On May 28, 2003 President Bush signed the Jobs and Growth Tax Relief Reconciliation Act of 2003 (the 2003 Act) into law. Some of the provisions of this bill (such as the increase in the child tax credit) will have little or no impact on those of us living abroad since our income is generally too high (due to allowances and so forth) to take advantage of such tax breaks. However, there are many provisions which will have a significant impact on how our taxes are computed for 2003 (and beyond) and this month's article will attempt to cover some of those changes.
Income Tax Brackets
For 2003 (and through 2010) the tax rates are 10%, 15%, 25%, 28%, 33% and 35%. For the higher tax brackets, these rates represent a 2% drop from the 2002 rates which were 10%, 15%, 27%, 30%, 35% and 38.6%.
In addition, the 10% and 15% brackets were expanded, resulting in more income being taxed at the lower rates in 2003 than were taxed at the lower rates in 2002.
Marriage Penalty Relief
For as long as I can recall there has always been a disparity between the standard deduction that two single individuals could take versus what a married couple was entitled to. For example in 2002 the standard deduction for a single individual was $4,700 whereas the standard deduction for a married couple was $7,850 (not two times the $4,700 or $9,400!).
Thankfully the 2003 Act has set this right by doubling the standard deduction for married couples to twice that of a single individual and so for 2003 the standard deduction for a single person is $4,750 and for a married couple it is $9,500 (unfortunately the relief is only temporary, though, as the disparity returns again in 2005).
This is an important change because many of us living overseas take the standard deduction as we no longer have sufficient deductions to itemize.
In addition, the 2003 Act expanded the 15% tax bracket for joint filers to twice that of single filers – another inequity in the tax law until now. Thus, for example, in 2002 the 15% bracket for a single individual ranged from $6,000 to $27,950 whereas for a married couple it ranged from $12,000 to only $46,700 (not twice the $27,950 or $55,900, as would have seemed logical).
For sales of property on or after May 6, 2003, the maximum tax rate on net capital gains is 15% (5% if you are in the 10 or 15 percent tax brackets). Prior to this change the rates were 20% and 10% respectively. The term “net capital gain” means the amount by which your net long-term capital gain for the year exceeds your net short-term capital loss.
(Note that under current law these lower rates will expire after December 31, 2008 at which point the old 20% and 10% rates will return. Also in 2008 the 5% rate for low-income taxpayers drops to zero percent. These same sunset provisions also apply to dividend income discussed below).
The top tax rate for qualified dividends received by individuals is reduced to 15% (and, again, 5% for individuals in the low tax brackets) and applies to dividends received from January 1, 2003 onwards.
Prior to 2003 all dividends were taxed at ordinary income tax rates; a taxpayer in the highest tax bracket in 2002 could have paid tax at 38.6% on dividends.
Dividends which qualify for the reduced rates are those received from domestic or qualified foreign corporations. A “qualified foreign corporation” is an entity that is either incorporated within a U.S. possession or is eligible for the benefits of a comprehensive income tax treaty with the U.S. (for a list of tax treaties which meet the requirements set out by the Secretary of State please refer to IRS Notice 2003-69 which can be found on the IRS website at http://www.irs.gov/pub/irs-drop/n-03-69.pdf). Dividends paid by foreign corporations which do not meet the “qualified” definition will still be eligible for the reduced rates if the foreign stock trades on an established securities market in the U.S.
Under the tax laws which existed in 2002 the tax would have been $9,486, however, after the 2003 Act the tax is only $8,014 – a savings of $1,472 (and the savings will be even greater, still, for taxpayers with higher levels of income)!