August 2003 Bulletin

Tax cuts bring sweeping changes


By Joel M. Blau, CFP

As orthopaedic surgeons around the country experience reduced earnings—as well as shock over the bear market’s devastation on their investment portfolios—they can take heart that some relief is on the way. Speculation regarding President George W. Bush’s tax package is now history.

What lies ahead are sweeping changes that will affect all taxpayers. While much less than the $726 billion originally proposed in January, the tax cut package passed by Congress last month offers $330 billion in tax breaks to families, businesses and investors in addition to providing $20 billion in state aid.

Tax reductions

The changes include not only tax rate reductions, but also reduced taxation of dividends and capital gains, an increase in the child tax credit and relief from the marriage penalty.

The third largest tax cut in the nation’s history, this tax package accelerates several income tax cuts that were scheduled to take effect later in the decade by slicing most income tax rates, including the highest rates, and is effective for tax year 2003.

Last year’s highest federal income tax bracket of 38.6 percent is now reduced to a maximum of 35 percent, creating a savings for many top-level taxpayers. Additionally, the 35 percent bracket is now being reduced to 33 percent, the 30 percent bracket is reduced to 28 percent, and the 27 percent bracket is reduced to 25 percent.

Impact on investment planning

Of significant interest to orthopaedic surgeons is the impact the new law has on investment planning. Under the old law, dividend income was taxed at the ordinary income level of the taxpayer’s bracket, or as high as 38.6 percent. Under the new law, the top dividend tax rate will drop to 15 percent and taxpayers in the lowest two brackets would pay dividend taxes at a maximum rate of 5 percent. To put this dividend tax reduction in perspective, 354 stocks on the S & P 500 currently pay cash dividends. The average dividend yield of those stocks is 2.32 percent.

While the dividend tax reduction will mostly benefit physicians, such as retirees who have a large amount of dividend-paying stocks, the capital gains tax reduction will help those whose primary objective is long-term growth, as opposed to maximum current income. The bill reduces the top capital gains rate of 20 percent down to a maximum of 15 percent for even the top level of taxpayers. The lower rates will apply to all dividends received this year and capital gains received after May 5, 2003.

Child tax credit

A focal point of the bill is a 40 percent increase in the child tax credit. For 2003 and 2004, the new law will increase the tax credit for dependent children under age 17 to $1,000, from $600 under the previous law. Affected taxpayers will receive rebate checks of up to $400 from the IRS within the next few months based on information obtained from the taxpayer’s 2002 return. These rebates, however, may not find their way to the majority of physician taxpayers because the original child tax credit was limited by the amount of income reported.

For 2002 filers, married couples with adjusted gross income exceeding $133,000 were not entitled to the credit. Even under the new law, married taxpayers with adjusted gross income exceeding $149,000 will not be entitled to any amount of the $1,000 child tax credit.

For married couples, the new tax law reduces the marriage penalty by increasing the standard deduction and the level at which the 25 percent tax bracket begins in 2003 and 2004. It also raises the exemption for the alternative minimum tax in 2003 and 2004.

Impact depends on income

The true impact of the new law on any taxpayer depends on the amount of income earned and dividend income received. For example, a married couple with a combined income of $300,000, two children under age 17, $50,000 of itemized deductions and $10,000 of dividend income would see their tax bill reduced by $6,919, or a savings of almost 10 percent compared to 2002.

As with any change in the tax code, it is crucial for taxpayers to consult with a tax advisor to determine the significance for their own financial situation.

Joel M. Blau, CFP, is president, MEDIQUS Asset Advisors, Inc.

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