President Bush Signs H.R. 2, Containing Major Tax Cut for Businesses
By Richard J. Melnick,
Jennifer H. Weiss and Stephen
A. Mihaly, Greenberg Traurig
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On May 28, 2003, President Bush signed the third-largest tax cut in U.S.
history, The Jobs and Growth Tax Relief Reconciliation Act of 2003.
The centerpieces of the Act are the general reductions in marginal tax
rates, further reductions in the tax rates on capital gains and dividend
income, and a significant increase in the amount of equipment that businesses
can expense immediately. Although most of the Actís provisions directly
affect individuals and not corporations, we expect the Act to have a powerful
effect on numerous industries, as well as on various forms of investing
and doing business. While most companies and individuals should benefit
from the Act, there will be losers as well.
|"We expect the Act to have a
powerful effect on numerous industries, as well as on various forms
of investing and doing business."
Set forth below is a brief summary of the main provisions of the Act
that can be expected to affect our clients, as well as some thoughts about
the Actís impact on the type and form of post-Act investments.
1. Acceleration of Individual Tax Rate Reductions and Increase of Alternative
Minimum Tax Exemptions Amount
Effective retroactive to January 1, 2003, most of the marginal tax
rates are reduced. In particular, the highest marginal rate falls to 35%
from 38.6%; and other rates drop to 32% (from 35%), 28% (from 30%) and
25% (from 27%). While the lowest marginal rates of 10% and 15% are not
reduced, the Act does expand the 10% tax bracket. These rate reductions
expire on January 1, 2011.
The alternative minimum exemption amounts are increased to $58,000
and $40,250 for joint and single filers, respectively, but only for 2003
2. Reduction of Taxes on Capital Gains and Dividends Derived by Individuals
a. Individual Capital Gain Tax Rate Reduction
The Act reduces the maximum tax rate for long-term capital gains to
15% (from 20%), effective for capital gains recognized or installment
payments received on or after May 6, 2003. In 2009, the maximum tax rate
on capital gains reverts to the pre-Act (20%) level. The lower rate applies
for both the "regular" tax and the alternative minimum tax. The rate reduction
does not apply to depreciation recapture on personal property (subject
to a maximum tax of 35%) or real property (subject to a maximum tax of
25%), or to sales of collectibles (subject to a maximum tax of 28%).
b. Individual Dividend Tax Reduction
The Act reduces the maximum tax rate on "qualified dividend income"
received by individuals (and not corporations) to 15%, which is 20 percentage
points lower than the 35% maximum rate that would otherwise apply. This
new 15% rate applies retroactively to the beginning of 2003 for both the
regular and alternative minimum tax, but expires after 2008, at which
time all dividends will be taxed at ordinary income tax rates. For this
purpose, "qualified dividend income" is dividend income which is paid
from either (i) a domestic corporation (except for dividends received
from a tax-exempt organization, or deductible dividends paid by a mutual
savings bank or to an ESOP), or (ii) a foreign corporation that meets
one of the following three tests: (1) it is incorporated in a U.S. possession,
(2) it is eligible for U.S. income tax treaty benefits which the Treasury
approves, or (3) the securities on which the dividend is paid are publicly
traded on a U.S. securities market. However, dividends paid from a "foreign
personal holding company," a "foreign investment company" or a "passive
foreign investment company" will not be eligible for the rate reduction.
It is not clear whether deemed distributions from "controlled foreign
corporations" will qualify for the dividend rate reduction.
The rate reduction will not apply in two potentially abusive situations:
(i) where the stock is held for less than 60 days during a 120-day period
commencing 60 days before the stock becomes ex-dividend; and (ii) where
the dividend recipient is under an obligation to make payments related
to the dividend with respect to positions in substantially similar or
"Qualified dividend income" will not include any amount that a taxpayer
takes into account as investment income under section 163(d)(4)(B). Section
163(d) limits investment interest deductions to the amount of an individual
taxpayerís "net investment income," thereby preventing individuals from
using interest deductions from investments to offset wage income. It will
also not include dividends paid by mutual funds in excess of the amount
of dividends received by the fund, unless at least 95% of the fundís gross
income (as specially computed) is comprised of "qualified dividend income."
As a corollary to these changes, the Act repeals the "collapsible corporation"
rules, and reduces the accumulated earnings tax and personal holding company
tax rates to 15% (from 35%).
c. Special REIT Considerations
Capital Gains and Dividends. As described above, the Act generally
reduces the maximum individual tax rate on capital gains and "qualified
dividend income" to 15%. Capital gains on sales of REIT stock and "capital
gain" dividends will be eligible for the reduced 15% rate (except to the
extent of the portion of a capital gain dividend attributable to depreciation
recapture on sales of real property which will continue to be taxed at
a rate of 25%). REIT dividends will be treated as "qualified dividend
income" and eligible for the 15% maximum rate only to the extent attributable
to REIT income on which a corporate level tax has been imposed, e.g.,
dividend income received by the REIT from a non-REIT U.S. "C"-corporation
including taxable REIT subsidiaries, REIT income subject to a "built-in
gains" tax in the prior taxable year (net of the taxes paid), and REIT
taxable income retained in the prior taxable year (net of the taxes paid).
