The legislation contains many of the elements of President Bush's plan for stimulating the U.S. economy, a plan that originally called for $726 billion in tax reductions through 2013. This scaled-back version now cuts taxes by $330 billion for stockholders, individual taxpayers, couples, and businesses, while including $20 billion for financially strapped states, a provision that Bush did not seek.
Although the legislation does not contain President Bush's proposals to eliminate the tax that individuals pay on corporate dividends, it will lower the top tax rate on both dividends and capital gains to 15 percent. The current top tax rate is 38.6 percent for dividends and 20 percent for capital gains. Lower income individuals would pay a 5 percent rate on both.
The new rates apply through 2007; in 2008, the lower rate would drop to zero. In 2009, today's higher rates would return.
On a personal level, the average taxpayer, including many owners and managers of HVACR businesses, will find that the new legislation accelerates several personal tax reductions that had been scheduled to occur later this decade. There would be an increase in the child credit to $1,000 per child, instead of the current $600. The highest income tax brackets would be reduced to 35 percent, 33 percent, 28 percent, and 25 percent. The lowest 10 percent tax bracket will be expanded to include more lower income taxpayers.
For married people filing joint income tax returns, the 15 percent tax bracket has been expanded and the standard deduction increased. The new law will also prevent more taxpayers from paying that dreaded alternative minimum tax that has drawn increasing numbers of middle-income taxpayers into its web in recent years. Unfortunately, most of these reductions will last only until 2005.
Of more interest to most HVACR business owners and managers, however, is the increase, from $25,000 to $100,000, in the amount of equipment expenditures that may be expensed and immediately deducted rather than capitalized. Many HVACR operations will also depreciate more of their assets over a shorter period, but the key provision for most contractors — even those with little in the way of equipment — remains the new limits for expensing.
Increased First-Year DeductionsAmong the key elements of the compromise between the House and Senate versions of the bill is an increase in the amount that HVACR businesses can expense from $25,000 to $100,000. Even the phaseout threshold, the amount at which the expensing deduction begins to decline, has been increased from its present $200,000 level to $400,000.
Under our present tax laws, every HVACR contractor may choose to treat expenditures for qualifying property, called Section 179 property, as an immediately deductible expense rather than a capital expenditure. Originally designed to spur investment in new equipment, the maximum expenditures qualifying for that Section 179 expensing election has gradually increased to its present $25,000 ceiling.
To qualify as Section 179 property, the property must be depreciable and for use in or by the HVACR business operation. Buildings and their structural components are specifically excluded, as are air conditioning or heating units. The majority of property used in an HVACR business does qualify, however.
The Section 179 dollar limitation, now at $400,000, must be reduced, dollar-for-dollar, by the cost of qualifying property placed in service during the year in excess of that limit. The amount disallowed under this limitation cannot be carried forward but few contractors will realistically exceed the new $400,000 “investment limitation.”
What's more, the total cost of property that may be expensed for any tax year cannot exceed the total amount of the operation's taxable income for that year. Fortunately, the amount disallowed as a result of the taxable income limitation is carried forward, although the total future deduction cannot exceed the maximum annual dollar cost ceiling, investment limitation or, if lesser, the taxable income limitation in that carry-forward year.
Bonus Write-Offs, New And OldThe new legislation provides an additional first-year depreciation deduction equal to 50 percent of the adjusted basis of qualified property. Qualified property is defined in the same manner as it was for the 30-percent additional first-year depreciation deduction created by the Job Creation and Workers Assistance Act of 2002.
The bonus allowance is only available for new property which is depreciable under MACRS and that has a recovery period of 20 years or less. While, again, excluding buildings, the bonus depreciation is available for most equipment, computer software, and even leasehold improvements.
In general, in order to qualify for the new 50-percent additional depreciation deduction, the property must be acquired after May 5, 2003, and before January 1, 2005. Naturally, property for which the 50-percent additional first-year depreciation deduction is claimed is not eligible for the 30-percent additional first-year depreciation deduction.
Dividends Defined FavorablyUnder the new tax law, dividends received by an individual shareholder from either domestic or qualified foreign corporations generally are taxed at the same rates that apply to capital gains. According to our tax rules, the term “dividend” applies to any distribution made by any corporation to its shareholders out of earnings and profits — either accumulated over its years in business or its profits for the current tax year. Many of the distributions made by an incorporated HVACR business fall within that definition.
This unique provision reduces the top tax rate on both dividends and capital gains. Under this legislation, the top tax rate on both dividends and capital gains will fall to 15 percent this year. Any contractor who is considered to be a low-income taxpayer, will pay 5 percent, falling to zero in 2008. Barring further congressional action, the current higher rates will return in 2009.
Of course, distributions of cash or property by an HVACR business operating as an S corporation will still be taxed according to a priority system that depends upon whether the S corporation has earnings and profits. Since the S corporation is, in essence, a corporation that has chosen to be treated as a partnership, it passes all of its income, deductions, credits, profits, and losses to its shareholders.
Thus, an S corporation can have no earnings and profits unless these are attributable to tax years when the business was not an S corporation (or to S corporation years beginning before 1983). An S corporation may also succeed to the earnings and profits of an acquired or merged corporation.
Growing Into The Alternative Minimum TaxThe alternative minimum tax (AMT) rules were designed to ensure that at least a minimum amount of tax is paid by both high-income and corporate taxpayers who reap large tax savings by making generous use of certain tax deductions and exemptions. Without the AMT, some of these taxpayers might be able to escape income taxation entirely.
In essence, the AMT functions as a recapture mechanism, reclaiming some of the tax breaks primarily available to high-income taxpayers, and represents an attempt by our lawmakers to maintain tax equality. Unfortunately, more and more taxpayers each year find themselves elevated to the ranks of high-income taxpayers.
The Tax Relief and Reconciliation Act of 2001 increased the amounts exempt from the AMT for individuals for the years 2001 through 2004. The new law increases those exemption amounts, raising the $49,000 exemption amount for married individuals filing a joint return to $58,000 for 2003 and 2004. The former $35,750 exemption for single taxpayers has been temporarily increased to $40,250 for tax years 2003 and 2004.
Benefit From The New Rules While You CanThe so-called “Jobs And Growth Tax Relief Reconciliation Act of 2003” tax cuts were less than half the $726 billion in tax reductions through 2013 that President Bush proposed in January as a tonic for the swooning economy. Of the legislation’s $350 billion price tag, $210 billion — or 60 percent — will occur this year and next. Almost half of the cost was devoted to accelerating income tax reductions enacted in the tax cut of 2001.
Tax cuts include the reduced taxes for married couples, the expansion of the lowest tax bracket, and the measures that will prevent more taxpayers from paying the alternative tax. Many of the tax breaks earmarked for individuals will significantly impact the personal tax bills of HVACR contractors as well.
On the business front, two new, temporary tax breaks were designed to encourage investment in businesses such as HVACR. Small contracting businesses can expense up to $100,000 in new equipment investments through 2005, as well as depreciate more of their assets through 2004. Today, however, is the time to make sure this new tax law helps stimulate the economy of you and your business.
Mark E. Battersby is a freelance writer, columnist, author, and lecturer with offices in suburban Philadelphia. He can be reached at 610-789-2480 or MEBatt12@Earthlink.net.
Publication date: 09/08/2003