The tax cut and you: Savings grow, then stop

The $1.35 trillion tax cut that President Bush is set to sign into law today may be one of the most convoluted pieces of legislation ever produced by the peculiar machinery of Washington fiscal politics.

What began on the campaign trail as a straightforward rate reduction has become something whose provisions appear and disappear like planets rising and setting in the sky. The entire bill is supposed to self-destruct on New Year's Eve, 2010, propelling the tax code back in time to the moment before the president scratched "George W. Bush" on the legislation.

Congress probably won't let that happen - but then again, nobody really knows what future Congresses will do. So what does all this mean for you, and your tax planning? Call back later, say experts. We're still reading the fine print, trying to figure it out.

"Personally, I think the 1986 tax act was more complex and far-reaching - but this one has to be up there," says Bob Trinz, a federal tax expert at RIA, a New York-based tax code information and software firm.

To understand the complex nature of the legislation, consider its centerpiece: the much-discussed across-the-board cuts for income-tax brackets.

The bill lowers from 15 to 10 percent the rate at which the first $12,000 of income on a joint return is taxed. This cut is aimed at helping lower-income workers, in particular, but it affects everyone who files - and it is retroactive to Jan. 1, 2001.

Rebate checks based on this reduction should be in the mail by mid-July.

But reductions for higher-bracket taxpayers don't kick in for years to come. The top 39.6 percent rate isn't scheduled to be reduced to 36 percent until 2007.

Then there are provisions aimed at easing the so-called "marriage penalty" that causes some couples to pay higher taxes than they would if they were unmarried and filing single, instead of joint, returns.

The marriage-penalty changes don't begin phasing in until 2006. They are not fully effective until 2011 - the date the entire legislation is supposed to self-destruct.

Estate-tax repeal is one of the most controversial aspects of the legislation, as it primarily benefits very high-income taxpayers. But under the bill's terms, it might better be called "semi-repeal." The legislation gets rid of the estate tax, all right - for one year. It goes away in 2010, then comes back in 2011, unless Congress votes to keep the repeal.

Overall, the legislation cuts taxes by only $270 billion through the near term of 2004. The bulk of its reductions - more than $800 billion of them - don't take place until its final years.

That means that there is plenty of time for Congress to continue fiddling with the tax changes. It also means that the $1.35 trillion price tag widely ascribed to the legislation is likely to be inaccurate, because the law may well change and because long-term predictions of national fiscal effects have not exactly been on the money in recent years.

This bothers some experts. Stan Collender, managing director of the Federal Budget Consulting Group at Fleishman-Hillard, says that when big tax changes were made in the Reagan era, policymakers did not presume they could make accurate decade-long forecasts of effects.

"The worst thing that could happen to the nation's fiscal planning is that they put in place a tax cut that costs a lot more or a lot less than they anticipate - and the truth is, they just don't have a clue," he says.

It's as if the US has gone out and bought a bigger house even though it has no idea what its future income will be, he says.

Meanwhile, tax planners are busy just trying to figure out how individuals who want to take advantage of the new laws can best make the bill benefit them.

So far, they have one word: save.

For those thinking about their future retirement, the law will eventually allow Americans to save almost twice what they can today in individual retirement accounts and 401(k) plans.

For those worried about their children's education, the bill greatly sweetens so-called 529 education savings plans, which are sponsored by states. It also will (eventually) quadruple the amount of money that can annually be saved in Education IRAs. Withdrawals from 529 plans and Education IRAs will be tax-free.

"The tax breaks for education are now substantially better than they were before," says Mr. Trinz.

But people need to act to take advantage of the breaks - and that they need to do so when their children are as young as possible, to allow the cash to accumulate.

(c) Copyright 2001. The Christian Science Monitor