REIT dividends received by a "C" corporation will not be eligible for
the dividends received deduction.
Tenant Improvements. The Act also permits taxpayers to expense
50% of the cost of specified "qualified property" in 2003 and 2004, including
so-called "second-generation" tenant improvements to nonresidential real
property. "Second generation" tenant improvements are leasehold improvements
made by a lessor, lessee, or sublessee pursuant to a lease of real property,
provided that the improvements are placed in service at least three years
after the date on which the building was first placed in service. The
Act extends the provisions of the prior law, generally permitting "bonus
depreciation" with respect to qualified property acquired after May 5,
2003 and before January 1, 2005 (previously September 11, 2004), but only
if a binding written contract for the acquisition was not in effect as
of May 6, 2003. In addition, the Act increases the first year depreciation
to 50% of the eligible costs incurred (previously 30%).
Closely-Held REITs. The Act does not include a proposed provision
which would have generally precluded any "person" other than another REIT
or a pension trust from owning 50% or more of a REITs shares.
3. Increase in Expensing/Bonus Depreciation
The Act increases the amount that businesses may expense for machinery
and equipment to $100,000 (from $25,000). The new rule applies retroactively
to equipment acquired in the 2003 tax year through the 2005 tax year,
and includes (for the first time) purchases of "off the shelf" software.
The deduction is phased-out for taxpayers placing up to $400,000 of machinery
and equipment into service. As noted above, the Act also increases the
"bonus" depreciation provisions allowing small and larger business taxpayers
to expense 50% (up from 30%) of the cost of new machinery in the year
of purchase for property placed in service after May 6, 2003 but before
December 31, 2004.
4. Planning Considerations
As noted above, the Actís provisions can be expected to have a significant
impact on both the type and form of investment. At this point, the Actís
ramifications on tax strategies are only beginning to emerge. Here are
a few initial observations.
- Despite the reduction in taxes on dividend income, most non-publicly
traded businesses will continue to be organized as partnerships, LLCs
and S corporations because these entities permit capital gains to be
taxed one time, at a maximum rate of 15%; "C" corporations still have
to pay corporate tax (up to 35%) on both net capital gains and ordinary
income before making dividend distributions of the net proceeds of their
capital gain transactions and any ordinary income to shareholders (both
of which will generally be taxable at a maximum rate of 15%).
- Investments in publicly traded stock will probably gain favor at
the expense of bonds (both taxable and tax-exempt), CDs, REIT stock
and pension-type investments such as IRAs, 401(k) plans and qualified
pension plans. Expect more corporations to issue preferred stock with
a regular dividend.
- Tax-deferral techniques, such as like-kind exchanges and tax-free
corporate reorganizations, will have to be analyzed carefully to see
how they compare to a taxable transaction.
- Investments in foreign corporations may prove to be very attractive,
particularly those foreign corporations that are able to reduce their
corporate-level taxes. Look for public stock offerings from corporations
incorporated in low- or no-tax jurisdictions (and that do not qualify
as a "foreign personal holding company" or a "foreign investment company").
Also, for those treaty country companies that would qualify for the
reduced dividend tax rate but for their status as a "foreign personal
holding company" or a "foreign investment company," expect to see such
companies engage in business outside the U.S. to avoid such status and
therefore be eligible for the dividend rate reduction.
- "C" corporations that have converted to S corporation status are
generally unable to make significant investments in passive assets such
as stocks and bonds unless they distribute all of their accumulated
earnings to the shareholders. At a current toll charge of 15% (plus
applicable state taxes), many S corporations may choose to make actual
or consent distributions in an amount sufficient to eliminate accumulated
earnings. Also, "C" corporations with substantial investment assets
should consider distributing accumulated earnings to shareholders and
electing S corporation status, in order to lock in a single level of
tax on future investment income (other than capital gains) at a tax
"cost" of 15% (plus applicable state taxes).
- The Act will affect tax planning for estates with assets (such as
real estate and corporate stock) that are likely to appreciate. For
large estates in particular, expect to see more gifting or intra-family
sales to take advantage of the low capital gains tax rate.
- The Act is also notable for those proposals that did not pass. These
include, among others, stricter rules on tax shelters; elimination of
so-called "inversion" transactions; repeal of the special exemption
for wages earned by US citizens working abroad; and reform of the foreign
export tax incentives. It is expected that these provisions will reappear
in an omnibus foreign tax bill to be introduced in the near future.
Greenberg Traurig has over 75 tax professionals (including a number of
tax attorneys in our European offices), and we will be spending a large
amount of time in the days to come analyzing the consequences of the Act
and developing investment, estate planning and other strategies that are
designed to maximize the benefits of the Act for our clients. We also have
a number of governmental affairs professionals who monitor and influence
tax legislation. We urge you to call us to review your personal situation
or that of a company of which you are a significant equity-holder or executive,
to see how you or your company can benefit from the Actís provisions.
© 2003 Greenberg Traurig
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feel free to contact one of our attorneys.
This GT ALERT is issued for general purposes only and is not intended
to be construed or used as legal advice. Greenberg Traurig attorneys provide
practical, result-oriented strategies and solutions tailored to meet our
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