Sunset Breaks Can Flame Out, Cast Lasting Glow

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 savings incentives for financing college. All of these and more will disappear by Dec. 31, 2010, unless Congress extends 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.”

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 from graduate students like Wilson, who consequently will have to pay about $2,000 in federal income taxes this year.

Yet the new tax bill extends the tax break for employer-provided education assistance through 2010 and reinstates it for graduate students 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.

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. Sunset provisions used to involve a handful of narrowly targeted breaks, like research and development tax credits and tax breaks for adoption.

Nonetheless, sunset provisions do have some supporters.

“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,” said Danielle Doane, director of government relations for Citizens for a Sound Economy, a group that advocates less government.

Despite the furor that sunsets have caused in the planning community, it’s not clear whether Congress will allow 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 group. “We think most of them will be made permanent long before that.”

That’s wishful thinking, counters Martin Sullivan, an economist who once worked on the staff of Congress’ Joint Committee on Taxation and now writes a column in the weekly magazine Tax Notes. “It is going to be tremendously difficult to extend this bill,” he said. “Congress will have to figure out how to pay for it again and how to get the votes again.”

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

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. It might be an ideal way to help defray college costs for a child who’s now 16, but it probably can’t be used to help finance higher education for a child who’s now 12.