There's a little something for everyone in the tax cut that President Bush championed and signed into law this week.
And that makes Greg Langl very happy.
"I think it's great," said Langl, a Cheektowaga father of two young boys who will get an $800 check from the government and find a little more in his paycheck this summer because of the tax cut. "Any time the government wants to send me back more of my money, I'm not opposed to it."
While the drop in the tax rate on dividends received the most attention, the tax cut also helps investors in other ways, by lowering the capital gains taxes they'll pay when they sell property or investments at a profit.
It helps average families by increasing by $400 the tax credit they receive for each child, to $1,000. Those checks go out over three weeks beginning July 25, based on the last two digits of the Social Security number of the first taxpayer listed on the return.
The new law also raises the standard deduction for married couples by more than $1,500 to provide relief from the marriage penalty.
Even lower-income taxpayers will benefit within weeks from lower overall tax rates and expanded tax brackets that make a greater portion of everyone's income subject to a lower tax rate.
But the new tax cut does not treat everyone equally. Depending on your financial circumstances, the impact of the tax cut can vary from relatively modest to quite substantial.
"It's basically nice for everyone. There's really something in there for everybody," said David A. Schlein, the tax partner at Lumsden & McCormick, a Buffalo accounting firm. "Who is it going to benefit the most? Wealthier people, because they're the ones who invest and have the most dividends and capital gains."
For instance, a married couple with two children earning $50,000 in income, will save $1,133 in taxes. And if that couple's income includes $2,000 in capital gains, their federal income tax bill would be cut almost in half -- a savings of $1,230 -- according to CCH, an Illinois publisher of tax information.
A wealthier couple, with $100,000 in income, including $15,000 in itemized deductions and $5,000 in capital gains, would save $2,492 under the new law.
In contrast, a single taxpayer with a $30,000 income, including $3,000 from dividends, would save just $350, or 12 percent, CCH said.
"It's not life-changing," Langl said. "We're going to pay some bills or use it toward our planned vacation to Florida in February."
Beyond that, the tax cut gives investors a further incentive to look at stocks -- especially those that pay dividends -- by cutting the top capital gains tax rate to 15 percent from 20 percent and allowing dividends, which previously were taxed as regular income, to be taxed at the lower capital gains rate. For an investor in the upper tax brackets, that can reduce the tax burden on dividend payments by up to 20 percentage points.
Incentive to pay dividends
Companies that have never paid dividends, such as Dell Computer and Oracle Corp., already have indicated that they might start making payouts to shareholders because of the new law. Others that pay small dividends will have a further incentive to increase them. And local investment advisers think the change will focus investors even more on blue-chip dividend-paying companies.
"It's going to send people back to looking at the companies that are the steady Eddies of the financial world that pay dividends," said Rosemary A. Ligotti, managing director at GoldK, a 401(k) investment services firm that has an office in Amherst.
Even so, after investors de-emphasized dividends for much of the growth-oriented 1990s, dividends are a much smaller factor in the stock market than they once were, with the yield on the Standard & Poor's 500 averaging just 1.7 percent. That means it would take a $100,000 investment in an S&P 500 index fund to generate $1,700 in dividends.
The capital gains tax cut also helps small business owners who sell their companies or real estate.
"It's a very strong positive for stocks, and it's a strong positive for small business owners," said Gerald T. Cole, the managing partner at Arbor Capital Management, an Amherst money management firm. "Stocks are more attractive now in any case, but the changes in capital gains and dividends tip the scales even more toward stocks."
Complicating matters is the temporary nature of many of the tax cut provisions. While the dividend and capital gains reductions will extend through 2008, the marriage penalty relief and the increased child tax credit last just two years before falling back to a reduced level.
That puts individuals in the position of trying to guess whether the tax cuts will be allowed to expire -- effectively increasing taxes -- or whether those reductions will be extended or made permanent by Congress.
"If Congress doesn't extend them, then they're going to be looked at as raising taxes," Schlein said.
For now, though, the best advice is to try to take full advantage of the tax plan and worry later about what might happen in 2005 and beyond, Ligotti said.
Here's a look at how the tax cuts will affect individuals and investors.
