A (Less) Taxing Time
By: Source: AARP Bulletin Today Date Posted: December 2003
Recent tax cuts will put extra money in the pockets of millions of Americans, especially those with younger children, investments and higher incomes. But don't count on them lasting forever, financial experts say—and certainly don't take the cuts as an occasion to overhaul your financial plans.
"It may make sense now to have more dividend-paying holdings than in the past," says George S. Middleton of Limoges Investment Management PC in Vancouver, Wash. But he and other experts say this is not a time to hurry into major changes, especially since the tax measure is laced with expiration dates.
Peg Downey of Money Plans in Silver Spring, Md., believes it's best to view the tax breaks as a short-term windfall. "It's something to be saved, to put aside," she says, "because … this isn't going to last."
Passage of the $350 billion tax package was a major victory for President Bush, who campaigned hard for it and says it will boost the economy by creating jobs and growth. Opponents, on the other hand, argue that it adds dangerously to mounting budget deficits.
Although the months-long debate over the legislation focused mainly on dividend taxes, the new law cuts a broad swath through the entire tax structure.
In addition to slashing the rate on dividend income, it accelerates rate cuts first approved in 2001, provides marriage penalty relief, reduces capital gains taxes, increases the child credit and reduces the number of people subject to the alternative minimum tax. [See The Tax Cuts in Brief.]
To squeeze the bill under budget limits, Congress loaded it with "sunset," or expiration, clauses. As matters now stand, none of the cuts is scheduled to last beyond 2010—and some are due to fade away as early as 2005. [See The Tax Cuts in Brief.]
Political observers say that tax cuts once granted are very difficult for politicians to take away, but financial advisers see that as too shaky a foundation to build on.
"It's better to plan on what you know, not on what might be," says Downey. Tom Davison of Summit Financial Strategies in Columbus, Ohio, adds that tax rates are historically more variable than the stock market.
"You want to be 'tax aware,' " he advises, "but you don't want to let [taxes] drive your actions. Investment for maximum total return [capital growth and dividends] always was and will be the goal, but don't chase dividends."
Who Saves What
The effects of the new law should be showing up soon. The IRS says employers should already have started withholding less tax, based on updated tax tables.
And it says it will begin mailing checks to taxpayers with children under 17 later this month—$400 for each child claimed on 2002 returns.
For older Americans, as with others, the biggest savings will go to those with the deepest pockets. When all the new tax breaks are factored in, for example, people over 65 with income between $30,000 and $40,000 will save an average of $310, compared to savings of $3,085 for people with income from $100,000 to $200,000. [See chart.]
In signing the legislation on May 28, the president said "the good news" is that it will give 12 million 65-plus Americans an average tax reduction of $1,401. Experts say, however, that while those numbers are correct, they can be misinterpreted.
The Tax Ax Means Cuts for Many
An analysis done last month by the Center on Budget and Policy Priorities, a Washington research organization, notes that 63 percent of households with people 65 and older—some 16.4 million—will save $100 or less.
Only about 11 percent, or some 2.8 million households, will save $1,401 or more, according to its study.
Financial planners say that these additional points are worth noting:
- Interest on savings will still be taxed at ordinary-income rates — though for most people those rates will now be lower.
- Dividends and capital gains that accumulate tax free in 401(k) and IRA plans will be taxed at ordinary-income rates when withdrawals from those plans are made.
- To qualify for the lower capital gains rate, the gains must be long-term (that is, on stock or property held one year or more) and have been taken after May 5.
- Similarly, dividends may not qualify if they come from stock held only for a short period.
You can estimate your savings from the tax cuts by using the Bush Tax-Cut Worksheet on SmartMoney.com.
preview