Dear Client:

Here at Mercurio & Bridgford P.A , we are committed to keeping you informed of tax law changes and tax planning information. As part of that commitment we are providing you with a brief summary of the tax law changes that have taken place in 2003 as well as year-end planning information.

2003 Tax Relief Act

In response to heavy pressure from the Bush administration, Congress passed tax cut legislation just before its Memorial Day 2003 recess.

The new law accelerates previously scheduled individual income tax rate cuts and grants short-term tax incentives for certain types of business investment. In general, the main beneficiaries are individual investors, small businesses planning to invest in new equipment or off-the-shelf computer software, and middle-income families with minor children. Almost all individuals who pay federal income tax will experience some tax reduction, and wage earners should see some of this reflected in lower withholding taxes during the second half of 2003. 

This letter gives you a brief overview of the new law, officially named the "Jobs and Growth Tax Relief Reconciliation Act of2003" to reflect its intended purpose of stimulating the economy.  Please feel free to contact us for additional information or to set up an appointment to discuss strategies for maximizing your benefits under the new law, including any reductions in your estimated tax payment schedule for 2003.

15% Top Rate on Dividends and Capital Gains

For many individuals, the new law makes a deep cut in the tax on dividends received in 2003 through 2008. Instead of being taxed at an individual's top bracket - up to 35% - qualified dividends will be taxed at a maximum of 15% (less for taxpayers in the two lowest brackets).  Thus, for example, $6,000 of qualified dividends would incur a tax of $900 instead of $2, 1 00, netting an additional $1,200 return.

In general, dividends eligible for this preferred treatment must come from domestic corporations or "qualified foreign corporations," including corporations organised in U.S. possessions, foreign corporations whose stock is traded on an established U.S. securities market, and certain other foreign corporations to be designated based on criteria set out in the new law.

Complementing the dividends tax cut is a cut in the top rate on most net capital gains to 15%(less for individuals in the two lowest brackets) through 2008. Unlike the dividends cut, however, the effective date of the capital gains is not retroactive to the beginning of the tax year 2003.Instead, the new rate generally applies to sales on or after May 6,2003. The prior-law top rate-generally, 20%-applies to most net capital gains realized before that date.

Estate and trusts also qualify for the reduced rates on capital gains and dividends.

Note that the new law reduces the top rate on dividends and net capital gains to 5% for taxpayers in the two lowest income tax brackets (i.e., 10% and 15%) through 2007 and to 0% in 2008. Taxpayers contemplating gifts to family members in these income tax brackets need to take the new top rates into account in selecting the gift property. Our office will be happy to help you "crunch the numbers" and otherwise assess the advantages and disadvantages of various options.

Increased Business Expensing Allowance and Bonus Depreciation

The new law provides two temporary incentives aimed primarily at small business.

• One provision retroactively increases the "Section 179 expensing" limitation to $100,000 (from $25,000) and the phase-out range to $400,000 (from $200,000). Also, this provision expands the category of eligible property-generally defined as tangible property other than real estate, such as machinery and equipment-to include off-the-shelf computer software.   Thus, for taxable years beginning after December 31, 2002, an eligible small business may deduct up to $100,000 of the cost of qualifying property, provided the total cost of all such property does not exceed $400,000. The $100,000 and $400,000 amounts will be adjusted for inflation in taxable years beginning in 2004 and 2005. The law is scheduled to revert to the old rules, however, in taxable years beginning after December 31,2005.

• The other incentive provision increases "bonus" first-year depreciation to 50% (from 30%) for certain property acquired and placed in service after May 5, 2003, and before January 1,2005. The placed-in-service date is extended by one year for self-constructed property.

Both of these provisions have numerous details that must be taken into account in determining the consequences of any specific transaction. Professional advice is a must for any business contemplating a transaction that might be affected by these rules. Our office is prepared to help you develop and implement your plans.

