maintain a high level of solvency. The new law is designed to encourage companies to build on the foundations of good business principles and grow according to reasonable success models - unlike the models of some recently failed companies, such as Enron. Typically, once a company begins paying a dividend, it is loath to reduce or stop the dividend, so investors often take dividends as a good-faith sign of a company's long-term prospects. Tax Savings for Small Businesses The new tax act isn't just for big corporations. Certain provisions related to business expenses will help America's 23 million small business owners. In fact, the U.S. Small Business Administration (SBA) reports that the new bill will provide approximately $9.7 billion in tax relief to small business owners. (Source: SBA news release, June 13, 2003.) The key provisions are designed to help small businesses buy more equipment by quadrupling the amount - from $25,000 to $100,000 - a small business can immediately expense for new business assets, such as computers, that are purchased in a tax year. So, for example, a small business can now buy computers and other office equipment and write off up to $100,000 of the cost in the first year, provided the company's total equipment purchases for the year don't exceed $400,000. Both the $100,000 and $400,000 amounts will increase to keep pace with inflation. Under previous rules, only the first $25,000 of purchases could be deducted as a business expense. The temporary rule will apply to tax years beginning this year, as well as in 2004 and 2005. In addition, the type of equipment that can be expensed immediately has been expanded to include off-the-shelf computer software. This change is designed to encourage small business owners to purchase the technology, machinery and other equipment they need to expand. Estimates are that more than 500,000 businesses will directly benefit from this change. (Source: SBA news release, June 13, 2003.) Also under the new rules, depreciation schedules for longer-term assets, such as business vehicles, will be accelerated. The changes include an increase on the additional first-year depreciation percentage to 50% and an increase in the first-year depreciation limit for certain automobiles, used in business, to approximately $10,710. Your Next Move As you evaluate the changes brought about by the new tax laws, weigh your options carefully. Before you alter your current portfolio or mix of assets, be sure you're considering the potential drawbacks and benefits of each investment. It's a good idea to review your investment plans with a professional tax planner and a qualified financial advisor on a regular basis to ensure that you're on track to meet your long- and short-term goals. Deric is a former Army officer and current financial advisor with American Express Financial Advisors Inc. For questions or comments, contact Deric at: Deric.c.bowden@aexp.com. This information is provided for informational purposes only. The information is intended to be generic in nature and should not be applied or relied upon in any particular situation without the advice of your tax, legal and/or your financial advisor. The views expressed may not be suitable for every situation. Investments are not guaranteed and are subject to investment risk including the possible loss of principal. American Express Financial Advisors Inc. Member NASD. American Express Company is separate from American Express Financial Advisors Inc. and is not a broker-dealer. Back to Top