Lower tax rates
Everyone will save because of an across-the-board reduction in marginal tax rates. This cut, which is retroactive to Jan. 1, could show up in paychecks by July 1 as a reduction in the amount of tax withheld; the IRS is urging companies to make the change as soon as possible. Under the plan, the top four tax rates will be reduced, speeding up a reduction that was originally supposed to take place in steps through 2006. Now rates will drop straight to their 2006 levels.
That means the 27 percent marginal tax rate will slide to 25 percent; the 30 percent rate will drop to 28 percent; the 35 percent rate will fall to 33 percent; and the top rate of 38.6 percent will slip to 35 percent.
These rate reductions would expire after 2010.
Beyond that, the tax plan increases the amount of income that is subject to the lowest 10 percent marginal tax rate by $1,000 for single filers and by $2,000 for married couples. That alone will save singles $50 a year and married couples $100 annually before reverting to last year's level in 2005.
Child tax credit
This tax break already was lucrative for families because it offers a dollar-for-dollar savings on tax bills, as opposed to a deduction, which just reduces the amount of income subject to tax.
Now it's even more valuable, rising to $1,000 for each child under age 17 this year and next for single taxpayers with income of less than $75,000 and couples earning less than $110,000. But the credit will drop to $700 from 2005 to 2008.
But not lower-income families, with 12 million children. They won't get any benefit from the expanded child tax credit because they already pay no taxes and the tax credit is limited to 10 percent of their income above $10,500, or $600, whichever is lower.
That means rebate checks for the increased child tax credit will not go to married filers earning less than $16,500 with one child; $22,100 with two children; or $26,625 with three children, according to the Center on Budget and Policy Priorities.
Likewise, the child tax credit is reduced by $50 for every $1,000 of income above $110,000 for married taxpayers filing jointly or $75,000 for single filers.
Eligible taxpayers who claimed the child tax credit on their 2002 returns can expect rebate checks of $400 per child to be mailed on July 25 to taxpayers with Social Security numbers ending in 00 through 33. The next batch will go out Aug. 1 to taxpayers with Social Security numbers ending in 34 through 66, followed by an Aug. 8 mailing date for Social Security numbers ending in 67 through 99.
Marriage penalty relief
This change eases the penalty that forces some married couples to pay more in taxes than they would if they were single. Essentially, it increases the standard deduction for married couples to double that of single filers and widens the amount of income that will be taxed at the 15 percent rate from $47,450 to roughly $56,800.
This tax break, however, lasts for only two years. The amount of income subject to the 15 percent tax rate will be reduced again in 2005.
Dividends and capital gains
The tax on long-term capital gains on transactions on or after May 6 drops from 20 percent to 15 percent for most individuals, with dividends taxed at the same rate. For lower-income investors, capital gains and dividends will be taxed at 5 percent from 2003 to 2007 and then drop to zero in 2008. This break mostly affects wealthier taxpayers, because just one taxpayer in seven with income under $20,000 reported receiving any dividends on their 2000 returns, and just 20 percent of the returns with incomes of $75,000 or less showed any dividends, according to CCH. In contrast, 87 percent of the returns with incomes of at least $200,000 reported dividends.
The lower tax on dividends also will create stiffer competition for municipal bonds, which state and local governments and their agencies sell to investors to fund their operations, touting their tax-free yields. But municipal bonds have limited growth prospects, barring a sharp drop in interest rates, while dividend-paying stocks offer more potential upside from rising share prices at a newly reduced tax burden. That could force municipalities to pay higher interest rates on new muni bonds.
"There will be some changes in investor behavior," Cole said. "Probably one of the biggest losers in all of this will be the municipalities that depend on the municipal bond market."
The elimination of all capital gains taxes on taxpayers in the 10 percent and 15 percent tax brackets in 2008 also poses some interesting possibilities for investors with children. "What you can do is give to the kids and have the kids sell," Schlein said.
The downside to the capital gains tax cut is that it devalues the capital losses that many battered investors are carrying forward from investment sales as the stock market plunged during the last three years. Those losses, which can be used to offset capital gains, now will cancel out gains that will be taxed at a 15 percent rate, rather than the higher 20 percent rate that was in place when the losses were realized.