Tax and Business Alert - AUGUST 2003

The Jobs and Growth Tax Relief Reconciliation Act of 2003

The Jobs and Growth Tax Relief Reconciliation Act of 2003 (the 2003 Act) was signed into law by the President on May 28, 2003. Most of the tax bill's benefits, as discussed below, are directed toward individuals. However, some key provisions are targeted toward businesses and are covered on page four.

Child Tax Credit. The 2003 Act raises the maximum allowable child tax credit for children under age 17 to $1,000 for 2003 and 2004 (up from $600). The increased credit amount (up to $400) will, in most cases, be refunded to taxpayers in 2003. The 2003 refunds will be based on information contained on their 2002 returns.

Increased 15% Bracket on Joint Returns. The 2003 Act increases the size of the 15% regular income tax bracket (for 2003 and 2004) on joint returns to twice the size of the same bracket for single taxpayers.

Increased 10% Regular Tax Bracket. The 2003 Act broadens the 10% regular tax rate bracket for 2003 and 2004. For 2003, the 10% regular income tax bracket increases to $7,000 from $6,000 for single individuals and to $14,000 from $12,000 for joint filers. The top of the 10% bracket for head of households remains at $10,000. In 2004, these amounts are indexed for inflation.

Regular Tax Rates Drop. The 2003 Act accelerates retroactively to the start of 2003 the reductions in the regular tax rates in excess of the 15% bracket that were scheduled to take place in 2004 and 2006. The 27%, 30%, and 35% brackets are each reduced by 2% to 25%, 28%, and 33%, respectively, while the 38.6% bracket is reduced to 35%.

Increased Standard Deduction on Joint Returns. The 2003 Act provides limited relief from the marriage penalty by increasing the standard deduction for 2003 and 2004 on a joint return to twice that of taxpayers filing as singles.

Relief from the Alternative Minimum Tax (AMT) Trap. Approximately 2.3 million taxpayers were hit by the AMT in 2002. The 2003 Act provides limited temporary relief from the AMI in 2003 and 2004 by increasing the AMT exemptions for single and married taxpayers as well as for married taxpayers who file separately.

Reduced Capital Gains Tax Rates. The 2003 Act reduces the 10% and 20% capital gains rates to 5% (0%, in 2008) and 15%, respectively. The lower rates are available for both regular tax and AMT. The new lower rates are effective for sales after May 5, 2003, and apply to qualifying assets held more than one year, the reduced rate is effective through 2008.

Dividend Tax Relief. Under the 2003 Act, dividends received by an individual (noncorporate) shareholder from domestic and qualified foreign corporations generally are taxed at the same rates that apply to long-term capital gains [i.e., the new dividend rates are 5% (0%, in 2008 for lower tax bracket taxpayers) and 15%]. The new dividend rates are effective for the entire 2003 calendar year and through 2008.

Testamentary Letters Provide Timely Guidance

A testamentary letter, also referred to as an estate-planning letter, should be part of your memorandum to dispose of your estate's personal property. It is not binding on your executor, but provides guidance concerning your wishes.

The testamentary letter can provide invaluable assistance to your executor and family members. An explanation in layman's terms of the workings of the will and estate plan in general should help the readers understand your desires and objectives. A description of the estate plan found in the testamentary letter must be consistent with your will. The letter may not be probated in lieu of your will but may be admissible in probate court to clarify an ambiguity in the will. The will and other legal documents will be controlling if any inconsistency arises. It generally is advisable for an attorney to review the testamentary letter with its description of the estate plan to ensure its accuracy.

It is important that the testamentary letter be consistent with the overall estate plan. If the letter contains directions that appear contrary to the will, it may provide impetus to an unhappy beneficiary's desire to contest the will. It is possible that the testamentary letter could be argued to be a revocation of the will if it is signed after the will is executed and is inconsistent with the will. For this reason, the attorney drafting the will should help prepare the testamentary letter in order to ensure consistency.

