If you're like most small business owners or investors, the current tax law changes confuse you. While you certainly want to take advantage of any tax savings you legally can, unless you are an IRS agent who can comprehend hundreds of pages of verbose text, you probably have no desire to read the tax law books, much less understand them. Unfortunately, what you don't know can cost you money and lots of it. To protect your assets or enhance your business, you need to understand, not only the current tax law changes that pertain to you, but also how to best use them to your advantage.
One of the most publicized tax law changes is the Bush Tax Reform Act, also know as the Job and Growth Tax Relief Act of 2003. Geared specifically for small business owners and investors, this tax relief act can help people in these two categories pay fewer taxes and keep more of the money they earn.
In order to utilize this new tax law, you first need to comprehend the law itself. Second, you need to understand the time frame for all the tax law changes. Finally, you need accurate strategies to take advantage of the law. The following will give you an explanation of each point.
In a nutshell, most taxpayers will receive a two percent reduction in their income tax rate. So if you're in the thirty-eight percent tax bracket, you'll automatically get reduced to the thirty-six percent tax bracket. Considering that the average American family pays thirty percent of their income in state and federal taxes, this one tax law change is a welcome relief.
Next, if you're married, the standard deduction for married couples goes up from $7,950 to $9,500 in 2003 and 2004. After that the deduction will fall to 18 percent of the single person's deduction. The deduction amount will rise yearly until 2009, when it will double that of a single person's deduction. Additionally, the child credit will increase from $600 per child to $1,000 per child for 2003 and 2004. All this equals great tax savings for American families.
In terms of investors and small business owners, many whom own stocks that pay dividends, should see a reduction in the amount of taxes they pay. In order to receive the new dividend tax rate, the income must meet certain qualifying criteria. Certain types of dividend income are specifically excluded from the definition of "qualified dividend income," so it is advisable to talk to a knowledgeable CPA about this aspect of the act. For most investors the tax on dividends will reduce to 15%. For those in the 10 to 15% tax bracket, the tax will reduce to five percent. Additionally, the law lowers the maximum long-term capital gains tax, which applies to stock and real estate transactions from 20% to 15%. For small business owners, the new tax law allows you to write off up to 50% of the depreciation on new qualified property purchases (as long as the property was purchased after May 5, 2003.)
Realize that these tax law changes are not permanent. The tax cuts, which equal $350 billion, have staggered and varying implementation schedules as well as come up for vote again in 2010. Additionally, small business owners need to make their qualified property purchases by the end of 2004 to take advantage of the bonus appreciation.
Regardless of the time frame, all these tax cuts quickly add up. Consider this: the Bush Tax Relief Act is the second largest tax cut in history. The goal is to put that $350 billion in tax cuts back into the taxpayers' pockets so they can revitalize the economy.
Strategies to Take Advantage of This New Tax Law
In order to take advantage of the tax savings you're entitled to, employ the following strategies:
- Buy high dividend paying stocks versus leaving your money in a CD.
For example, if you invested $250,000 in a CD that pays two percent interest, you will generate $5,000 in income from that investment; however, when you cash out you'll pay $1,750 in taxes (at the 35% tax bracket). Your income, after taxes, would be $3,250. Now if you were to put that same $250,000 into a common stock paying two percent dividends, you would generate $5,000 income. But because it's a dividend payment and not an interest payment, your tax would only be $750 (taxed at the 15% dividend rate), and your income after taxes would be $4,250. Naturally, income from stock is subject to fluctuation.
- Use the right account for the right investment.
Qualified Dividend Income in tax-deferred accounts or qualified investments such as IRAs, 401Ks, Keoghs, etc. does not receive the full benefit of the dividend tax reduction because when the funds are withdrawn from the account, they will be taxed as regular income. In other words, you pay the full regular income tax on these as determined by your tax bracket. So don't use these types of accounts for dividend income. Instead, let the funds in these accounts sit and grow. For high dividend income, you need to use taxable accounts, such as tax-free municipal bonds or long-term dividend paying stocks. These types of investments, made outside a tax-deferred account, will yield you the greater tax savings under the new laws.
- Buy equipment for your small business.
If you've been contemplating buying depreciable, tangible personal property for use in your business (such as computers or vehicles), then now is the time to do it. As long as you make your purchase before the end of 2004, you can write off up to 50% of the depreciation on these items in the first year. So if you purchase a new computer system for your office that costs $25,000, for example, you can write off $12,500 from your taxes. Realize that before you do this, you need to talk to your accountant. Depending on your situation, it may be better for you to write off only 30% of the depreciation, or it may be better for you to take advantage of Section 179 and write off 100%. Your accountant can help you decide on the best route to take.
While no one enjoys paying taxes, the new tax laws can help you feel a little less pain when April 15 rolls around. So familiarize yourself with the new tax laws and put some strategies into place that will make the new laws work for you. When you do, you'll keep more of your hard-earned money in your pocketand that's a feeling everyone enjoys.
Wachovia Securities does not render legal, accounting, or tax advice. Please consult your tax or legal advisors before taking any action that may have tax consequences. This information is for general information purposes only and not meant as a full explanation of the material presented.