Individual Income Tax Cuts

The new law retroactively reduces the top four rate brackets to the levels previously scheduled to take effect in 2006. The following table shows these changes:

 
Also, the new law retroactively, albeit temporarily, accelerates the expansion of the 10% bracket by increasing the level of income taxed at that rate in taxable years 2003 and 2004. For 2003 joint filers and surviving spouses will pay 10% on the first $14,000 (versus $12,000) of taxable income and single filers will pay at that rate on the first $7,000 (versus $6,000). For 2004, the $14,000/$7,000 amounts are to be adjusted for inflation. But the 10% bracket will revert to the previous levels of $ 12,000/$6,000 from 2005 through 2007, return to the $14,000/$7,000 levels for 2008, and be adjusted for inflation after 2008.

"Marriage Penalty" Relief

Although the 2001 tax cut legislation included "marriage penalty" relief, it deferred implementation until taxable year 2005, at which point the relief was to be phased in over several years. The new law temporarily accelerates this relief in taxable years 2003 and 2004 by:

Expanding the 15% bracket for joint filers to 200% of the amount applicable to single filers.
 

 
Increasing: the standard deduction for joint files to 200% of the amount applicable to single filers..

Child Tax Credit Increase

The new law temporarily increases the maximum child tax credit to $1,000 (from $600) per child for taxable years 2003 and 2004.

Any taxpayer who was allowed a child tax credit for 2002 may receive an advance payment of the increased credit amount for 2003-up to $400 per child-before October 1,2003, based on information from the 2002 return.

Note that the new law did not change the phase-out rule whereby the credit amount is reduced at the rate of $50 for each $1,000 (or fraction) by which a taxpayer's "modified adjusted gross income" exceeds certain threshold amounts. For example, the phase-out range begins at $110,000 for joint filers.

Alternative Minimum Tax Relief for Individuals

The new law temporarily increases the alternative minimum tax exemption amount for 2003 and 2004 by $9,000 for joint filers and surviving spouses and by $4,500 for single filers and married filing separately. Thus, the exemption amounts in those years will be $58,000 for joint filers and surviving spouses, $40,250 for single filers, and $29,000 for married filing separately.

These increased exemption amounts are estimated to substantially reduce the number of individuals subject to the alternative minimum tax in 2003 and 2004. Beginning in 2005, however, the exemption amounts are scheduled to drop significantly: to $45,000 for joint filers and surviving spouses, $33,750 for single filers, and $22,500 for married filing separately. Hence, absent future Congressional action, the alternative minimum tax could become a major tax "trap" for many individuals.

Tax Planning

The following information highlights several tax-saving opportunities for you to consider. I would be happy to meet with you to discuss specific strategies.

IRA, Retirement Savings Rules for 2003

Traditional IRAs: Individuals who are not active participants in an employer pension plan may make deductible contributions to an IRA. The annual deductible contribution limit for an IRA for 2003 is $3,000. Depending on AGI, individuals who are active participants in a plan may make deductible contributions to an IRA. For 2003, the AGI phase-out range for deductibility of IRA contributions is between $40,000 and $50,000 of modified AGI for single persons (including heads of households), and between $60,000 and $70,000 of modified AGI for married filing jointly.  Above certain salary ranges, no deduction is allowed.

For 2003, a $500 "catch-up" contribution deduction is allowed for taxpayers age 50 or older by the close of the taxable year who meet the other qualifications for IRA deductions. Thus, the total deductible limit for these individuals may be as high as $3,500.

In addition, an individual will not be considered an "active participant" in an employer plan simply because the individual's spouse is an active participant for part of a plan year. Thus, you may be able to take a full $3,000 deduction for an IRA contribution regardless of whether your spouse is covered by a plan at work, subject to a phase-out if your joint modified AGI is $150,000 to $160,000. Above this range, no deduction is allowed.

Roth IRA: This type of IRA permits nondeductible contributions of up to $3,000 a year. Earnings grow tax-free, and distributions are tax-free provided no distributions are made until more than five years after the first contribution and the individual has reached age 59 Y2. Distributions may be made earlier on account of the individual's disability or death. The maximum contribution is phased out for persons with AGI above certain amounts: $150,000 to $160,000 for joint filers, and $95,000 to $110,000 for single filers (including heads of households). For 2003, a $500 "catch-up" contribution is allowed for taxpayers age 50 or older by the close of the taxable year, making the
total limit $3,500 for these individuals.

