SECTION 13. TAX PROVISIONS RELATED TO RETIREMENT, HEALTH, POVERTY,
EMPLOYMENT, DISABILITY AND OTHER SOCIAL ISSUES
CONTENTS
Introduction
Tax Provisions
Use of Distributional Analysis
Tax Provision Estimates
Net Exclusion of Pension Contributions and Earnings
Individual Retirement Plans
Exclusion of Social Security and Railroad Retirement Benefits
Exclusion of Employer Contribution for Medical Insurance
Premiums and Medical Care
Medical Savings Accounts
Cafeteria Plans
Health Care Continuation Rules
Group Health Plan Requirements
Tax Benefits for Accelerated Death Benefits and Long-Term Care
Insurance
Deduction for Health Insurance Expenses of Self-Employed
Individuals
Exclusion of Medicare Benefits
Deductibility of Medical Expenses
Earned Income Credit
Exclusion of Public Assistance and SSI Benefits
Dependent Care Tax Credit
HOPE Credit and Lifetime Learning Credit
Qualified State Tuition Programs and Education IRAs
Student Loan Interest Deduction
Exclusion for Employer-Provided Dependent Care
Work Opportunity Tax Credit
Welfare-to-Work Tax Credit
Exclusion of Workers' Compensation and Special Benefits for
Disabled Coal Miners
Additional Standard Deduction for the Elderly and Blind
Tax Credit for the Elderly and Certain Disabled Individuals
Tax Provisions Related to Housing
Owner-Occupied Housing
Low-Income Housing Credit
Tax Credit and Exclusion for Adoption Expenses
Child Tax Credit
The Effect of Tax Provisions on the Income and Taxes of the
Elderly and the Poor
Hypothetical Tax Calculations for Selected Families
Tax Treatment of the Elderly
Distribution of Family Income and Taxes
Federal Tax Treatment of Families in Poverty
References
INTRODUCTION
The preceding sections of this publication discuss direct
payments to individuals for retirement, health, public
assistance, employment, and disability benefits provided
through entitlement programs within the jurisdiction of the
Committee on Ways and Means. The Federal Government also
provides benefits to individuals through elements of the income
tax set forth in the Internal Revenue Code of 1986 (the Code).
The Code is entirely within the jurisdiction of the Committee
on Ways and Means.
Tax Provisions
Several different types of income tax provisions are
available to provide economic incentives. Examples include:
exclusions, exemptions, deductions, preferential rates,
deferrals and credits (see Joint Committee, 1996). Measuring
the amount of benefit afforded by a tax provision is difficult.
However, one way to measure the benefit is to review the total
estimated amounts excluded, exempted, or otherwise afforded
special treatment under various provisions of the income tax.
Use of Distributional Analysis
Analyzing the effectiveness of tax provisions at achieving
their policy goals often involves examining the distribution of
benefits from the provisions allocated by the income class of
those who take advantage of the provisions. The income concept
used to show the distribution of tax expenditures by income
class is adjusted gross income plus: (1) tax-exempt interest;
(2) employer contributions for health plans and life insurance;
(3) employer share of FICA taxes; (4) workers' compensation;
(5) nontaxable Social Security benefits; (6) insurance value of
Medicare benefits; (7) minimum tax preferences; and (8)
excluded income of U.S. citizens living abroad.
This definition of income includes items that clearly
increase the ability to pay taxes, but that are not included in
the definition of adjusted gross income. However, it omits
certain items that clearly affect ability to consume goods and
services either now or in the future, including accrual of
pension benefits, other fringe benefits (such as military
benefits, veterans benefits, and parsonage allowances), and
means-tested transfer payments (such as AFDC, Supplemental
Security Income, food stamps, housing subsidies, and general
assistance).
The tax return is the unit of analysis. Table 13-1 shows
the distribution of all tax returns for 1997 by income class.
Unless specifically indicated, all distributional tables
exclude returns filed by dependents. All projections of income
and deduction items and tax parameters are based on economic
assumptions consistent with the December 1996 forecast of the
Congressional Budget Office.
