What you didn't know about the new tax law - Economic Observer

BY NOW, THE CASH REGISTERS should be ringing with Pres. Bush's advanced child tax rebate purchases--and you should be taking home more money because of the new tax law's lower rates. The latest revisions are replete with well-publicized goodies. Sometimes, though, it's not what you don't know that gets you in trouble; it's what you think you know. Here are a couple of examples of where the general rule seems simple, but the minutia can get you in hot water:

Deduct your SUV. The new law has increased your Section 179 election to expense (rather than to depreciate) from $25,000 to $100,000. Headlines have declared this to be an opportunity to buy and completely deduct the cost of an SUV in a single year. Let's look at what's really happening.

Many years ago, Congress passed a law limiting the annual deductions you can take on a "luxury" ear that's used for business. A luxury car was defined as just about anything that had an engine Actually, back in 1986, it covered cars costing as little as $11,250 For 2002 tax returns, the vehicle could cost as little as $15,500 to be impacted. To avoid covering "real" business vehicles, like trucks, the law was written so that cars with an unloaded gross vehicle weight of more than 6,000 pounds were exempt. In fact, for trucks and vans, the standard was loaded gross vehicle weight--the maximum recommended weight for the vehicle, fuel, passengers, and cargo.

So, if your car weighs more than 6,000 pounds, it's not covered by the limitations. It has nothing to do with n special break for SUVs. It's merely a weight issue. A sufficiently heavy Roils Royce would qualify. If your SUV weighs 6,000 pounds or less you're covered by the limitations, and your maximum first year's deduction for a vehicle used 100% for business is capped a $10,710 ($3,060 plus a new bonus depreciation of $7,650). If the limitations don't apply, your vehicle is considered in be a piece of business equipment. Just like, say, a new copier, such "equipment" would qualify for the special Section 179 election (if used more than 50% for business). This means that if you used the vehicle 101)% for business, you could deduct, in the first year, as much as $100,000 in cost.

All dividends will he taxed at a maximum 15% rate. This is line, but everything called a "dividend" really isn't a "dividend" and won't qualify. A qualifying dividend is a distribution of a corporation's earnings and profits, which already has been taxed to the corporation. Let's look at cases where there may be some confusion:

* Mutual funds have, in the past, reported short term capital gain as dividends. Both were taxed at ordinary rates rather than at the lower capital gains rates. Now, such distributions must be separated out since short term capital gains don't qualify for the lower five to 15% rates.

* Do you have a margin account with your broker? If so, then you may have a problem. Your broker often lends out securities in such accounts to other investors who sell short using your stock. These borrower investors receive the dividends and they reimburse you for what they receive. You end up with the same dollars, but these "payments in lieu of dividends" don't qualify as dividends and would be taxable at rates as high as 35%!

The rate reduction on dividends is retroactive to Jan. 1, 2003. So, if earlier in the year your broker lent out your securities, and a dividend was paid, that dividend didn't qualify for the lower rate. Surprise!

* You just bought a stock and the company declares and pays a dividend. Then you sell the stock. Is your dividend subject to the maximum 15% rate? Maybe. Here's why: Congress wants you to invest for the long term. In order to get the lower rate, you need to have held the stock for more than 60 days during the 120-day period beginning 60 days before the ex-dividend date. So, if you don't hold the stock a minimum of 60-plus days, there's no way you're going to qualify for the lower rates. Even if you hold the stock for more than 60 days, it has to be within that 120-day window to qualify.

Leverage your investments. The general rule with leverage (using borrowed money to finance your investments) is that any time your yield exceeds your cost of money, borrow, This becomes even more advantageous if you're deducting the interest cost on margin loans at 35% while being subject to a maximum 15% tax on your earrings.

You actually can come out ahead even if your yield is lower than your cost of money. For instance, borrow $10,000 at five percent and your interest is $500. At a 35% tax rate, your deduction reduces your net after tax cost to just $325 (65% of $500). If your $10,000 is invested at 4.5%, you'll have $450 in income. Taxed at a 15% rate, that leaves you with $382.50 (85% of $450). That's $57.50 more than the cost of borrowing the money. There's a trap here, though. First, you have to itemize your deductions to get the deduction for investment interest. Then that investment deduction is limited in your investment income.