By Leon Dutkiewicz, CPA
President Bush may not have succeeded in getting all the tax cuts that he proposed, but the Jobs and Growth Tax Relief Reconciliation Act of 2003 does contain significant tax savings for physicians and other highly compensated individuals. In fact, the Tax Act contains some significant tax breaks for virtually all taxpaying Americans. These are some of the highlights:
Tax rates on capital gains and dividends. For taxpayers in the highest tax brackets, the tax rate on capital gains and dividends will be lowered to 15 percent for the years 2003 to 2008. Taxpayers in lower income brackets will pay a five percent tax rate on capital gains and dividends in years 2003 to 2007, and no taxes on such income in 2008. Capital gains tax relief, effective as of May 6, 2003, will lower the 20 percent rate once paid by most high bracket taxpayers. The new and highly touted dividends provision is effective retroactive to January 1, 2003. This will result in significantly lower tax on dividends that had previously been taxed, at taxpayers’ marginal rates, as high as 38.6 percent. Both types of relief are scheduled to expire at the end of 2008. (See the 2003 individual tax rate reduction discussion below for more good news.)
Section 179 small business expensing. Purchases of assets such as medical equipment, office computer systems and the like can be written off in the year they are placed in service up to certain limits. Those limits have been increased from $25,000 to $100,000 in total. The phase-out threshold level for these direct write-offs also increased from $200,000 to $400,000. These limits and thresholds are effective for property placed in service in tax years beginning in 2003, 2004 and 2005. The threshold provides that once total purchases of qualified assets in a given tax year reaches the $400,000 level, the allowance of $100,000 per year begins to decline dollar for dollar down to zero at the $500,000 level. So with careful planning, the newly increased limit of $100,000 can be fully utilized, at least for three years, and result in some significant tax savings – as well as create a golden opportunity to update office technology with the help of Uncle Sam. Any Section 179 expense that exceeds net taxable income generally can be carried over to subsequent years for use until fully written off. (Note: This is a deduction, not a credit. The net cost to the medical practice will still approximate 65 percent of the original purchase price, after the immediate tax deduction is taken into account.)
“Bonus” depreciation. Under the 2002 Tax Act an additional amount of depreciation on new assets placed into service after September 10, 2001 gave taxpayers an additional 30 percent of depreciation to write off. With the 2003 Tax Act that “bonus” has been increased to 50 percent for property acquired and placed in service after May 5, 2003 and before January 1, 2005. Just as with the earlier 30 percent bonus depreciation, buildings and used property do not qualify for this provision.
As an illustration, a medical practice decides to update some imaging equipment and buys an ultrasound and flat film cameras that cost $150,000. Other assets purchased amount to less than $250,000, so no phase-out of the Section 179 deduction is required. The new equipment that will make the practice more efficient and reduce the chances for diagnostic error can produce, along with outstanding images of Junior’s fractured tibia and intact spleen, a deduction of $130,000 from taxable income, assuming that there is enough income to absorb the entire $100,000 Section 179 expense.
The first-year percentage for these types of assets is generally 20 percent for the first year, 32 percent for the second, 19.2 percent for the third year and lesser percentages for the remaining two years until the asset is completely “recovered” (read written-off.) How can this be? Let’s say the entire $100,000 of Section 179 expense is applied to the purchase of the new piece of equipment. That leaves $50,000 of “basis” eligible for additional depreciation. Under the new limits, 50 percent or $25,000 of the remaining $50,000 basis can be written off as bonus depreciation. And on top of the $100,000 and the $25,000, an additional $5,000 (under MACRS depreciation, the remaining basis of $25,000 generally can be depreciated over the five year life assigned to this type of asset) of regular depreciation can be expensed.
Be careful how you cluster your asset purchases, however. The depreciation regulations are different if more than 40 percent of all assets purchased in a given tax year are acquired in the last quarter of a tax year. The reduced amount allowable for regular MACRS depreciation must be applied to all assets regardless of when acquired, not just to the assets placed into service in the last quarter of the tax year. This treatment is known as the “Mid-Quarter convention” and was designed primarily to discourage taxpayers from loading up on asset purchases during the last three months of a tax year, encouraging taxpayers to spread their acquisitions over the entire tax year. Remember, the benefits of Section 179 expensing, the “bonus” depreciation and the Mid-Quarter convention apply only to the purchase of hard, tangible assets. They do not apply to purchases or improvements to real estate; however, purchased computer software is now eligible for deductions under Section 179.
Child tax credit. This tax benefit has been increased from $600 to $1,000 for 2003 and 2004. Advance rebates of up to $400 per eligible child will be mailed this summer to those families who qualify for the Child Tax Credit. No filings or other correspondence from the taxpayer is required because the IRS will review taxpayers’ 2002 returns and automatically mail the advance rebates to those who appear to qualify for 2003. This credit phases out when modified adjusted gross income (AGI) exceeds $110,000 for joint return filers, $55,000 for those filing as married filing separately and $75,000 for single taxpayers. Chances are that this credit may not apply to most medical practitioners due to the AGI limitations but this credit can be very meaningful to the office and paraprofessional staff in many medical offices.
Ten percent income tax bracket increase. This expansion of the taxable income bracket base has been accelerated so that it will be effective in 2003 and 2004. This will give joint filers an additional $2,000 of income ($1,000 for singles) to be taxed at the lowest rate of 10 percent. Once again, this tax break probably won’t be applicable to most medical practitioners but may affect members of the office and paraprofessional staff.
2003 individual tax rate reductions. The reduction in tax rates for individuals has been accelerated. Reductions that had been scheduled to take place in 2004 and 2006 will now become effective retroactive to January 1, 2003. Now, the 2003 rates will be 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent, a reduction of two percent to three percent for the top four tax brackets. The IRS has issued revised withholding tables for immediate use in determining the lower withholdings from employees’ paychecks.
Marriage tax penalty relief. This ongoing dilemma has been addressed and the steps to soften the “penalty,” while not a cure, have also been accelerated. The Tax Act will increase the standard deduction and expand the 15 percent income bracket. Both would be twice the amount for singles, effective for years 2003 and 2004. While this bitter medicine won’t be sweetened for higher-income taxpayers, at least the Service has taken its first steps towards fixing the conundrum.
Alternative minimum tax exemption amounts. The threshold above which modified taxable income becomes susceptible to the dreaded alternative minimum tax (AMT) has been increased to $58,000 for married couples filing joint returns ($40,250 for single filers) for taxable years beginning in 2003 and 2004. This is an increase of $9,000 for couples and $4,500 for individuals and will help some taxpayers with relatively high-itemized deductions escape from the AMT, or obtain a lower AMT result.
In order to maintain some semblance of revenue neutrality, many of these new provisions apply only for a few years and they are all scheduled to sunset after 2010 (as set forth under the 2001 Tax Act), unless, of course, another piece of future legislation extends or makes these revisions permanent. The tax prognosis may even improve further this year. Some in Congress have indicated that there may be two more tax bills in 2003.
Leon Dutkiewicz, CPA , is with Margolis & Company P.C., a regional certified accounting and business-consulting firm located in Bala Cynwyd, Pa.