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Tax law brings benefits, but it’s very complicated

Updated: May 3, 2013 12:14PM

Originally published: August 7, 2001

Congress should be ashamed--and so should the president. The headlines are positive, but the details of this new tax law have created a financial planning and tax nightmare that will haunt us for the next 10 years. Any financial benefits that might be reaped from expanding the limits for retirement-plan contributions and changes in the estate-tax exemption may be far outweighed by the costs of professional advice to deal with this new law.

While the intentions may have been good, the new law is horrendously complicated. And it will change every single year for the next 10 years, as credits and limits are phased in and out.

Then, it’s anyone’s guess whether the final provisions will be enacted in 2010 after several more congressional and presidential elections.

It’s a tax law that was finally passed in the middle of the night to beat a Memorial Day deadline--and it’s clear that the lawmakers were working in the dark. Yet, like the proverbial sausage, it’s now the law we have to live with. So here are some of the key provisions:

Retirement plans

The good news is that you’ll be able to contribute more to your retirement plan--especially if you’re over 50. The bad news is that those increased contributions will be phased in over the next six years, in a rather complicated way. For example, allowable IRA contributions rise to $3,000 from 2002 through 2004, and then rise to $4,000 until 2008, when the maximum rises to $5,000. People over age 50 will be allowed to contribute an extra $500 above those limits in 2002, and then an additional $1,000 each year thereafter.

Company retirement plan contributions are similarly affected. Allowable 401(k) plan contributions rise in stages over the next eight years to $15,000 from the current $10,500. Plus, there’s a provision for creating an after-tax 401(k) starting in 2006.

Obviously, the increased contribution limits are a huge plus for today’s workers. Not only do they get a larger deduction for the increased contributions, but the matching contributions by employers will also rise. And the entire pot of retirement funds will grow tax-deferred. But the record-keeping task for both IRAs and 401(k) plans will be enormous, as employers--and the IRS--must check birth date records for allowable contributions.

Estate tax changes

The changes in the estate and gift tax are even more complicated. The headline is that the estate tax is eliminated--but only for one year, and that year is 2010! In the meantime, the exclusion --the amount that is not taxed--rises every year, and the tax rate falls slightly each year.

For example, the current $675,000 exemption (and which had been scheduled to rise to $1 million in 2006) will immediately jump to $1 million in 2002. Then it will rise to $1.5 million in 2004, to $2 million in 2006, and up to $3.5 million in 2009. The top tax rate on estates will ultimately drop from 55 percent to 45 percent in 2009.

But don’t jump for joy. In 2010, when the estate tax goes away, it will be replaced by a capital gains tax that heirs will be forced to pay. If you purchased stocks, mutual funds, or a house that appreciated in value over the years before your death, your heirs will take on your original cost and pay gains when the asset is sold. (Currently, your heirs receive your assets with a ‘’stepped-up’’ value as of the date of death.) That means keeping detailed records on the cost of everything you own.

Your heirs won’t have to pay capital gains taxes on all of those assets. There will be a $1.3 million exemption for single people, and an additional $3 million for transfers to a spouse. The executor of the estate will be given the task of choosing which assets will be chosen to accommodate those exclusions. When it comes to the sale of a residence, heirs will still receive the $250,000 exemption on a personal residence.

If you’re single, and have substantial assets, the best time to die would be in 2009, when you’ll get the maximum $3.5 million exclusion from taxes and your heirs get the step-up tax basis on everything else!

Otherwise the record-keeping will be a nightmare, as your heirs and executor try to calculate your purchase costs--and potential gains--on all of your assets.

Worst of all, the estate tax is scheduled to come back in full force when this bill expires in 2011--but the capital gains changes may survive.

Whatever you do, don’t plan to die in 2011, when the entire estate tax picture is in flux. Plus, don’t rule out the possibility of increased state taxes, which may be voted in as the states lose their share of federal estate tax revenues over the next 10 years.

Education savings

There are also huge, but complicated, changes on both the saving and lending side of the college funding issue. Starting in 2002, there will be a rising deduction for college tuition paid--up to $4,000 per year.

Currently, interest paid on student loans is deductible for the first 60 months of repayment. Under the new tax bill, all student loan interest would be deductible for those with $65,000 income on a single return and $130,000 on a joint return.

Plus, the popular Section 529 plans would get a boost as withdrawals become tax-free. And allowable Education IRA contributions would rise to $2,000.

The Bottom Line

There’s a benefit for just about everyone in this new tax law. And that’s what is most appealing on a political basis. But Congress missed a golden opportunity to simplify the entire process of tax and financial planning. If an idea is good, there’s no reason to delay implementation.

Credits and deductions could have been made immediate, instead of phasing in over the years. The estate tax limit could have been raised immediately, not over the years.

When you balance out the costs and benefits, the big winners on this new tax law will be the politicians--along with the tax and estate planning experts--not the taxpaying public. And that’s The Savage Truth.

Terry Savage is a registered investment adviser for stocks and commodities and is on the board of directors of McDonald’s Corp. and Pennzoil-Quaker State Co. Send questions via e-mail at

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