02-7: The sun will rise again

http://www.savingforcollege.com/articles/02-7-the-sun-will-rise-again

"Oh sure," my friend Harry tells me, "it's easy for you to promote the idea of using 529 plans. Your youngest kid will just about be done with college by the year 2011." Harry, of course, is bemoaning the "sunset" clause attached to the tax cuts signed into law last summer. Due to federal budget buffoonery, the tax exclusion for qualified 529 plan withdrawals is scheduled to expire at the end of the year 2010 (along with just about every other item contained in the 2001 Economic Growth and Tax Relief Reconciliation Act). You see, Harry has two children ages 5 and 6. As it now stands, the law says that those children will have to report any earnings withdrawn from Harry's 529 college savings accounts on their federal tax returns, even when the withdrawals are used for their college costs. This assumes, of course, that they don't jump from sixth grade straight into Harvard. "Get real," I tell my friend. "Which members of Congress, in their right minds, are going to deny a continuing tax break to the millions of families that are trying so hard to save for future college expenses? It would be political suicide. You've got to believe the exclusion is going to be made permanent, or at least extended beyond 2010." Sounding as confident as possible, I then had to admit my disappointment in hearing that the House of Representatives on September 4, just back from its summer recess, had rejected a bill (HR 5203) that would make permanent the education provisions of the 2001 tax law. Although obviously bad news for college savers like Harry, the good news, I suppose, is that HR 5203 made it to the floor of the House so quickly and received a majority vote in favor (two-thirds was needed for passage). The better news is that a similar bill will return on another day to face another vote, and the outcome will be one to celebrate. How can I be so sure of this? My logic goes like this: 1. College costs continue to rise rapidly and families need to generate earnings on their savings just to keep up with these increases. Taxing those earnings simply makes no sense. Congress must realize that college-educated people are good for our society, and so will make the right move to make the exclusion permanent. 2. OK, so maybe Congress won't realize that, especially when our representatives see that the college tax exclusion takes money from the federal budget. It's unthinkable, however, that the entire 2001 tax law would be allowed to sunset. Too many problems would result if we revert to pre-2002 law; students with special needs lose out; college-sponsored prepaid tuition plans blow up; grandparents no longer can change 529 account beneficiaries among cousins; rollovers from one 529 plan to another 529 plan trigger tax and penalty. Something has to be done to address these specific issues, and many more like them. Congress will see a piecemeal fix to be an incomplete and difficult solution, and so will act on a general and permanent fix. 3. OK, so maybe Congress will go for the piecemeal fix. In fact, I've observed narrowly-targeted bills being introduced on an almost daily basis in both the House and Senate. If it goes this route, I would hope to see a piecemeal extension to the 529 exclusion as well. However, I can see where a few strings might be added. Perhaps only the earnings built up before 2011 continue to escape tax (the so-called grandfathering approach). Or maybe the 529 exclusion will continue, but only for families below a certain income level. Yes, I tell Harry, the sun will rise again. Worst case? I'm wrong, and Harry's kids report some taxable income. I may argue that such a result is really not such a bad thing. College students tend to be in very low tax brackets. And any tax owed on withdrawals will probably be offset by tuition tax credits they can claim. But Harry wants a simple answer, and I agree with him. Congress should provide one soon and give skittish savers one less thing to worry about.