Roth IRA Conversion Rule: Funds in a traditional IRA may be rolled over into a Roth IRA. Such a rollover, however, is treated as a taxable event, and you will pay tax on the amount converted. No penalties will apply if all the requirements for such a transfer are satisfied.

401(k) Contribution: The 401(k) elective deferral limit is $12,000 for 2003, up from $11,000 in 2002. If your 401(k) plan has been amended to allow for catch-up contributions for 2003 and you will be 50 years old by December 31,2003, you may contribute an additional $1,000 to your 401(k) account, for a total maximum contribution of$13,000 ($12,000 in regular contributions plus $1,000 in catch-up contributions).

SIMPLE Plan Contribution: The SIMPLE plan deferral limit is $8,000 for 2003, up from $7,000 in 2002. If your SIMPLE plan has been amended to allow for catch-up contributions for 2003 and you will be 50 years old by December 31, 2003, you may contribute an additional $500.

Deferring Income to 2004

If you expect your AGI to be higher in 2003 than in 2004, or if you anticipate being in the same or a higher tax bracket in 2003, you may benefit by deferring income into 2004. Deferring income will be advantageous so long as the deferral does not bump your income to the next bracket. Some ways to defer income include:

Delay Billing: If you are self-employed, delay year-end billing to clients so that payments will not be received until 2004.

Interest and Dividends: Interest income earned on Treasury securities and bank certificates of deposit with maturities of one year or less is not includible in income until received. To defer interest income, consider buying short-term bonds or certificates that will not mature until next year. If you have control as to when dividends are paid, arrange to have them paid to you after the end of the year.

Accelerating Income Into 2003

In limited circumstances, you may benefit by accelerating income into 2003. For example, you may anticipate being in a higher tax bracket in 2004, or perhaps you will need additional income in order to take advantage of an offsetting deduction or credit that will not be available to you in future tax years. Note however that accelerating income into 2003 will be disadvantageous if you expect to be in the same or lower tax bracket for 2004. In any event, before you decide to implement this strategy, we should "crunch the numbers."

If accelerating income will be beneficial, Accelerate collection of Accounts Receivable: If you are self-employed and report income and expenses on a cash basis, issue bills and attempt collection before the end of2003. Also see if some of your clients or customers might be willing to pay for January 2004 'goods or services in advance. Any income received using these steps will shift income from 2004 to 2003.

Deduction Planning

Deduction timing is also an important element of year-end tax planning. Deduction planning is complex, however, due to factors such as AGI levels and filing status. If you are a cash-method taxpayer, remember to keep, the following in mind:

• Deduction In Year Paid: An expense is only deductible in the year in which it is actually paid.

• Payment By Check: Date checks before the end of the year and mail them before January 1, 2004.

• Promise To Pay: A promise to pay or providing a note does not permit you to deduct the expense. But you can take a deduction if you pay with money borrowed from a third party.  Hence, if you pay by credit card in 2003, you can take the deduction even though you won't pay your credit card bill until 2004.

AGI Limits: The AGI limits on itemized deductions affect deduction planning. For 2003 returns, overall itemized deductions are reduced by 3% of the AGI exceeding $139,500 ($69,750 if married filing separately). Similarly, certain deductions may be claimed only if they exceed a percentage of AGI: 7.5% for medical expenses, 2% for miscellaneous itemized deductions, and 10% for casualty losses.

Standard Deduction Planning: Deduction planning is also affected by the standard deduction. For 2003 returns, the standard deduction is $9,500 for married taxpayers filing jointly, $4,750 for single taxpayers, $7,000 for heads of households, and $4,750 for married taxpayers filing separately. If your itemized deductions are relatively constant and are close to the standard deduction amount, you will obtain little or no benefit from itemizing your deductions each year. But simply taking the standard  deduction each year means you lose the benefit of your itemized deductions. To maximize the benefits of both the standard deduction and itemized deductions, consider adjusting the timing of your deductible expenses so that they are higher in one year and lower in the following year.

We hope you have found this information useful. Please contact us if you have any questions about the new tax laws and how they might affect you or if you need assistance with your tax planning.
 

Sincerely,

Mercurio & Bridgford, P.A.