The letter assists your executor in administering the estate, supplying him or her with as much information as possible regarding the location of important documents (e.g., will, life insurance, burial policies), your assets and liabilities, and professional advisors and other individuals to consult during administration.

Like other parts of your estate plan, the testamentary letter should be reviewed and updated periodically. It should be kept in a safe place other than a safe deposit box so your executor may gain quick access to it. This is particularly true of burial instructions that are included within the testamentary letter. The funeral may occur before It is possible to gain access to a safe deposit box (e.g., if the death occurs on a weekend or holiday).

Annuity Payout Options

If you own annuities, you are likely to have several payout options available to meet your individual cash flow requirements. Some of the more common payout options include:

Life Only Annuity payments are made only over the lifetime of the annuitant; nothing is paid to the annuitant's estate or heirs. This option provides for a larger payment when compared to the joint and survivor option (see below) since it is based on only one life.

Joint and Survivor Annuity payments continue over the lives of the annuitant and a surviving joint-annuitant. The payment under this option will be smaller than under the life only option because it is based on two lives.

Life and Period Certain Annuity payments are made for the life of the annuitant or for a specified period, whichever is longer. For example, if the annuitant dies within one year after payments begin on a ten-year payout, payments will continue to be made to the annuitant's beneficiary for nine years. The annuity payment under this option would be less than under the life only option because the insurer has guaranteed payments for a term that could extend beyond the annuitant's life.

Installment Refund Annuity Payments to the annuitant or the annuitant's estate or heirs continue until the payout equals the amount paid to originally purchase the annuity. This option will also result in an annuity payment that is less than the annuity under the life only option.

Financial Website for Women

Women live, on average, seven years longer than men; yet have less in retirement assets and are less likely than men to have pensions and savings. They are also more likely to need nursing home care, but quite often have no long-term care insurance. Women earn, on average, 25% less than men and, therefore, require different financial planning and practices than their male counterparts. Thankfully, there is a great deal of information available online to assist women (as well as men) with investing, insurance, and employment decisions.

The University of Illinois Cooperative Extension Service website at www.urbanext.uiuc.edu features A Working Woman's Guide to Financial Security. This online guide has three sections. The first section, Planning for Financial Independence, discusses developing your financial I.Q., organizing family and financial records, spending hints, the use of credit cards, and how and where to save your money. The second section, Developing Your Financial Independence, covers insurance, Social Security, and making the most of your retirement plan. Thinking Ahead, the third 'section, discusses investment goals, investment options, where to retire, and how to forecast retirement income and expenses.

Life Insurance Strategies for Individuals and Business Owners

Life insurance can be a valuable tool for you both individually and as a business owner to save taxes, recover from the loss of a key executive, and successfully exit your business. Here are a few ideas for using life insurance you might find beneficial.

Irrevocable Life Insurance Trust (ILIT)

One of the best methods of keeping life insurance proceeds out of your estate and ensuring that your estate has the necessary liquidity to meet its obligations is to create an irrevocable life insurance trust (ILIT). As a source of funding, you can transfer an existing life insurance policy (or other assets) to the ILIT. Alternatively, the ILIT can purchase a new life insurance policy. At your death, the proceeds from the life insurance policy are paid to the ILIT, not to your estate. The ILIT effectively removes assets from your estate (and from your surviving spouse's estate) while at the same time making the insurance proceeds available to meet the needs of your surviving spouse, estate, and beneficiaries.

With an ILIT, you as grantor of the trust select the trustees who will manage the insurance proceeds and specify how such proceeds should be invested. In addition, you can determine when your beneficiaries will receive the policy proceeds. Assets in the trust, whether a life insurance policy or otherwise, are not subject to probate and can, in many cases, be protected from creditor claims. The trustee of the ILIT may (but cannot be required to) purchase assets from or loan money to your estate, if necessary, providing liquidity to pay debts and taxes.

Key Person Life Insurance

When the continued success of your business enterprise depends on the abilities, talents, or services of a particular employee (key employee), it is appropriate for your company to insure that person.

