When enacted in 2001, the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) contained in its last section a sunset provision. While certain sections of the legislation have subsequently been made permanent, this aspect of the legislation meant that after 2010 it will be as if it had never been enacted and the tax code reverts to what it was prior to 2001. Or as the inimitable Yogi Berra might say, “It’s like déjà-vu, all over again.”
Why was a provision like this necessary? In large part, it ensured the legislation complied with the U.S. Senate’s budgetary rules, one of which basically was that spending and tax policies contained in a budget resolution could not increase the deficit in future years.
As the federal deficit for the current fiscal year is projected to exceed $1.8 trillion, it’s quaint to consider that there was a time when Congress took steps to prevent the deficit from annually exceeding $700 billion.
For all taxpayers, it is important to understand the impact this sunset will have on their tax liability. Because as Yogi also wisely said, “You’ve got to be very careful if you don’t know where you are going, because you might not get there.”
EGTRRA covered eight areas of the tax law. Three sections focused on reducing individual income taxes and one on tax incentives for individuals to offset the cost of post-elementary school education. A minor section provided alternative minimum tax relief. There were two significant sections; one dealt with estate and gift taxes and the other with pensions and retirement arrangements.
Fortunately, the Pension Protection Act of 2006 repealed the sunset provision of EGTRRA related to all of its 38 pension and retirement arrangement changes. Consequently, those will not be considered here.
A key reason for enacting EGTRRA was to reduce marginal tax rates for individuals. Under pre-EGTRRA law, the highest marginal tax rate for individuals was 39.6 percent. EGTRRA reduced it to 35 percent. In addition, it created a new 10 percent income rate bracket for a portion of taxable income that had been taxed at 15 percent and reduced the existing 28 percent, 31 percent and 36 percent rates to 25 percent, 28 percent and 33 percent respectively.
Beginning in 2011, however, the current EGTRRA rates will increase to those that existed prior to it and income brackets currently tax at 10 percent will be taxed at 15 percent.
EGTRRA also repealed the phase-out of personal and dependent exemptions and itemized deduction limits imposed on higher income taxpayers beginning after 2009. Repeal as used here has a unique, ethereal quality in that both the phase-out and deduction limit return to the tax law in 2011.
What this means for many taxpayers is that deferring income recognition to a later tax year may no longer be as economically beneficial as it is when rates are stable or decreasing.
When income tax rates are stable, a given amount of income recognized in the current tax year or in a later tax year results in the same amount of tax. But deferring income recognition to a later year produces an economic benefit by allowing a taxpayer to invest in the current year money that would have been used to pay income taxes and realizing returns on these investments that would otherwise be foregone.
Conversely, with income tax rates increasing, deferring a given amount of income to a year after 2010 carries the cost of additional tax, a cost that is difficult to eclipse given the low returns currently available from many investments that carry minimal risk.
Serious consideration, as well, should be given to making gifts before 2011. For gratuitous transfers of property during 2010 the maximum rate gift tax rate under EGTRRA will be reduced to the maximum individual income tax rate of 35 percent. Whereas, on January 1, 2011 the maximum rate that will be imposed increases to 55 percent.
For estates of decedents fortunate enough to die in 2010, the benefit will be that the estate tax is repealed. An important ancillary to the repeal is that any appreciation in the property held by a decedent will be effectively transferred to the recipients of said property and subject to income tax when sold. Consistent with the sunset provision of EGTRRA, however, the estate tax returns January 1, 2011.
The U.S. Naval Observatory’s Astronomical Applications Department defines a sunset as the time when the upper edge of the disk of the Sun is on the horizon. Beginning in 2010, the EGTRRA provisions not yet made permanent will be just above the horizon. In 2011 they will sink below it.
John D. Blair Sr. is a managing partner at Blair, Bohlé & Whitsitt, PLLC., a CPA firm that provides accounting, assurance, tax compliance and planning services in addition strategic planning and tax minimization strategies to privately held businesses. Contact him at 704-841-9800 or visit www.bbwpllc.com.