Gomola & DiBella, LLP, CPAs -- Special 2003 Tax Issue Newsletter

Important Notice

Brian DiBella has left the firm.

Gary Gomola and all of the other staff members
have merged with Mahoney, Sabol & Company

www.mahoneysabol.com

We are now located at 213 Court Street, Suite 204, Middletown CT 06457
Phone: 860-344-8883 Fax: 860-346-3057

CLIENT ALERT - SPECIAL 2003 TAX ISSUE

The information contained in this newsletter is designed to keep our clients and friends informed of developments and ideas which we feel are important. Should any subjects be of interest please call one of us. The articles contained in this newsletter are not intended as a substitute for legal, accounting or tax advice. You should seek professional advice on the particular issues which concern you.

At this point, the only information we have regarding these new tax rules is the statutory language of the Act and the Congressional Committee Reports. Our interpretations of these new rules are based upon the information contained in these two documents. Additional clarifications will be issued later by the IRS in the form of regulations and other official pronouncements. Our firm will monitor these future developments. - June 2003

Jobs and Growth Tax Relief Reconciliaton Act of 2003

This tax relief package, touted as the third-largest tax cut in U.S. history, provides tax relief to virtually every person who pays federal income tax. To help you take maximum advantage of this new law, this letter summarizes the changes made by the Jobs and Growth Tax Relief Reconciliation Act of 2003.

This tax legislation contains a roller coaster of effective dates. Few of the items contained in the 2003 Act are permanent. Consequently, timing is critical to take advantage of many of the benefits. As you read this letter, please pay special attention to the effective dates which change from one provision to another. We offer several planning ideas in this letter. However, you cannot properly evaluate a particular planning strategy without calculating your overall tax liability (including the alternative minimum tax) with and without the strategy. Please be careful! Call us before adopting any tax planning recommendation.

This letter is intended to highlight the 2003 Act provisions that we believe affect the largest number of our clients. Accordingly, we do not address every change made by the Act. If you are interested in a tax change that is not addressed here, please contact us. Also, most states have not adopted the provisions of the Jobs and Growth Tax Relief Reconciliation Act of 2003. So, state income tax implications of these changes are uncertain at this time.

TAX RELIEF PROVISIONS IMPACTING PRIMARILY INDIVIDUALS

More Income Taxed at 10% Effective January 1, 2003. Retroactive to January 1, 2003, the new law increases the amount of income taxed at 10% from $6,000 to $7,000 of taxable income for single filers (a maximum savings of $50) and from $12,000 to $14,000 for joint filers (a maximum savings of $100). For heads of households, the 10% tax bracket was not changed and continues to apply to the first $10,000 of taxable income. Planning Alert! The new expanded 10% tax bracket for joint and single filers only applies for 2003 in 2004. For 2005 through 2007, the 10% bracket reverts back to its original levels ($6,000 and $12,000). In 2008, it will again return to $7,000 for single taxpayers and $14,000 for joint filers.

Acceleration of Rate Reductions to January 1, 2003. The new law accelerates individual marginal tax rate cuts that were, previously, scheduled to be fully effective in 2006. Effective January 1, 2003, the top four tax rates are reduced to 25%, 28%, 33%, and 35% (down from 27%, 30%, 35%, and 38.6%). For income taxed in the highest bracket, this is a 3.6% rate decrease. For income taxed in the 27%-35% tax brackets, it is a 2% rate decrease. However, due to the sunset provisions of the 2001 Act, these new rates will increase to 28%, 31%, 36%, and 39.6% after 2010. Tax Tip. By mid June, the IRS is expected to mail updated wage withholding tables to employers that reflect these tax rate cuts. The revised tables are available now at the IRS website (www.IRS.gov). Planning Alert! Certain itemized deductions and personal exemptions are reduced as your adjusted gross income exceeds certain thresholds. Therefore, your Aeffective tax rate@ is usually greater than these Aofficial rates.@ Caution! Even though the tax rates for 2003 have been reduced, if your total tax liability for 2003 is greater than your total liability for 2002 (e.g., because your income is up or your deductions are down), you may wish to ask your employer not to change your withholding. Reducing your withholding without careful planning, could result in an underpayment penalty. If we worked with you to establish the amount of your 2003 withholding, please have your employer continue withholding the amounts we suggested until you talk with us!

