by George G. Jones and Mark A. Luscombe
The temporary nature of the tax cuts just passed by the Jobs and Growth Tax Relief Reconciliation Act of 2003 is generating confusion for taxpayers and practitioners.
Capital gains and dividend rate reductions end after 2008; income tax rates are accelerated by three years but still sunset after 2010; marriage penalty relief, a larger child tax credit and higher AMT exemptions, as well as a more generous 50 percent bonus depreciation, are available only through 2004; and a quadrupled Section 179 expensing limit ends after 2005. (For more on dividends and the new law, see Bob Rywick’s column, p. 18.)
Having said that, it’s easier to lose track of the flip side of these temporary provisions - their starting dates. No major provision starts on JGTRRA’s May 28, 2003, date of enactment. Instead, the new incentives start retroactively either on Jan. 1, 2003, or May 6, 2003.
● Jan. 1, 2003, applies to the accelerated income tax rate reductions, marriage penalty relief, the new rate on dividends, the larger child credit, AMT relief, and the increased Section 179 expensing.
● May 6, 2003, is the start date for the capital gains rate reduction and enhanced bonus depreciation.
Each of these JGTRRA provisions carries with it certain issues on how its effective date is applied. Some of them can be tricky to navigate.
Capital gains rate reduction
The maximum net capital gains rate has been lowered from 20 percent to 15 percent, effective for gain “taken into account” on or after May 6, 2003. For this purpose, the sale date, rather than the sales contract date, determines when amounts are “taken into account.” A sale or exchange is a taxable transfer of the benefits and burdens of ownership of an asset as determined under federal tax law. This typically occurs with the passing of title, but may occur earlier. Substance, not form, controls.
In connection with the sale of stocks or bonds, the trade date occurs when the sale is entered into or an agreement to sell specified securities is made. The settlement date is the date that the actual security and cash change hands. For sales of securities traded on a public exchange, realization occurs on the trade date. Gain or loss on short sales of securities, however, is recognized on the settlement date as set by exchange rules.
Under normal rules, the lower rates will apply to installment payments received on or after May 6, 2003, even though the sale or exchange under the installment contract occurred earlier.
However, this treatment (and the 15 percent rate) will not apply to installments in connection with dispositions of stock or securities traded on an established securities market. Installment sales of publicly traded securities are treated as if all payments are received in the year of sale.
Whether a mutual fund’s distributed capital gains qualify for the 15 percent rate is determined at the entity level. The fund should provide the investor with this information.
Of course, the traditional rules on what are long-term capital gains also come into play. The 15 percent rate is available when a capital asset has been held for more than 12 months. Generally, a taxpayer begins counting the holding period on the date after the day on which the property was acquired.
For example, if property was acquired on May 5, 2002, the taxpayer’s holding period began on May 6, 2002. The date that the asset is disposed of is part of the holding period. Thus, if the taxpayer sells the asset on May 6, 2003, he is not entitled to the 15 percent rate because it was not held for more than one year.
Dividend rate reduction
After Dec. 31, 2002, the top federal tax rate for dividends received by an individual is 15 percent (5 percent for those whose incomes fall in the 10 percent or 15 percent rate brackets). Application of this effective date follows the general year-end rules for dividends.
A cash-basis shareholder-taxpayer includes a dividend on corporate stock in gross income when the dividend is unqualifiedly made subject to the taxpayer’s demand.
Practical considerations control, however, so that a dividend declared payable on December 31, and mailed on that day, will not be deemed to have been constructively received in December.
In the case of dividends, another timing rule also comes into play. In order to qualify for the new 15 percent rate, stock must be held for at least 60 days during the 120-day period beginning on the date which is 60 days before the date on which the stock goes “ex-dividend.”
Section 179 expensing jumps from $25,000 to $100,000 for qualifying property that is purchased and placed in service after Dec. 31, 2002.
The task here for most taxpayers is to get qualifying property that exceeds the overall $25,000 limit for 2002 out of the 2002 tax year and into tax year 2003, arguing either that purchase or first use did not take place until 2003.
Taxpayers may take the direct expense deduction for qualifying property only for the tax year in which the qualifying property is purchased and placed in service.
Once an expensing election has been made on a return for a property, it may not be revoked without IRS consent. This alone will rule out most “retroactive” tax planning through amended 2002 returns. For taxpayers who have yet to file 2002 returns, or who are counting on proving that the asset is attributable to 2003 expensing, the purchase and first-used-in-business timetable may prove critical.
“Purchase” is generally the simpler of the two concepts. It usually takes place when title is transferred and prior to use in the business. Property is placed in service when it is placed in a condition or state of readiness and availability for its assigned use. Under the regulations, property does not actually need to be used.
For example, equipment may be considered placed in service when acquired for a specifically assigned function, but is undergoing testing or is being held as a stand-by spare part.
Enhanced bonus depreciation
Fifty percent bonus first-year depreciation applies to new property that is acquired after May 5, 2003, and placed in service before Jan. 1, 2005 (Jan. 1, 2006, for property with a special, longer production period).
The bonus is for first-year depreciation only. The 50 percent rate does not apply if a binding written contract for acquisition of the property was in effect before May 6, 2003.
Qualifying components, however, will not fail to qualify for 50 percent bonus depreciation simply because a binding contract to acquire a component of the property is in effect prior to May 6, 2003.
Property that is manufactured, constructed or produced for a taxpayer’s own use will qualify for 50 percent bonus depreciation if the taxpayer begins manufacture, construction or production after May 5, 2003.
Timing may be everything, at least in certain situations under which a taxpayer tries to fit within the key starting dates for JGTRRA tax breaks.
Coming within the effective dates for either the new capital gains or dividends rate can, in the former case, mean a 25 percent reduction in tax (from the 20 percent to the 15 percent rate); or over a 50 percent reduction in tax (from a high of 35 percent to 15 percent) for the latter.
Proving that a purchase-and-use comes within the time periods for a business to claim the enhanced expensing and/or bonus depreciation allows that business to write-off a more substantial portion, if not all, of its capital purchases immediately in its first year.
For many taxpayers, therefore, the difference between December 31 and January 1, and May 5 and May 6, will never be more significant.
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