In most years the tax code is a “must read” in the worst sense of the phrase: advisors feel compelled to bone up only because it's pretty much an obligation to do so.
This year, this is doubly true. Last year's relatively exciting tax overhaul renders the rules for this coming year — let's be honest — extra dull by comparison.
But dull does not mean unimportant, and for advisors who can motivate themselves to pay attention, there are still some significant opportunities embedded in 2004's tax laws.
The Song Remains the Same
Before we look at the changes, let's consider some of the key tax laws that won't be affected in 2004:
Income tax rates remain stable, with a top bracket of 35 percent.
Maximum tax rate for capital gains and dividends holds steady at 15 percent.
Annual IRA contributions will again be $3,000 in 2004, and individuals age 50 and over can make “catch-up” contributions of $500.
The alternative minimum tax exemption remains at $58,000 in 2004 before it sunsets in 2005.
Now let's review some of the changes for 2004 that could affect your clients:
Estate Tax Implications
Perhaps the most significant change in 2004's tax laws is to the federal estate tax. In 2004, $1.5 million can be passed to heirs tax-free, up from $1 million in 2003. This amount will gradually rise to $3.5 million in 2009, at which time all limitations will be eliminated. While this year's higher federal estate tax exemption amount is good news for many clients, keep in mind that the gift-tax exemption remains fixed at $1,000,000. Also, there is no increase in the amount of the annual gift-tax exclusion, which remains $11,000 per recipient.
However, the special annual exclusion for gifts to non-citizen spouses was raised to $114,000 in 2004. Another slight change to be aware of is a decrease in the estate- and gift-tax rate. The highest estate-and gift-tax rate goes down to 48 percent from 49 percent in 2003.
There is still much uncertainty surrounding the permanent repeal of the estate tax. Therefore, you'll want to be sure your clients are protected from it, and when helping them develop gifting strategies, you should work to minimize or eliminate the amount of taxable gifts.
Qualified Plan Contributions on the Rise
Participants in 401(k), 403(b) and 457 plans can now contribute $13,000 in 2004, up from $12,000 in 2003. The news is even better for individuals age 50 and older, as they can put aside $16,000 this year, versus $14,000 in 2003.
Despite 2003's strong equity market performance, the three year bear market from 1999-2002 caused many clients to lose substantial amounts of their retirement nest eggs. As a result, their qualified-plan accounts may need to be adjusted to put them back on track with their retirement goals. If you haven't already done so, it's time to get involved in the asset allocation decision for these retirement assets. Don't forget to review the portion of their contributions (and/or matching contributions) being invested in employer stock, as the percentage may be too high and may limit their diversification.
Higher Defined Benefit Limits
The year 2004 brings many changes to defined benefit and contribution plans. The limitation on the annual benefits under a defined benefit plan will increase from $160,000 to $165,000 in 2004 and the annual compensation limit will be raised by $5,000 to $205,000 in 2004.
The maximum contribution under section 415(c)(1)(A) has increased from $40,000 to $41,000. This $1,000 increase affects Keoghs, profit-sharing plans, and other defined-benefit and contribution plans.
With the “tax season” now encompassing the entire year, it's important to continually work with your clients to ensure that their portfolios are positioned to make the most of the current laws. With the rapidly rising federal budget deficit, there's a possibility that increased taxes, both on a state and federal level, could occur sooner rather than later. Therefore, be proactive to make the most of the 2003 tax law changes and the revisions to 2004's rates.
Susan L. Hirshman is vice president at JPMorgan Fleming Asset Management. jpmorganfleming.com