Alternative Minimum Tax Exemption Increased. The AMT was originally enacted so individuals who reduced their taxes with aggressive deductions (e.g., tax shelter deductions, accelerated depreciation, etc.) would pay some Aminimum tax.@ However, each year the number of individuals paying the AMT increases. One reason more people are paying the AMT is that income levels are increasing, but, the amount of income exempt from the AMT has not increased significantly. For years beginning in 2003 and 2004, the AMT exemption amount is increased from $49,000 to $58,000 for married, and from $35,750 to $40,250 for single taxpayers. Planning Alert! These increased exemption amounts do not solve the alternative minimum tax problem; they only provide a small amount of relief.

Child Tax Credit Increased. For 2002, you were allowed a $600 tax credit for each child under age 17 and the credit was reduced if your "modified adjusted gross income" on a joint return exceeded $110,000 ($75,000 if single). Starting in 2005, this $600 credit was scheduled to increase until it reached $1,000 in 2010. For 2003 and 2004, the new law increases the child tax credit to $1,000. Planning Alert! The new law does not change the income phase-out levels. Also, the credit will be reduced after 2004, but will again reach $1,000 in 2010. You May Get a Tax Rebate Check This Year. If you claimed the child credit on your 2002 return and your child is not over age 17 by the end of 2003, you may receive an IRS rebate check as early as this July for up to $400 per eligible child. The rebate will be determined based on the information you provided to the IRS on your 2002 return but will reduce the child credit otherwise allowed on your 2003 return. Planning Alert! In the summer and fall of 2001, virtually all taxpayers received a rebate check from the IRS as a result of a retroactive decrease in tax rates for 2001. That is not the case with this tax bill. Only those taxpayers that qualified for the child credit on their 2002 return will be entitled to a rebate this year.

Marriage Penalty Relief. If you are married and file a joint return with your spouse, you may be paying more income tax than the total you and your spouse would pay if you were each single. This so-called Amarriage penalty@ generally occurs when each spouse has significant income. Sometimes, this penalty makes it advantageous for engaged couples (both of whom have significant income) to postpone November or December weddings until January of the following year to save taxes. The new law reduces the tax penalty for marriage by increasing the standard deduction and the size of the 15% tax bracket on a joint return.

Increased Standard Deduction for Married Taxpayers. For 2002, the basic standard deduction for a joint return was 167% of the standard deduction for a single taxpayer. For 2003 and 2004, the basic standard deduction for a joint return increases under the Act to 200% of the single return amount. As a result, for 2003, the standard deduction on a joint return will jump from $7,950 to $9,500. Planning Alert! If your itemized deductions (e.g., home mortgage interest, state and local taxes, etc.) exceed this increased standard deduction, you receive no tax benefit from this change. However, you may benefit from the increase in the 15% tax bracket for married taxpayers discussed below.

Married Taxpayers Will Have More Income Taxed at 15%. Prior to the law change, the amount of income on a joint return taxed at the 15% tax rate was 167% of the amount of income on a single taxpayer=s return taxed at 15%. For 2003 and 2004, the amount of income on a joint return taxed at 15% will be double the amount taxed at 15% on a single person=s return. If you are a joint filer, this change could reduce your taxes by as much as $935 for 2003.

TAX RELIEF PROVISIONS IMPACTING PRIMARILY BUSINESSES

Additional First Year Depreciation Increased from 30% to 50%. In 2002, in order to stimulate purchases of business assets other than real estate, Congress enacted a new first-year 30% additional depreciation deduction for the cost of Aqualified property@ purchased after September 10, 2001 and before September 11, 2004. This additional depreciation deduction is allowed for both regular and alternative minimum tax purposes. Under the 2003 Act, this first-year depreciation deduction is increased to 50% for qualifying property acquired after May 5, 2003 and before January 1, 2005. However, even if you acquire the property after May 5, 2003, it will not qualify for the 50% deduction if the purchase was pursuant to a binding written contract in effect before May 6, 2003 (although it may qualify for the 30% bonus depreciation). This 50% bonus depreciation deduction is, instead of, not in addition to, the 30% deduction. Planning Alert! To qualify for this deduction, you must satisfy various requirements summarized below. Caution! Connecticut does not allow this bonus depreciation, as a result it can be better in many circumstances to elect out of its application.

Qualifying Property. Like the 30% deduction, the 50% deduction generally applies only to MACRS property that has a MACRS depreciation period of 20 years or less. Most tangible personal property (e.g., machinery, equipment, cars, trucks, etc.) will qualify as well as certain types of depreciable real property (e.g., sidewalks, roads, fences, farm buildings, etc.). Please call us if you need more information regarding the types of qualifying property.

