The 2003 Tax Act: It Pays Big Dividends, for Some Anyway
Society Members Discuss the Impact of the New Cuts

By Jay Dismukes

The White House likes to say that the Jobs and Growth Tax Relief Reconciliation Act of 2003 is a victory for income-tax-paying Americans, but even if that’s true, the legislation has clearly bestowed investors with the first-place trophy.

From interviews conducted with four CPAs across New York state, one thing is clear: the act’s real winners are those with the sorts of meaty financial portfolios that will significantly benefit from new capital gains and, especially, the dividends tax rates—a finding that perhaps comes as little surprise. Equally apparent is the act’s unerring capacity for muddying up an already overly complicated tax code.

Though the act’s unconditional victor has never really been in doubt, its designated loser—the demographic that will benefit the least—appears to less certain and varies from practitioner to practitioner, all four of whom are members of the New York State Society of CPAs. Similarly difficult to gauge is the legislation’s ability to fulfill its unofficial but highly touted promise to boost the economy and create jobs.

And the Winner Is…

For property sold after May 5, 2003, the act cuts maximum tax rates on net capital gains from 20 percent to 15 percent. The cuts to the maximum tax rate on dividends paid after Dec. 31, 2002, are more striking, sheared down from 35 percent to 15 percent. Capital gains and dividends rates will be lowered to 5 percent for taxpayers in the 10- and 15-percent brackets.

All four of the practitioners said they have a number of clients who will enjoy these new rates.

“This bill is definitely for big-time investors,” said Alan E. Weiner, a partner with Holtz Rubenstein & Co., LLP, in Melville. Though many of Weiner’s clients receive substantial dividend income, the former Society president said noticeably fewer have capital gains appreciation on their stocks, a situation that Daniel M. Fordham, a partner with Martindale Keysor and Company, PLLC, of Plattsburgh, also noted.

Sole practitioner Edward L. Arcara, whose firm Edward L. Arcara, CPA, is located in Buffalo, said he believes many of his elderly clients who live off of their trust income will perhaps alter their investment behavior, focusing more on dividend stocks than growth stocks. In general he thinks the provisions could encourage people who were previously burned to get back into the market, but perhaps more importantly, the dividends cut will put the onus on corporate America to concentrate on actual earnings rather than trying to meet Wall Street expectations.

“Ultimately if the cash is not there, the dividends won’t be, so it will refocus the investor who will ask, ’Why aren’t you paying out dividends if you are making money?’” Arcara, vice president of the Buffalo Chapter, said.

Neil H. Tipograph, a partner with Imowitz Koenig & Co., LLP, in Manhattan, also believes the dividends provision could turn more people on to high-dividend-paying securities, but he doesn’t foresee the less dramatic capital gains cut changing investment behavior too much.

As pointed out by the practitioners, small businesses, if they choose to take advantage of the provisions, also could fare well under the 2003 tax plan.

In particular, the first-year “bonus” depreciation on qualifying equipment purchased after May 5, 2003, through 2004, has been increased from 30 percent to 50 percent. The section 179 deduction has also been raised from $25,000 to $100,000, with the amount of the property cost limitation increased to $400,000 from $200,000.

“Those are definitely very generous incentives for people to buy equipment and machinery,” Tipograph, a member of the New York Multistate and Local Taxation Committee, said. “They will certainly increase the purchases by the businesses.”

Arcara said his business clients will be encouraged by the provisions, noting one client in particular who previously couldn’t take advantage of the expensing rules having purchased over the $200,000 limitation. He also believes the provisions will make it easier for them to ascertain their tax position.

Weiner and Fordham, president of the Adirondack Chapter, are somewhat less enthusiastic about the business provisions. Noting that interest rates already are low, Weiner considers the provisions “timing differences,” the benefits of which small businesses, under prior legislation, eventually would have received anyway. And though a few may seize the opportunity to buy equipment, Fordham said many of his business clients usually do not purchase that much equipment in the course of a year.

What About Us?

Of course the act includes other changes that will positively impact taxpayers. Chief among these is the acceleration of the tax rate reductions from the 27-, 30-, 35- and 38.6-percent tax brackets to 25 percent, 28 percent, 33 percent and 35 percent, respectively. The 15-percent tax bracket for married taxpayers filing jointly has been expanded to $56,800—twice that of single taxpayers—and so has the 10-percent tax bracket.

The child tax credit jumps from $600 to $1,000 for 2003 and 2004, and the standard deduction for married taypayers filing jointly has increased to $9,500 from $7,950.

