‘Sunsets’ Cast Shadow Over Tax Planning


The big tax cut passed by Congress last month will put a few extra dollars in the pockets of most taxpayers, but it’s a bust for anyone who wants to do long-term financial planning. The reason: Tax deductions and credits you count on today could be gone tomorrow.

Within 10 years, so-called sunset provisions could wipe away every one of the 440 changes that the Economic Growth and Tax Relief Reconciliation Act of 2001 makes to the already voluminous tax code.

What’s at stake? Bigger tax credits for small children, relief from the so-called marriage penalty, more generous deductions for retirement savers, repeal of the estate tax and a variety of savings incentives for financing college. All of these and more will disappear on or before Dec. 31, 2010, unless Congress votes to extend them.

It’s a situation that leaves tax experts sputtering.


“These are the kinds of things that add a staggering amount of complexity to the tax code and drive people crazy,” said Scott Hodge, executive director of the Tax Foundation in Washington. “It builds cynicism, it builds frustration among taxpayers, and it ultimately costs people a lot of money.”

Added William Massey, editor of the newsletter RIA Federal Taxes Weekly Alert, “How do you plan with something like this?”

Steve Wilson, a Silicon Valley purchasing manager, understands the problem all too well. When he went back to night school several years ago, his employer agreed to pay for many of his work-related classes. The employer-paid education assistance was even more valuable because Wilson didn’t have to pay tax on it, thanks to a special tax break.

Unfortunately, this break was on a regular sunset and sunrise cycle, which caused Congress to review it every few years. The result: Part of the tax break was taken away for graduate students like Wilson, who consequently will have to pay about $2,000 in federal income taxes this year.


Ironically, the new tax bill extends the tax break for employer-provided education assistance through 2010 and reinstates it for graduate students beginning next year.

“There are just too many mixed signals,” Wilson said.

Tax sunset provisions have been around since the mid-1980s, when Congress created a formula for speeding so-called reconciliation bills through Congress.

Reconciliation bills have to conform with tax and spending levels already approved in earlier budget resolutions. That often requires putting strict time limits on the bill’s provisions. In return, reconciliation bills can’t be delayed by a filibuster or loaded up with unrelated amendments--tools that foes often use to kill pending legislation.

In today’s closely divided Congress, reconciliation protection allowed the then-Republican majority to pass the new tax law in record time. The trade-off was a landmark piece of tax legislation that could disappear in a decade.

The situation is particularly jarring with the new tax law because it affects all taxpayers and virtually every portion of the tax code. That’s a change from the past, when sunset provisions involved a handful of narrowly targeted breaks, such as research and development tax credits and tax breaks for adoption.

Nonetheless, sunset provisions do have some supporters.

“Sunsetting is a way to set a goal for when Congress will look at what a program is doing and whether it’s working,” said Danielle Doane, director of government relations for Citizens for a Sound Economy, a Washington-based group that advocates less government.


“I think having a sunset provision is a good way to get rid of something that has completed its purpose or is a bad program,” Doane said.

Despite the furor that sunsets have caused in the planning community, it’s not at all clear that Congress will actually allow all of these new tax breaks to expire.

“We are not worried that any of these provisions are not going to exist in 2011,” said Dan Danner, senior vice president for federal public policy at the National Federation of Independent Business, a small-business advocacy organization.

“We think most of them will be made permanent long before that.”

That’s wishful thinking, countered Martin Sullivan, an economist who once worked on the staff of Congress’ Joint Committee on Taxation and now writes a column for Tax Notes, a weekly magazine on federal tax developments.

“It is going to be tremendously difficult to extend this bill,” he said. “To extend it, Congress will have to figure out how to pay for it again and how to get the votes again. Republicans no longer control the Senate, and there’s not as much money in the surplus anymore.”

Many breaks in the new tax bill, including those affecting college savings, retirement and estates, require long-term planning. But because of sunset stipulations, the breaks may turn out to be strictly short-term.

For instance, one provision in the new law gives parents a tax deduction for paying college tuition. But the provision lasts just four years--starting in 2002 and sunsetting in 2006. So where it might be an ideal way to help defray college costs for a 16-year-old, it probably can’t be used to help finance higher education for a 12-year-old.


“Can’t you just see parents saying to their kids, ‘I’m sorry, but I can’t afford your senior year. The tax break expired’?” said the Tax Foundation’s Hodge.

“When you’re not really sure whether a tax break is going to be there in the future, it makes it hard to make those long-term decisions.”

Another provision allows people age 50 and up to make “catch-up” contributions to their tax-advantaged retirement plans that exceed the current maximum annual amounts allowed by law.

The idea is that a 50-year-old probably has already paid for life’s biggest expenses, such as houses and the kids’ college tuition, and now may have enough disposable income to save more. Catch-up contributions can make up for lost time.

A 40-year-old who is strapped for cash might be tempted to rely on that provision, figuring that once the kids graduate from college, there will be more disposable income to set aside for retirement. But no one knows whether the catch-up provision will be available when this taxpayer may be in a position to take advantage of it.

Sunset provisions pose the biggest challenge to taxpayers who are trying to plan their estates, experts agree.

Estate planning, by its very nature, involves making decisions today for an event--death--that may happen far in the future. The focus of estate planning is to leave heirs as much tax-free money as possible and leave the rest of an estate to spouses or charities. The latter two groups can receive bequests of any size without paying a portion to Uncle Sam.

Typically, attorneys accomplish that goal by creating a trust that grants an amount of money equal to the federal estate tax exemption--currently $675,000--to the children and leaves the rest to the spouse.

When the tax exemption amount is relatively stable, an estate plan will specifically reference the estate tax exemption, saying something like, “I bequeath $675,000 to be divided equally among my children, with the remainder of my estate going to my surviving spouse.”

However, the new law changes the amount that can be given tax-free to heirs each year and then eliminates the estate tax entirely in 2009. Because death is unpredictable, it’s impossible to hit a moving target. Thus, including one specific number in an estate plan won’t work.

Unfortunately, vague wording that leaves to children an amount equal to the estate tax exclusion won’t work either. Why not? If a person died in 2009, when the estate tax is scheduled to be eliminated, that would cause a spouse to be disinherited because all the money would go to the children, said Philip J. Holthouse, partner in the tax law and accounting firm of Holthouse Carlin & Van Trigt in Los Angeles.

So what’s a taxpayer to do? Some planners suggest simply playing the odds by assuming that these tax breaks will be extended--as many others have been in the past--and making investment and savings “bets” accordingly. But others point out that anyone who followed such a strategy could lose thousands of dollars if the tax breaks do expire and the bets prove to be wrong.

“It’s a sad, sad state of affairs,” economist Sullivan said. “There are innocent bystanders in these political wars.”


Into the Sunset

The new federal tax bill is laced with so-called sunset provisions, expiration dates that limit the life span of various tax breaks and other features of the law. Here is when some key tax breaks for individuals will expire unless Congress votes to extend them:

Tax break: Expiration date*

Medical savings accounts: 2002

Tax credit for first-time home buyers in Washington: 2003

Tax credit for qualified electric vehicles: 2004

Increased alternative minimum tax exemption: 2004

Deduction for qualified tuition expenses: 2005

Increased child tax credit: 2010

Boosted contributions to education IRAs: 2010

Tax-free treatment of 529 savings plans: 2010

“Marriage penalty” relief: 2010

Exemption for employer-paid education assistance: 2010

Adoption tax credits: 2010

Increased dependent-care credits: 2010

Estate tax repeal: 2010

* Expiration date is Dec. 31 of indicated year.

Sources: Joint Committee on Taxation, Times research