Used Property Generally Does Not Qualify for the Bonus Depreciation. You will qualify for the additional 50% depreciation deduction only if your business is the first taxpayer to actually use the qualified property.

Additional First Year Depreciation on Passenger Automobiles. The maximum annual depreciation for passenger automobiles used in a business is capped at certain dollar amounts. For example, for 2001 and 2002, the maximum first year depreciation on a business automobile was originally capped at $3,060. Under last year=s tax legislation, for passenger automobiles purchased after September 10, 2001, the first year depreciation cap was increased by $4,600 if the additional 30% depreciation was taken for the auto. Consequently, the maximum first year depreciation on a qualifying passenger automobile placed in service after September 10, 2001 was $7,660 ($3,060 plus $4,600). Under the 2003 Act, for business automobiles purchased after May 5, 2003 and before January 1, 2005, and for which the 50% bonus depreciation is taken, the first-year depreciation limitation is increased by $7,650 (rather than $4,600).

�179 Deduction Increased to $100,000. For 2002, you could take an up-front deduction of up to $24,000 for the cost of qualifying '179 property (e.g., machinery, equipment, furniture, fixtures, etc.). This deduction was phased out dollar for dollar to the extent the total purchases of '179 property exceeded $200,000 for the year. For tax years beginning in 2003, 2004, and 2005, the 2003 Act increases the '179 deduction to $100,000 (and the phase-out level begins at $400,000, not $200,000). The deduction will be reduced to $25,000 for tax years beginning after 2005. The following are several observations about the �179 deduction:

Off-the-Shelf Computer Software Now Qualifies. Under prior law, no computer software qualified for the �179 deduction because it was not tangible personal property. For tax years beginning in 2003, 2004, and 2005, off-the-shelf computer software qualifies for the �179 deduction. Off-the-shelf software is, generally, software that is readily available for purchase by the general public.

The �179 Deduction is Taken Before the 50% Deduction. Assume that on September 1, 2003, a calendar year business purchases $400,000 of computer equipment (5-year property), which represents the only �179 property purchased in 2003. Assume further that the computer purchases qualify for the maximum �179 deduction, the new 50% additional first year depreciation deduction, and the normal MACRS depreciation deduction. The total deductions in 2003 on the computer purchases would be $280,000, computed as follows: (i) a �179 deduction of $100,000, plus (ii) additional 50% first year depreciation of $150,000 on the remaining basis ([$400,000 - $100,000] x 50%), plus (iii) $30,000 of MACRS depreciation ([$300,000 - $150,000] x 20% [using half-year convention and 200% declining balance]). Planning Alert! Like any other depreciation, the '179 deduction is subject to the ordinary income recapture provisions if the property is sold.

Select Your �179 Property Wisely. Since you can select the property that you want to qualify for the �179 deduction, it is generally preferable to allocate the �179 allowance to the qualifying property that has the longest depreciable life. Also, if you have more than $100,000 of qualifying �179 property acquisitions during 2003 and you acquired property both before May 6^th and after May 5^th, it may be preferable to select assets acquired before May 6, 2003 for the �179 deduction. That way, the �179 deduction will reduce the 30% additional up-front depreciation amount rather than the 50% additional depreciation amount.

Don't Forget the Taxable Income Limitation. Your �179 write off cannot exceed your business income ,computed without regard to the '179 deduction.

25% of Corporate Estimated Tax Payments for September Delayed. The 2003 Act provides that 25% of any corporate estimated tax payments that would otherwise be due in September, 2003 will not be due until October 1, 2003. The purpose of this provision is to shift revenue from the fiscal year of the federal government ending September 30, 2003 to the year ending September 30, 2004.

TAX RELIEF IMPACTING PRIMARILY INVESTORS

In a bold move to help bolster Wall Street, Congress slashed the tax rates for individuals on dividends paid on stock and, somewhat unexpectedly, reduced the individual tax rates for most long-term capital gains. These rate reductions do not apply to capital gains or dividends received by C corporations.

