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Extra12/30/2009 6:55 PM ET

Congress lets 50 tax breaks expire

Key tax breaks are mired in limbo, leaving individuals and businesses in a bind. Extensions are expected later, but in these tight times, nothing is certain.

By Forbes.com

When members of the U.S. Senate headed home last week, they left the future of 50 individual and business tax breaks in limbo. All of the breaks expire at the end of 2009.

Among them are the research tax credit and an annual alternative minimum tax "patch," which keeps 23 million additional middle-income Americans from being forced into calculating and paying the dreaded AMT. (For 2009, with the patch in place, 4 million upper-middle-income and high-income families will pay the AMT.)

Most of the fading-out 50 can, and probably will, be reauthorized retroactively, creating an inconvenience for some taxpayers but not the same sort of mess as Congress' failure to resolve the future of the estate tax. The estate tax will expire Dec. 31, and Democrats are pledging to resurrect it retroactively, leading to all sorts of potential legal problems, as well as some planning opportunities, for wealthy families.

Among the expiring individual tax breaks:

  • The deduction for state and local sales taxes for itemizers (which benefits mainly residents of states that don't impose an income tax).
  • The additional $1,000 deduction for real-estate taxes for people who claim the standard deduction.
  • The $4,000 deduction for college tuition.
  • A $250 deduction for teachers who spend their own money on classroom supplies.

A familiar problem

This isn't the first time Congress has let some of the 50 breaks lapse. In fact, expiring provisions have come to be known as "extenders," because instead of eliminating them or making them permanent and recognizing their true costs, Congress simply extends them year by year.

This time around, on Dec. 9, House Democrats pushed through a bill extending most of the breaks, at a cost of $31 billion. The Senate, mired in partisan warfare over health care reform, never took up a similar measure. On Dec. 22, Senate Finance Committee Chairman Max Baucus, D-Mont., and ranking committee member Charles Grassley, R-Iowa, issued a joint letter promising to extend the provisions retroactively as soon as possible.

But taxpayers can't count on early action.

"We've seen this movie before," says Clint Stretch, the managing principal of tax policy with Deloitte Tax. "When this has happened in the past, it's been literally months before Congress has gotten around to fixing things."

For example, Congress finally included dozens of lapsed tax breaks in the October 2008 bank bailout, making them retroactive to Jan. 1, 2008.

Meanwhile, taxpayers have some decisions to make. For example, if the AMT patch isn't passed by the time their first 2010 estimated tax payments are due in April, they'll have to decide whether to pay extra money or risk underpaying and incurring a penalty. One lapsed provision allows taxpayers age 70 1/2 or older to transfer up to $100,000 directly from an individual retirement account to charity without booking the amount transferred as income. Older folks planning a charitable gift may want to do this before Jan. 1.

Uncertainty for companies

For businesses, the lapsing of the research-and-development credit -- a $7 billion-a-year break -- is a particular problem, as companies must plan for long-term research commitments amid uncertainty. Since its enactment in 1981, the credit has been extended 13 times. In the mid-1990s, there was a one-year gap when it wasn't extended retroactively.

"Companies are sensitive to that," says Monica McGuire, the executive secretary of the R&D Credit Coalition in Washington, D.C., which represents such research heavyweights as 3M, AT&T, Genentech, Hewlett-Packard and Xerox. "If Congress is serious about jobs in this jobless recovery, they ought not to treat the credit like a yo-yo."

The lapse could also affect companies' reported earnings, because they won't be able to assume the credit will be extended. The expiration stands in contrast to President Barack Obama's call for the credit to be made permanent.

"Under my budget, this tax credit will no longer fall prey to the whims of politics and partisanship," Obama said in March to technology executives at the White House. "It will be far more effective when businesses like yours can count on it, when you've got some stability and reliability."

Multinationals argue that uncertainty over the credit makes the U.S. look less competitive when they are deciding whether to locate new research projects here or in countries with permanent tax incentives.

Multinationals are also frustrated that two other tax provisions -- known as the Subpart F and look-through rules -- haven't been extended. Subpart F affects how U.S. shareholders can be taxed on certain income that a company earns abroad. The look-through provision exempts some of that income, including dividends paid to shareholders, from being taxed in the U.S.

"Until there is clarity, companies may have to avoid doing certain transactions," Stretch says. "Basically, it fouls up their marketplace."

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Other corporate breaks that are in limbo include a railroad-track maintenance credit, special expensing rules for U.S. film and television productions, and tax laws that help Puerto Rican and U.S. Virgin Islands distillers.

The House extenders bill that was passed Dec. 9 did not include the AMT patch. Stretch says it's likely the AMT patch and the traditional extenders, including the research credit, will be approved sometime in 2010.

Still, with the budget deficit growing, the Bush-era tax cuts set to expire at the end of 2010 and economic advisers to Obama looking at options for tax reform, nothing is certain.

"Who knows what's going to happen next year?" McGuire asks.

This article was reported by Ashlea Ebeling for Forbes.com.

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