TABLE 13-1.--DISTRIBUTION OF TAX RETURNS BY INCOME CLASS, 1997
----------------------------------------------------------------------------------------------------------------
All returns Taxable Itemized Tax
Income class (thousands) \1\ \2\ returns returns liability
----------------------------------------------------------------------------------------------------------------
Below $10................................................... 21,496 1,642 130 -$5,364
$10-$20..................................................... 24,714 9,122 921 -4,029
$20-$30..................................................... 19,926 12,990 2,156 16,455
$30-$40..................................................... 16,441 13,966 3,399 33,817
$40-$50..................................................... 12,449 11,502 3,947 40,823
$50-$75..................................................... 19,605 19,397 10,041 108,548
$75-$100.................................................... 9,241 9,206 6,975 92,691
$100-$200................................................... 7,310 7,293 6,441 145,699
$200 and over............................................... 1,648 1,644 1,527 208,042
---------------------------------------------------
Total................................................... 132,830 86,763 35,537 636,683
----------------------------------------------------------------------------------------------------------------
\1\ The income concept is defined at the beginning of this chapter.
\2\ Includes filing and nonfiling units. Filing units include all taxable and nontaxable returns. Nonfiling
units include individuals with income that is exempt from Federal income taxation (e.g., transfer payments,
interest from tax-exempt bonds, etc.). Excludes individuals who are dependents of other taxpayers and
taxpayers with negative income.
Note.--Money amounts in millions of dollars, returns in thousands. Detail may not add to total due to rounding.
Source: Joint Committee on Taxation.
Tax Provision Estimates
Table 13-2 provides various estimates for 33 tax
provisions related to retirement, health, poverty, employment,
disability, and housing. These provisions are examined in
detail in this chapter including their legislative history, an
explanation of current law, and a brief assessment of their
effects.
NET EXCLUSION OF PENSION CONTRIBUTIONS AND EARNINGS
Legislative History
Prior to 1921, no special tax treatment applied to employee
retirement trusts. Retirement payments to employees and
contributions to pension trusts were deductible by the employer
as an ordinary and necessary business expense. Employees were
taxed on amounts actually received as well as on employer
contributions to a trust if there was a reasonable expectation
of benefits accruing from the trust. The 1921 Code provided an
exemption for a trust forming part of a qualified profit
sharing or stock bonus plan.
The rules relating to qualified plans were substantially
revised by the Employee Retirement Income Security Act of 1974
(ERISA), which added overall limitations on contributions and
benefits and other requirements on minimum participation,
coverage, vesting, benefit accrual, and funding. Further
revisions of these rules have been made in every major tax bill
enacted after 1974.
TABLE 13-2.--ESTIMATED TAX BASE EXCEPTIONS AND CREDITS UNDER THE PRESENT INCOME TAX FOR VARIOUS ITEMS,\1\
CALENDAR YEARS 1998-2002
[In billions of dollars]
----------------------------------------------------------------------------------------------------------------
Year
Item ------------------------------------------------------------ Total
1998 1999 2000 2001 2002 1998-2002
----------------------------------------------------------------------------------------------------------------
I. Tax base exceptions related to:
Retirement:
Net exclusion of pension
contributions and earnings......... $320.0 $333.7 $348.0 $347.7 $342.1 $1,691.5
Keogh plans......................... 19.6 20.9 22.2 23.6 25.1 111.4
Individual retirement plans......... 49.8 52.3 55.2 58.4 62.8 278.5
Exclusion of Social Security and
railroad retirement benefits in
excess of employee share of payroll
tax \2\............................ 262.4 272.0 281.9 292.0 302.5 1410.8
Health:
Exclusions of employer contributions
for medical care, health insurance
premiums and long-term care
insurance premiums \3\............. 248.2 260.0 272.7 286.4 301.6 1,369.0
Exclusion of Medicare benefits:
Medicare part A................. 135.6 146.8 158.8 171.1 184.4 796.7
Medicare part B................. 63.2 70.5 78.5 86.2 94.6 393.0