Key person insurance should be owned by, and payable to your company, and the company should pay the premiums. The premium payments will not be deductible by the company for income tax purposes and will not be taxable to the employee as compensation (assuming the employee has no beneficial interest in the policy). In addition, your company will receive the insurance proceeds tax-free.

The amount of key person insurance needed is based on the value of the key employee's services, the increase in net income and goodwill attributable to the key employee, and the cost of recruiting and training a replacement. One approach is to pick some multiple of current salary as a proxy for his or her value (a common formula is 5 to 10 times the key employee's annual salary).

Buy/Sell Agreements

Buy/sell agreements help provide a ready market for selling an ownership interest in a closely held business. Typically, the agreement provides that an owner's interest in the business will be sold (or at least offered for sale) at a specified price to the business entity or the other owners when a specified event occurs. The events that will trigger the sale of the ownership interest are specified in the buy/sell agreement. Common triggering events include an owner's death, disability, or retirement.

Life insurance is often purchased to fund the sale of a business under a buy/sell agreement, in the right circumstances, using funds from an insurance policy can be the most efficient and economical way to fund the purchase of a business interest at the death of an owner. Life insurance that builds cash surrender value (whole, universal, or variable life) can also help fund a sale at the owner's retirement. The owners' ages and health should be considered when determining whether life insurance should be used to fund a buy/sell agreement. It might be cost-prohibitive to acquire life insurance for older owners or those who are in poor health.

New Tax Law Provides Incentives to Purchase Business Equipment

The Jobs and Growth Tax Relief Reconciliation Act of 2003 (the 2003 Act) increased the amount available to business owners for bonus depreciation and immediate expensing for Qualified equipment purchases.

Bonus Depreciation Increased The Job Creation and Worker Assistance Act of 2002 (the 2002 Act) brought us a special 30% depreciation allowance for property meeting three broad criteria. Namely, the asset had to be qualified property (property that meets one of four specific definitions), acquired after September 10, 2001 and before September 11, 2004, and originally placed in use after September 10, 2001. The bonus depreciation is determined without any prorating based on when during the tax year the property is placed in service. So, even property placed in service on the last day of the tax year is eligible for the full deduction.

The 2003 Act increases the bonus depreciation amount from 30% to 50% of the adjusted basis of qualified property. To qualify for the 50% bonus depreciation deduction, the property generally must be acquired and placed in service after May 5, 2003, and before January 1, 2005. (Certain longer-lived property and transportation property has until December 31,2005, to be placed in service.) Similar to a provision in last year's tax bill, otherwise qualified property doesn't qualify for the 50% deduction (but generally would qualify for the 30% deduction) if there was a binding written contract for the acquisition in effect before May 6, 2003.

Observation: The 2003 Act makes property acquired as late as December 31, 2004 eligible for the 50% (or, if elected, 30%) bonus depreciation (rather than the prior law cut-off of September 10, 2004).

Increased Section 179 Expensing Under prior law, the standard Section 179 (election to expense certain otherwise depreciable business assets) limit for 2003 is $25,000. This limit is reduced dollar-for-dollar to the extent the amount of qualifying Section 179 property placed in service during the tax year exceeds $200,000.

The 2003 Act increases the maximum dollar amount that may be deducted to $100,000 for property placed in service in tax years beginning in 2003, 2004, and 2005. (After 2005, the limit reverts back to $25,000.) In addition, for purposes of the phase-out of the deductible amount, the $200,000 threshold is increased to $400,000 for these same three years. These $ 100,000 and $400,000 limitations are indexed annually for inflation for tax years beginning after 2003 and before 2006. For 2003 through 2005, taxpayers are allowed to revoke the Section 179 election on an amended return without the consent of the IRS. With the 2003 Act, off-the-shelf computer software placed in service in a tax year beginning in 2003, 2004, or 2005 now qualifies as Section 179 property.

Please call us if you have questions about the 2003 Tax Act.