Congress recently passed the "Jobs and Growth Tax Relief Reconciliation Act of 2003" (the "Act") which lowers the tax on qualified dividends and long-term capital gains to 15%. Short-term capital gains continue to be taxed as ordinary income (35% for 2003). The new dividend rate is retroactive to January 1, 2003 and the long-term gains rate is effective on or after May 6, 2003.

In light of these changes, tax-managed equity strategies remain an integral component of an investor's taxable portfolio. The Act has only a minor impact on Dimensional tax-managed equity funds, which still seek to maximize after-tax returns. Specific changes include:

Short-Term Capital Gains. Avoiding short-term gains represents the greatest opportunity to maximize after-tax returns. The Act has increased the spread between short-term and long-term rates (35% vs. 15% under the new law compared to 38.6% vs. 20% under the old rules). Thus, eliminating short-term gains continues to be the highest priority in tax management.

Long-Term Capital Gains. The act has reduced the long-term gains rate, but harvesting losses is still a worthwhile pursuit to defer tax liability. The compounding effect of tax deferment is a major benefit to shareholders.

Dividend Yield. Qualified dividends are now taxed at the same rate as capital gains. The tax-management algorithm will take this change into account by 1) adjusting its rules to reflect the lessened effect of dividends tax on after-tax returns, and 2) seeking to avoid non-qualified income to the extent it is tax-inefficient. In order for dividends to be qualified, the Act requires a certain holding period around ex-date and puts restrictions on securities lending and the stock’s country of origin. Portfolio management will ensure compliance with these requirements in order to achieve the low qualified rate.

As long as investments continue to be taxed, investors should continue to tax manage. Portfolios should strive to avoid unnecessary costs and to benefit from the compounding effect of tax deferral. Detailed control over each portfolio rule ensures that Dimensional and its investors achieve targeted asset-class exposure in the most tax-efficient and cost-effective manner possible—regardless of changes to the code.

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