Deductibility of medical expenses
\4\................................ 34.7 37.8 40.9 44.8 48.7 206.9
Deductibility of health insurance
expenses of the self-employed \5\.. 5.3 5.8 6.9 7.4 9.4 34.8
Exclusion of accelerated death
benefits........................... 1.1 1.4 1.7 2.1 2.5 8.8
Poverty:
Exclusion of public assistance and
SSI cash benefits.................. 51.1 52.5 55.7 54.6 59.1 273.0
Employment:
Exclusion of employer-provided
dependent care \6\................. 5.2 6.0 6.6 6.9 7.1 31.8
Employee stock ownership plans
(ESOPs)............................ 11.6 12.5 13.3 14.0 14.7 66.1
Exclusion for benefits provided
under cafeteria plans \7\.......... 29.6 33.3 36.6 40.2 44.2 184.0
Elderly and disabled:
Exclusion of workers' compensation
and special benefits for disabled
coal miners:
Workers' compensation........... 30.7 31.5 32.5 33.2 34.0 161.9
Special benefits for disabled
coal miners.................... 1.1 1.0 1.0 1.0 0.9 5.0
Additional standard deduction for
elderly and blind.................. 12.3 12.9 13.8 14.6 15.8 69.4
Housing:
Deductibility of mortgage interest.. 168.9 174.9 181.0 187.9 194.6 907.3
Deductibility of property tax on
owner-occupied housing............. 69.2 72.7 75.9 80.1 84.5 382.4
Exclusion of interest on State and
local government bonds for owner-
occupied housing................... 7.9 8.4 8.4 8.5 8.5 41.7
Depreciation of rental housing in
excess of alternative depreciation
system............................. 9.2 8.4 8.3 8.6 9.6 44.1
Exclusion of interest on State and
local government bonds for rental
housing............................ 3.6 3.7 3.6 3.5 3.4 17.9
Families:
Qualified State tuition programs and
education IRAs..................... 0.4 0.5 0.7 0.8 1.1 3.5
Student loan interest deduction..... 0.1 0.1 0.1 0.2 0.3 0.8
Employer-provided adoption expenses (\8\) (\8\) (\8\) (\8\) (\8\) (\8\)
II. Tax credits related to:
Poverty:
Earned income credit:
Nonrefundable portion........... 22.5 23.4 24.4 25.3 26.4 122.0
Refundable portion.............. 5.2 5.3 5.5 5.9 6.1 28.0
Employment:
Dependent care credit............... 2.7 2.8 2.9 2.9 3.0 14.3
Work opportunity tax credit......... 0.2 0.1 (\8\) (\8\) (\8\) 0.4
Welfare-to-work tax credit......... (\8\) (\8\) (\8\) (\8\) (\8\) 0.1
Elderly and disabled:
Tax credit for elderly and disabled. (\8\) (\8\) (\8\) (\8\) (\8\) 0.1
Housing:
Low-income housing tax credit....... 3.2 3.5 3.9 4.3 4.6 19.6
Families:
Child tax credit:
Nonrefundable portion.......... 16.6 20.5 20.4 20.2 19.8 97.5
Refundable portion............. 0.9 1.1 1.1 1.1 1.1 5.3
HOPE credit and lifetime learning
credit............................. 6.2 6.3 7.2 7.7 7.6 35.1
Adoption credit.................... 0.4 0.4 0.4 0.2 0.2 1.5
----------------------------------------------------------------------------------------------------------------
\1\ Estimates of exclusions and deductions represent changes in the tax base; they do not measure changes in tax
liability. Tax effects of provisions are not comparable.
\2\ In addition to OASDI benefits for retired workers, these figures also include disability insurance benefits
and benefits for dependents and survivors.
\3\ Estimate includes employer-provided health insurance purchased through cafeteria plans and health care
spending through flexible spending accounts.
\4\ Amounts reported on tax returns in excess of the medical deductions floor (7.5 percent of adjusted gross
income).
\5\ Amounts deductible from gross income: 45 percent of health insurance expenses in 1998 and 1999, 50 percent
in 2000 and 2001, and 60 percent in 2002. Remaining amounts are deductible on schedule A with other itemized
medical expenses.
\6\ Estimate includes employer-provided child care purchased through dependent care flexible spending accounts.
\7\ Estimate includes amounts of employer-provided health insurance purchased through cafeteria plans and
employer-provided child care purchased through dependent care flexible spending accounts. These amounts are
also included in other line items in this table.
\8\ Less than $50 million.
Note.--Details may not add to totals due to rounding.
Source: Joint Committee on Taxation.
Since ERISA, Congress has also acted to broaden the range
of qualified plans. In the Revenue Act of 1978, Congress
provided special rules for qualified cash or deferred
arrangements under section 401(k). Under these arrangements,
known popularly as 401(k) plans, employees can elect to receive
cash or have their employers contribute a portion of their
earnings to a qualified profit sharing, stock bonus, or pre-
ERISA money purchase pension plan.
