Investment strategies whould change with tax reduction

Pat Calhoon is branch manager for Smith Barney, a division and service mark of Citigroup Global Markets Inc.

The recently enacted Jobs and Growth Tax Relief Reconciliation Act introduces a $330 billion tax and economic growth package designed to stimulate the U.S. economy through a variety of tax cuts and credits.

Although many of the act's provisions are retroactive to Jan. 1 and the legislation expires beginning in 2009 some provisions expire sooner.

The results of these changes may cause individuals to re-think their current investment strategies. Following are the highlights of the new legislation and some steps individuals may want to consider.

Lower ordinary income tax rates. In fact, taxpayers will see less federal tax withholding from their paychecks this summer. Individuals should consider contributing this excess cash into the company's 401(k) plan, flexible spending plan or even a payroll deduction 529 plan. If an individual pays estimated taxes, be sure to recalculate payments based upon the new rates.

Dividend-paying stocks may become more attractive. The maximum tax rate on dividends for individuals falls to the more generous capital gains rate of 15 percent (or 5 percent if the capital gains rate is currently 10 percent). If individuals are seeking current income with some growth opportunities, they may want to consider shifting a larger percentage of their portfolios to high-quality equities that have a history of increasing their dividend payment over time. Most, but not all, will qualify for the lower dividend rate so check with a tax advisor for the tax treatment of specific securities.

Lower taxes on capital gains. Long-term capital gains rates are lowered to 15 percent and 5 percent. Distributions from 401(k) plans and other tax-deferred retirement accounts are not eligible as either capital gains or dividends available for the reduced rate. So if an individual is drawing from a retirement account, he or she may want to consider favoring equities in taxable accounts, and fixed income in retirement accounts. Also, if an individual is heavily invested in highly appreciated securities, now may be the ideal time to realize gains at the lower capital gains rate and diversify the portfolio.

Higher child tax credit. In 2003 and 2004, the $600 child tax credit is increased to $1,000. In 2005, the child tax credit reverts to present laws, currently scheduled to be $700. Individuals would realize the $400 savings in the form of a refund check later this summer based on filing status and income on the 2002 return.

Establish or add to an Education Savings Account for a child. These accounts allow money to grow tax-free, provided it is used for education expenses (including grades K-12). The maximum annual contribution is $2,000.

Relief of the marriage penalty. For couples filing a joint return, the standard deduction will increase to twice that of a single filer and the 15 percent bracket will expand in 2003 and 2004. In 2005, this provision reverts to current levels.

Consider putting the savings into a traditional or Roth IRA. For couples where one spouse works, establish a spousal IRA for the non-working spouse and contribute the maximum annual contribution of $3,000.

Relief of the alternative minimum tax. The alternative minimum tax exemption is increased to $58,000 for married-joint filers and $40,250 for single files for 2003 and 2004.

Slightly fewer taxpayers may be subject to the alternative minimum tax. If an individual resides in a state with high income taxes, exercise incentive stock options or realize a substantial capital gain, he may unexpectedly find himself subject to the alternative minimum tax. Be sure to work closely with a tax advisor throughout the year to assess potential liability and address this alternative tax.

Special depreciation allowance for businesses. The recently introduced first-year depreciation allowance of 30 percent for certain property has been increased to 50 percent for property acquired after May 5, 2003, and before Jan. 1, 2005. Businesses looking to expand operation should consider making any necessary capital expenditure by December 2004, the scheduled sunset date for this provision.

Expansion of Section 179 expensing for small businesses. The existing $25,000 Sec. 179 deduction limit on certain property is increased to $100,000 for property purchased in tax years 2003 through 2005. Additionally, the $200,000 income threshold for phase-out is increased to $400,000 during tax years 2003 through 2005.

Eligible business owners should consider reinvesting the tax savings in a qualified retirement plan. Recently, many new retirement plans have been introduced, including the One-Person 401(k), which make economic sense for small-business owners.

Before taking any action, individuals should contact a tax, legal and financial consultant to see how the new tax reductions will benefit them and to determine whether changes to their financial plans may be appropriate.