Though beneficial to many, there is the distinct possibility that other taxpayers—indeed, entire groups—may fall through the cracks. According to Tipograph, this circumstance may be all too apparent in New York City, where a sizable group of taxpayers fall under the alternative minimum tax. If they happen to be in the AMT and do not receive any dividend or capital gain income, the federal tax act could completely sidestep them, he said.

Making matters worse for this group of taxpayers is the situation at the state and city level, where personal income tax rates have temporarily increased.

“The raising of the state and local income taxes for people subject to the federal AMT will be a very expensive proposition for them,” Tipograph said. “It means that they may not get any federal tax benefit.”

While the act increased the AMT exemption for single as well as married taxpayers filing jointly, Tipograph believes that the reduction of the top rate from 38.6 percent to 35 percent without a reduction of the AMT top rate of 28 percent will cause more people to fall under the AMT. Tipograph believes that at the same time they were cutting marginal tax rates, the legislators should have cut the AMT. Weiner, who recently headed the NYSS-CPA Tax Simplification Task Force, also believes the AMT could be especially harmful to New York state taxpayers, depriving them of any benefits.

Another segment of the taypaying population that could be left out in the cold includes senior citizens who live off of the income from their retirement plans. Dividend or capital gain income invested in these plans loses its character, Weiner said, and when taken out, is treated as pure ordinary income.

Arcara said the capital gains provisions will have little if any impact on his young clients who got in the market when it was too high and now hold capital losses. According to Fordham, middle America—families with a couple of kids and joint incomes at either end of the $125,000 to $175,000 range, but who aren’t business owners or have limited dividend or capital gain income—probably will benefit the least from the act, because their incomes just barely place them in the higher brackets and narrowly prevent them from taking advantage of the child tax credit.

The C Word

“You have to tax plan based on the facts established today. If they change, all you can do is shrug your shoulders, because you did the best you could with the information you had at the time,” Arcara said. “We don’t have crystal balls so it is very difficult to do any type of long-range planning, and it’s actually hurting the taypayers.”

When asked to identify their concerns with the act, all four practitioners mentioned the additional complexity that the legislation brings to the tax code. In particular, Arcara and Weiner said the continued use of sunsets, which Weiner referred to as “bad tax policy,” are especially burdensome to CPAs trying to plan for their clients. To illustrate the problems with sunsets, Weiner used the example of an individual who has to take into consideration that the dividend paying stock he buys today may become worth less in the future by virtue of the fact that the rate is due to sunset, that is, revert to taxability at standard income tax rates, in 2009.

Of course there are plenty of other items in the act that are sure to give practitioners headaches. The possibility that more people could come under the AMT will further complicate planning. Additionally, certain dividends do not qualify for the reduced rates, which will also make the practitioner’s job tougher.

Tipograph also cited the states’ decoupling of the bonus depreciation and the anticipated decoupling of the section 179 deduction as “clear examples of increasing the complexity to the tax preparation.”

Because of the substantial loss in state revenue resulting from the small business provisions states that have not already done so may decide to decouple from the federal laws, which then results in the practitioner having to keep a set of depreciation for both federal and state taxing authorities and adding time to the preparation and planning scheme, Fordham pointed out.

The X Factor

“We have taken aggressive action to strengthen the foundation of our economy so that every American who wants to work will be able to find a job,” President Bush said during the May signing of the 2003 tax act.

In addition to providing tax relief, the Bush administration has positioned the act as a jobs growth and economic stimulus package. While this may eventually prove true, the practitioners are not so certain.

As a boost for the economy, Arcara likes the act’s, especially the dividend cuts’, chances, noting that the provision will re-establish the focus “on the profitability of corporate America and not any of the funny business that’s gone on there.” He is less certain about the act’s ability to root up new jobs.

Weiner doesn’t necessarily believe the act will generate growth, but it all depends on what people do with the money, he said. While the cuts could help further revitalize the market, he questions whether the small business provisions will be enough to warrant more employees, especially since the cuts don’t apply to large corporations.

Tipograph also thinks there will be a pick-up in investment activity, but he said he doesn’t know if it will be sufficient to turn the economy around.

Though some businesses are actually growing and moving into northern New York, where unemployment levels are better than much of the state, Fordham said he doesn’t know of any that are basing their decisions to expand simply on the new cuts.

“Just paying less money in taxes isn’t going to make them go out and hire new employees or expand business,” Fordham said. “They are going to have to see the ability for the economy to get better to increase overall business performance.”