The New Tax Breaks--Now You See Them, Now You Don’t
The recent unsuccessful efforts to make permanent some of the tax breaks passed by Congress last summer--such as abolishing the estate tax--underscore warnings that tax experts issued soon after the tax bill was passed: It’s tough to make long-term financial plans when important tax issues are in flux.
“It is absolutely impossible for the average American to figure out what’s going on over the next 10 years,” said John S. Barry, chief economist at the Tax Foundation, a nonpartisan, nonprofit tax research group based in Washington. “The fact that all of these tax breaks are temporary and phasing in and phasing out makes it impossible to plan.”
Last summer’s tax law created several new breaks for people with children, those financing college, those saving for retirement and those wanting to leave their heirs substantial estates.
However, the law was drawn up based on an obscure rule that doesn’t allow budget-affecting changes to last longer than 10 years. As the result, the 2001 law expires Jan. 1, 2011.
Moreover, to address certain popular policy goals--such as reducing the tax cost of marriage for two-income couples--while making shorter-term budget projections work out, Congress decreed that some provisions of the law phase in and phase out before 2011.
For instance, the law created a new tax deduction for those paying tuition and fees for higher education. The maximum deduction is $3,000 this year; it rises to $4,000 during 2004 and 2005. But it disappears in 2006, said Mark Luscombe, principal tax analyst for CCH Inc., a Riverwoods, Ill.-based publisher of tax information.
Why? The provision was expensive, and the money to fund it was needed to help pay for the lower tax rates included in the 2001 package, and to provide relief from the so-called marriage penalty. Marriage-penalty relief ramps up in 2005 and evaporates at the end of 2010.
The Great Unknown
“It’s tough to know what to do,” said Martin Nissenbaum, director of personal tax planning with Ernst & Young in Washington. “We have a tax law that we know is going to expire. Meanwhile, we have a Congress capable of making new laws, and we have no idea what else they’re going to do to us in the next eight years.”
Temporary breaks are never intended to stay that way, tax experts say. Supporters of the changes believe the breaks will prove so popular that legislators will be pressured to find a way to make them permanent. And certainly, the money was found to extend once-temporary tax breaks for adoption and for workers who get financial aid from their employer to attend school.
But to extend or create any new tax cut, Congress must find a way to pay for it. Often that means some other tax break or government project must fall by the wayside. And those projects have supporters too.
Recently, House Republicans were rebuffed in their efforts to make last summer’s changes to estate taxes and the marriage penalty permanent, illustrating just how tough it can be to extend a tax break--even a popular one--when the federal budget is tight.
Meanwhile, taxpayers are left to guess whether the breaks they’re banking on will be there when they’re needed.
The best strategy for saving for college expenses often is dictated by how a particular savings vehicle might be taxed, for instance. But do parents dare put their toddler’s college savings in a 529 savings plan when the federal tax exclusions that make these plans economically viable are set to expire before the child enrolls in school?
Most experts say they should, because Congress has a long record of extending popular tax breaks. And few have proved as politically popular as those that finance education.
“The stuff that has overwhelming bipartisan support will probably get renewed,” said Philip J. Holthouse, partner at Los Angeles tax law and accounting firm Holthouse Carlin & Van Trigt. “I would be more cautious about planning your future on figuring that the estate tax changes are going to be around--or even banking on some of the marriage-penalty fixes.”
The estate tax presents a particularly bewildering dilemma. Death is difficult to plan on a schedule, and the law as written almost requires one.
The amount that individuals can leave to their heirs rises substantially over the next eight years, potentially providing a huge benefit to heirs of those who survive until the ninth year, when the estate tax is eliminated.
But in 2011, the tax reverts to what was in place before the 2001 law, cutting back the amount that can be left tax-free to heirs to $1 million.
“The joke when they brought in this estate tax law was that we were all going to spend the next 10 years undoing what we’d spent the last 10 years doing, and then spend the next 10 years reconstructing it again,” said Charles Rettig, a tax attorney with Hochman, Salkin, Rettig, Toscher & Perez.
If Congress doesn’t address the estate tax, people will have to redraft their wills every year or create incredibly complex documents that bequeath assets differently based on the year that the individual dies, Nissenbaum said.
“The estate-planning provisions are just making everyone crazy,” he said.
System Is the Problem
And experts can offer taxpayers little in the way of a solution, except advice to be vigilant in keeping their documents up to date and providing as much flexibility as possible in their written plans, Rettig said.
But the real problem is the system by which tax laws get passed, said Barry of the Tax Foundation.
Every year, a government office releases a projection of how the economy is likely to perform, and consequently, how much the government is likely to pull in through tax revenues over the next 10 years. Congressional rules encourage legislators to shoehorn tax revisions made during that time frame into those projections, Barry said.
The problem is that economic predictions are notoriously inaccurate--even over short periods.
“As we are finding out right now, it’s practically impossible to look out even one month and hope to be right,” Barry said. “Predicting what the economy will do over 10 years is simply an impossible task.”
As a result, when writing tax laws, legislators rely on “sunset” provisions and income thresholds that bar many taxpayers from taking advantage of new provisions. That, in turn, can subvert the intended goal of the tax break, which probably was aimed at encouraging some public policy goal.
“Fundamentally, what we should be looking at when setting tax policy is principals,” Barry said. “Congress has to stop basing tax policy on budget projections that are simply impossible to make.”
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Times staff writer Kathy M. Kristof, author of “Investing 101” (Bloomberg Press, 2000), welcomes your comments and suggestions but regrets that she cannot respond individually to letters or phone calls. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof @latimes.com. For past Personal Finance columns visit The Times’ Web site at www.latimes.com /perfin.
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For a Limited Time Only
The 2001 tax cut included many tax breaks that change or expire after a specified period, making financial planning difficult for many Americans. Here’s a look at some of the breaks and how long they will last.
* Adoption tax credit: Rises to $10,000 for 2003 through 2010; disappears in 2011
* Child tax credit: Rises gradually to $1,000 in 2010; reverts to $500 in 2011
* Expanded dependent-care credit: In effect this year; expires in 2011
* Marriage-penalty relief: Takes effect in 2005; expires in 2011
* Higher education deduction: Rises to $4,000 in 2005, disappears in 2006
* Estate tax: Amount excluded from tax rises gradually to $3.5 million in 2009; tax disappears in 2010, then reappears in 2011, when the amount excluded reverts to $1 million
Source: Joint Committee on Taxation