An employee stock ownership plan (ESOP) is a special type
of qualified plan that is designed to invest primarily in
securities of the employer maintaining the plan. Certain
qualification rules and tax benefits apply to ESOPs that do not
apply to other types of qualified plans.
Explanation of Provision
In general
Under a plan of deferred compensation that meets the
qualification standards of the Internal Revenue Code (sec.
401(a)), an employer is allowed a deduction for contributions
to a tax-exempt trust to provide employee benefits. Similar
rules apply to plans funded with annuity contracts. An employer
that makes contributions to a qualified plan in excess of the
deduction limits is subject to a 10-percent excise tax on such
excess (sec. 4972).
The qualification rules limit the amount of benefits that
can be provided through a qualified plan and require that
benefits be provided on a basis that does not discriminate in
favor of highly compensated employees. In addition, qualified
plans are required to meet minimum standards relating to
participation (the restrictions that may be imposed on
participation in the plan), coverage (the number of employees
participating in the plan), vesting (the time at which an
employee's benefit becomes nonforfeitable), and benefit accrual
(the rate at which an employee earns a benefit). Also, minimum
funding standards apply to the rate at which employer
contributions are required to be made to certain plans to
ensure the solvency of pension plans.
If a defined benefit pension plan is terminated, any assets
remaining after satisfaction of the plan's liabilities may
revert to the employer. Such reversions are included in the
gross income of the employer and are subject to income tax plus
an additional excise tax (sec. 4980). The excise tax is 20
percent if the employer establishes a qualified replacement
plan or provides certain benefit increases. Otherwise, the
excise tax is 50 percent. Transfers of excess assets can be
made from an ongoing defined benefit plan to pay certain
retiree health benefits if certain requirements are satisfied
(sec. 420). The assets transferred are not includable in the
income of the employer or subject to the tax on reversions.
Minimum participation rules
A qualified plan generally may not require as a condition
of participation that an employee complete more than 1 year of
service or be older than age 21 (sec. 410(a)).
Vesting rules
A plan is not a qualified plan unless a participant's
employer-provided benefit vests at least as rapidly as under
one of two alternative minimum vesting schedules (sec. 411).
Benefit accrual rules
The protection afforded employees under the minimum vesting
rules depends not only on the minimum vesting schedules, but
also on the accrued benefits to which these schedules are
applied. In the case of a defined contribution plan, the
accrued benefit is the participant's account balance. In the
case of a defined benefit plan, a participant's accrued benefit
is determined under the plan benefit formula, subject to
certain restrictions. In general, the accrued benefit is
defined in terms of the benefit payable at normal retirement
age and does not include certain ancillary nonretirement
benefits.
Each defined benefit plan is required to satisfy one of
three accrued benefit tests. The primary purpose of these tests
is to prevent undue backloading of benefit accruals (i.e., by
providing low rates of benefit accrual in the employee's early
years of service when the employee is most likely to leave and
by concentrating the accrual of benefits in the employee's
later years of service when he is most likely to remain with
the employer until retirement) (sec. 412).
Coverage rules
A plan is not qualified unless the plan satisfies at least
one of the following coverage requirements: (1) the plan
benefits at least 70 percent of all nonhighly compensated
employees, (2) the plan benefits a percentage of nonhighly
compensated employees that is at least 70 percent of the
percentage of highly compensated employees benefiting under the
plan, or (3) the plan meets an average benefits test (sec.
410(b)). In addition, a plan is not a qualified plan unless it
benefits the lesser of: (1) 50 employees, or (2) 40 percent of
the employees of the employer (sec. 401(a)(26)). For years
beginning after 1996, pursuant to the Small Business Job
Protection Act of 1996, the latter rule is modified to apply
only to defined benefit plans. For years beginning after 1996,
a defined benefit plan is not a qualified plan unless it
benefits at least the lesser of: (1) 50 employees, or (2) the
greater of 40 percent of the employees of the employer or 2
employees (or if there is only 1 employee, such employee).
General nondiscrimination rule
In general, a plan is not a qualified plan if the
contributions or benefits under the plan discriminate in favor
of highly compensated employees (sec. 401(a)(4)).
