The question, "What happens if the Bush tax cuts sunset?" may seem a little silly at first.
After all, Congress would never let the cuts from the 2001 and 2003 tax acts sunset in 2011, especially those benefiting lower-income taxpayers, would they? The majority in Congress probably would not want to, but in an election year, when compromises are hard to come by, and with a very full legislative agenda for the rest of the year, many commentators are starting to give even odds to a sunset actually happening.
Of course, like the present no-estate-tax situation, the issue won't be unequivocally solved - or at least resolved one way or another - at the end of this legislative year. The prospect of leaving the "hard choices" to another Congress remains, in which retroactive changes to Jan. 1, 2011, are still an option.
It also may seem like a silly question because everyone is talking about what the sunset would mean: higher marginal rates, higher capital gain and dividend rates, and a return to an estate tax with a high rate and low exemption. But there are a lot of other provisions, especially in the 2001 Act, that also could sunset that are not getting nearly as much attention. You also cannot just go back to your summary of those tax acts to see what could sunset next year. Over the last decade, other tax legislation, particularly the Pension Protection Act of 2006, has eliminated the sunset provisions for certain provisions of the 2001 Act. These include the pension, IRA, and some of the education provisions.
This column will not focus on the marginal rate, capital gain rate, dividend rate, and estate tax issues. Instead, we will try to identify some of these less obvious provisions that could still go away next year if Congress fails to act.
PROVISIONS SUBJECT TO SUNSET
Child Tax Credit. Under the 2001 Act, the Child Tax Credit was to gradually work its way up from $500 to $1,000 in 2010. Subsequent legislation brought us to the $1,000 level much sooner but did not change the sunset. Under current law, the Child Tax Credit reverts to $500 in 2011. As with many of the Bush tax cuts, the reversion to 2001 levels is not adjusted for inflation, despite the fact that the dollar in 2011 will be worth more than it was in 2001, irrespective of the recent economic downturn.
Return of Pease and PEP. The phase-out of exemptions and itemized deductions for higher-income taxpayers has been gradually eliminated since the 2001 Act, until in 2010 they are completely gone. In 2011 the Pease (itemized deductions) and PEP (personal exemptions phase-out) limitations return. Taxpayers who have been increasingly able to take advantage of exemptions and certain itemized deductions may no longer be able to do so.
Marriage penalty relief. Although many provisions of the Tax Code still create a possible marriage penalty, the 2001 Act eliminated the marriage penalty in the standard deduction and in the 15 percent tax bracket. The new 10 percent tax bracket created by the 2001 Act also had no marriage penalty. Although subsequent legislation accelerated the effective dates of some of the relief, the 2011 sunset remained. In 2011, therefore, a possible marriage penalty will return to the standard deduction and 15 percent tax bracket under current law. The marriage penalty relief in the phase-out range for the Earned Income Credit enacted as part of the 2001 Act will also sunset in 2011.
Child and dependent care credit. The 2001 Act increased the percentage and the amounts of the child and dependent care credit. The 35 percent maximum percentage and $3,000/$6,000 maximum credit effective since 2003 would revert in 2011 to a 30 percent maximum percentage and $2,400/$4,800 maximum credit - again, unadjusted for intervening inflation since 2003. The employer-provided child care credit is also scheduled to sunset in 2011.
Adoption credit and exclusion. The doubling of the adoption credit and the exclusion for employer-provided adoption assistance in the 2001 Act is also scheduled to sunset. However, due to a provision in the recent health care legislation, the sunset has been postponed for one year to 2012.
Regularly expiring provisions. Several temporary types of relief introduced in the 2001 Tax Act have become regularly expiring provisions that have been renewed a number of times since their original enactment. These include Alternative Minimum Tax relief in the form of increased exemption amounts and allowance of non-refundable credits, the above-the-line deduction for tuition and fees, and some of the alternative energy vehicle credits. All of these are subject to potential sunset in 2011, but they have, in the case of the energy credits, already been replaced by different credits or they have been subject to expiration so frequently that the 2011 sunset does not seem a particularly unique event.
Presidentially declared disasters. Authority to extend deadlines for presidentially declared disaster areas is also scheduled to sunset in 2011.
Education IRAs. The contribution limits on Coverdell IRAs will revert from $2,000 to $500, and tax-free distributions will no longer be allowed for elementary and secondary education expenses starting in 2011. Also sunsetting in 2011 is the inclusion of graduate programs in employer-provided educational assistance. The increased phase-out range for student loan interest would also go away in 2011, and the 60-month limitation on student loan interest would return.
PROVISIONS NOT SUNSETTING
Thanks primarily to the Pension Protection Act of 2006, a number of provisions of the 2001 Act are no longer subject to sunset in 2011. These include provisions with respect to IRA contribution limits, deemed IRAs, qualified retirement planning services, qualified tuition and 529 college savings plans, qualified plan contribution and benefit limits, catch-up contributions, the start-up credit, the saver's credit, rollover rules, ESOP rules, and top-heavy plan rules.
Also, by separate legislation, the exclusion for restitution payments to victims of Nazi persecution from the 2001 Act was made permanent.
SUMMARY
This list provides a worst-case scenario, if Congress fails to act, or acts in a way contrary to what had been rational expectations as late as last spring. No one expects all of these provisions to sunset, especially those of benefit to lower-income taxpayers.
Still, few people expected the estate tax repeal to actually arrive, and so far survive, in 2010. It is always difficult to predict exactly what Congress will do, and alerting your clients to the possible risks is always timely advice.
George G. Jones, JD, LL.M, is managing editor, and Mark A. Luscombe, JD, LL.M, CPA, is principal analyst, at CCH Tax and Accounting, a Wolters Kluwer business.
