[16113]
May 23, 2003
TO: TAX MEMBERS No. 31-03
ACCOUNTING/TREASURERS MEMBERS No. 28-03
OPERATIONS MEMBERS No. 16-03
INTERNATIONAL MEMBERS No. 18-03
TRANSFER AGENT ADVISORY COMMITTEE No. 53-03
RE: CONGRESS APPROVES JOBS AND GROWTH TAX RELIEF RECONCILIATION ACT
Congress today approved the “Jobs and Growth Tax Relief Reconciliation Act of 2003”
(the “Act”). The President is expected to sign the Act next week. The Act, among other things,
lowers the tax rate on capital gains and certain dividends and, through tax bracket rate
reductions, lowers the backup withholding rate.
Capital Gains Rate Reduction
The Act reduces the tax rate on long-term capital gains attributable to sales or exchanges
on or after May 6, 2003. The 20 percent rate is reduced to 15 percent; the 10 percent rate is
reduced to 5 percent through 2007 and to zero for 2008. The lower rates are eliminated (and the
higher rates of present law are reinstated) beginning in 2009.
The qualified 5-year gain rules that were enacted in 1997 -- and lower the top capital
gains rates from 20 percent to 18 percent, and from 10 percent to 8 percent, for certain assets
held for more than 5 years -- are expressly repealed by the Act. In 2009, however, the repeal
expires and the qualified 5-year gain rules effectively are reinstated.
The lower tax rates apply generally to shareholder redemptions of regulated investment
company (“RIC”) shares and to the receipt of RIC capital gain dividends. In the case of capital
gain dividends, the date the gain is taken into account by the RIC is the relevant date for
determining application of the effective date. For example, a capital gain realized by a RIC on
April 30, 2003, that is distributed as a capital gain dividend on December 1, 2003, is taxed at the
present law capital gains tax rates (generally 20 or 10 percent) rather than at 15 or 5 percent.
Thus, RICs may distribute both pre-May 6 and post-May 5 capital gain dividends in 2003.
2
Dividend Rate Reduction
The Act also reduces the tax rate on “qualified dividend income” (“QDI”) to the 15
percent and 5 percent net capital gain rates, effective January 1, 2003. The lower rates on
qualified dividend income expire after December 31, 2008.
A RIC may flow through to its shareholders the QDI that it receives on its portfolio
holdings and designates as such. Specifically, a RIC may designate as QDI the aggregate
amount of qualifying dividend income for the taxable year, if the amount of qualifying
dividends received by the RIC is less than 95 percent of its gross income (as specially computed
by excluding long-term capital gains). Where the amount of QDI is 95 percent or more of the
RIC’s gross income, 100 percent of the RIC’s dividends (other than capital gain dividends) may
be designated as QDI.
The Act defines QDI as dividends from domestic corporations and “qualified foreign
corporations.” A qualified foreign corporation includes (1) a corporation incorporated in a U.S.
possession, (2) a corporation that is eligible for relief under an income tax treaty with the United
States that includes an exchange of information agreement (with exceptions for Barbados and
any other country that the U.S. Treasury determines has a treaty with the U.S. that is not
satisfactory for purposes of this provision), and (3) a corporation the stock of which is readily
tradable on an established securities market in the U.S. A corporation will be treated as having
stock so traded if an American Depository Receipt (“ADR”) backed by such stock is so traded.
Excluded from this definition of qualified foreign corporation are passive foreign investment
companies (“PFICs”), foreign investment companies and foreign personal holding companies.
The Act provides that for foreign tax credits, rules similar to the capital gain rate
differential rules of Section 904(b)(2)(B) will apply to the dividend rate differential. These rules
reduce a taxpayer's foreign source income for purposes of the foreign tax credit limitation,
which may have the effect of reducing the availability of foreign tax credits associated with
QDI.
Certain holding period rules apply before a dividend is eligible for treatment by an
individual shareholder as QDI. Specifically, the taxpayer must hold the stock for at least 61
days during the 120-day period beginning 60 days before the stock became ex-dividend. In the
case of preferred stock, the holding period is 91 days during the 180-day period beginning 90
days before the stock became ex-dividend.
If a qualified dividend is an extraordinary dividend (within the meaning of Section
1059(c)), then any loss on the sale or exchange of the underlying stock is a long-term capital loss
to the extent of the extraordinary dividend.
Substitute payments received in lieu of dividends (as in the case of securities loans) are
not QDI. The Act’s Statement of Managers provides that Congress expects the IRS to waive
penalties for broker-dealers who make a good faith attempt to accurately report QDI
information, but are unable to reasonably comply with reporting requirements due to the time
required to modify information reporting systems. A taxpayer who receives a Form 1099-DIV
showing a dividend may treat that amount as QDI unless the taxpayer has reason to know that
the amount (or some portion thereof) was paid in lieu of a dividend.
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Backup Withholding Rate
Under Section 3406, backup withholding is imposed at the fourth lowest individual
income tax rate. Since the Act also accelerates the cuts in income tax rates previously enacted
by the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”), the backup
withholding rate will become 28% when the Act is signed by the President. The Statement of
Managers accompanying the Act indicates that Congress recognizes that certain taxpayers may
have already been subject to backup withholding at a higher rate, and that taxpayers should
recover any over-withholding by filing a income tax return (and not from the payor). The
Statement of Managers also indicates that Congress expects Treasury to allow payors a
reasonable transition period to implement the new backup withholding rate.
Keith Lawson David Orlin
Senior Counsel Assistant Counsel
Attachments
Note: Not all recipients receive the attachments. To obtain copies of the attachments, please visit our members
website (http://members.ici.org) and search for memo 16113, or call the ICI Library at (202) 326-8304 and request the
attachments for memo 16113.
Attachment no. 1 (in .pdf format)
Attachment no. 2 (in .pdf format)
Attachment no. 3 (in .pdf format)