Long-Term Capital Gains Tax Reduced. The new law generally reduces the tax rate on long-term capital gains from 20% to 15% for individual taxpayers above the 15% tax bracket. The new 15% rate applies only to capital gains "properly taken into account" after May 5, 2003 and before 2009. If the long-term capital gains would otherwise be taxed in the 10% or 15% tax bracket, the long-term capital gain rate is reduced from 10% to 5% from May 6, 2003 through 2007. For 2008 only, the tax rate on qualifying long-term capital gains for taxpayers who would otherwise be in the 10% or 15% tax bracket is zero. Also, the 18% and 8% rates for assets held more than five years are repealed. All these rate changes sunset after 2008, and on January 1, 2009 the tax rates on long-term capital gains revert back to 20%, 10%, 18% or 8%. The following are important points to keep in mind regarding these new rate reductions for long-term capital gains:

The New 15%/5% Rates Do Not Apply to All Capital Gains. The new 15%/5% capital gains rates only apply to capital gains that would otherwise qualify for the 20% or 10% rates under the old rules. Therefore, the maximum capital gains rate on "collectibles" (e.g., artwork, antiques, etc.) and "qualified small-business stock" (which qualifies for a 50% capital gains exclusion) remains at 28%. Likewise, if you sell a depreciable building, the gain attributable to the straight-line depreciation you took on the building is taxed at a maximum capital gains rate of 25% and does not qualify for the new 15%/5% rates. Planning Alert! Long-term capital gains recognized by a regular C corporation receive no tax rate break and may be taxed at a rate as high as 39%.

Prior Year Installment Sales May Qualify for New Rates. The new 15%/5% capital gains rates apply to any long-term capital gains Aproperly taken into account@ after May 5, 2003. Consequently, if you are reporting long-term capital gains on collections from a qualified installment sale of property that occurred prior to May 6, 2003, capital gains triggered by collections after May 5, 2003, may qualify for the new 15%/5% capital gains rates.

New Capital Gains Rates Apply in Calculating AMT. The new law makes it clear that the lower capital gains rates apply for both regular tax and alternative minimum tax purposes.

Maximum Tax on Dividends Reduced from 38.6% to 15%. The new legislation provides that dividends paid to individuals in 2003 through 2008 will be taxed at a maximum rate of 15%. For 2003 through 2007, the rate is 5% for taxpayers who would otherwise be in the 10% or 15% ordinary income tax bracket. For 2008 only, the tax rate on dividends for taxpayers who would otherwise be in the 10% or 15% tax bracket is zero. After 2008, dividends will no longer qualify for these special rates and will once again be taxed at the regular individual tax rates. The reduced tax rate on dividends applies for both regular and alternative minimum tax purposes. The following are things to keep in mind concerning the new rules for taxing dividends:

Closely-Held Corporation Stock Qualifies. Although earlier proposals would have allowed tax relief only to dividends paid by "publicly-traded corporations", the final legislation generally applies the new lower tax rates to dividends paid by domestic corporations (closely-held as well as publicly-traded) and to publicly-traded foreign corporations.

Certain Dividends Do Not Qualify. There is a laundry list of dividends that do not qualify for the new lower rates such as dividends from various tax exempt organizations and farmers' cooperatives, certain dividends paid by mutual savings banks, dividends on certain stock that is held for 60 days or less, and deductible dividends paid on ESOP stock. Generally, dividend distributions from Regulated Investment Companies (RICs) and distributions from Real Estate Investment Trusts (REITs) will qualify for the 15%/5% rates to the extent that the RIC (mutual fund) or the REIT receives and distributes qualifying dividend income. The definition of "qualifying dividends" is extremely complex. Please call our firm if you want more information.

Maximum $3,000 of Capital Losses Allowed Against Dividend Income. Although most long-term capital gains and qualifying dividend income are both taxed at the15%/ 5% tax rates, capital losses can generally be used only to offset capital gains. Unfortunately, capital losses do not offset dividend income in the same manner as capital gains. However, as under prior law, capital losses in excess of capital gains may reduce up to $3,000 of your taxable income.

Dividends Distributed From Qualified Retirement Plans Will Not Get Preferential Tax Treatment. Taxable distributions from qualified retirement plans (e.g., profit-sharing plans, pension plans, '401(k) plans, regular IRAs, etc.) will be taxed at ordinary income tax rates even if the funds represent dividends paid on stock held in the retirement plans. Tax Tip. This might make it beneficial to hold a larger percentage of your interest generating investments in your retirement plan while holding a larger percentage of your dividend paying stock investments outside of the plan.

The articles contained in this newsletter are not intended as a substitute for legal, accounting or tax advice. You should seek professional advice on the particular issues which concern you.

Edited by Gary R. Gomola, CPA, CVA June 2003