Limitations on contributions and benefits
The maximum annual benefit that may be provided by a
defined benefit pension plan (payable at the Social Security
retirement age) is the lesser of 100 percent of average
compensation, or $125,000 for 1997 (sec. 415(b)). The dollar
limit is adjusted annually for inflation. The dollar limit is
reduced if payments of benefits begin before the Social
Security retirement age and increased if benefits begin after
the Social Security retirement age.
Funding rules
Pension plans are required to meet a minimum funding
standard for each plan year (sec. 412). In the case of a
defined benefit pension plan, an employer must contribute an
annual amount sufficient to fund a portion of participants'
projected benefits determined in accordance with one of several
prescribed funding methods, using reasonable actuarial
assumptions. Plans with asset values of less than 100 percent
of current liabilities are subject to additional, faster
funding rules.
Taxation of distributions
An employee who participates in a qualified plan is taxed
when the employee receives a distribution from the plan to the
extent the distribution is not attributable to employee
contributions (sec. 402). With certain exceptions, a 10-percent
additional income tax is imposed on early distributions from a
qualified plan (sec. 72(t)). A 15-percent excise tax is imposed
on distributions that exceed a certain amount in any year (sec.
4980A). Section 4980A was repealed by the Taxpayer Relief Act
of 1997 for excess distributions received after December 31,
1996.
Failure to satisfy qualification requirements
If a plan fails to satisfy the qualification requirements,
the trust that holds the plan's assets is not tax exempt. An
employer's deduction for plan contributions is only allowed
when the employee includes the contributions or benefits in
income, and benefits generally are includable in an employee's
income when they are no longer subject to a substantial risk of
forfeiture.
SIMPLE retirement plans
The Small Business Job Protection Act of 1996 created a
simplified retirement plan for small business called the
Savings Incentive Match Plan for Employees (SIMPLE) (secs.
408(p) and 401(k)(11)). SIMPLE plans may be adopted by
employers with 100 or fewer employees and who do not maintain
another employer-sponsored retirement plan. A SIMPLE plan can
be either an individual retirement arrangement (IRA) for each
employee or part of a qualified cash or deferred arrangement
(401(k) plan). If established in IRA form, a SIMPLE plan is not
subject to the nondiscrimination rules generally applicable to
qualified plans and simplified reporting requirements apply. If
adopted as part of a 401(k) plan, the plan does not have to
satisfy the special nondiscrimination tests applicable to
401(k) plans and is not subject to the top-heavy rules. The
other qualified plan rules continue to apply. SIMPLE plans are
subject to special rules regarding eligibility of employees to
participate and special contribution limits.
Effect of Provision
The tax treatment of pension contributions and earnings has
encouraged employers to establish qualified retirement plans
and to compensate employees in the form of pension
contributions to such plans. There are two potential tax
advantages of being compensated through pension contributions.
One advantage is the ability to earn tax-free returns to
savings. When saving is done through a pension plan, the
employee earns a higher rate of return than on fully taxed
savings.\1\ The second advantage is that an employee's tax rate
may be lower during retirement than during the working years.
---------------------------------------------------------------------------
\1\ This applies to pension contributions made by employers.
Employees may also be able to contribute to qualified plans. Employee
contributions may be made with aftertax dollars. If so, the tax
advantage given to these contributions is smaller than the tax
advantage given to employer contributions, and consists of the deferral
of tax on accumulated earnings.
---------------------------------------------------------------------------
These tax provisions directly benefit only persons who work
for employers with qualified plans and who work for a
sufficient period of time before their benefits vest in such
plans. The current extent of this coverage and recent trends in
coverage are described below.
Coverage
The term covered, as used here, means that an employee is
accruing benefits in an employer pension or other retirement
plan. The best current comprehensive evidence on pension
coverage comes from a supplement to the April 1993 Current
Population Survey (U.S. Department of Labor, 1994). The data
referred to below come from that survey unless otherwise noted.
As of April 1993, 63 percent of full-time wage and salary
workers employed in the private sector reported that they
worked in firms with an employer-sponsored pension plan. Half
of the full-time wage and salary workers employed in the
private sector were covered by an employer-sponsored pension
plan. Most of these workers were covered by basic defined
benefit or defined contribution plans (23 percent), and another
10 percent had both a basic plan and a 401(k) type contributory
plan (see table 13-3).\2\ For another 17 percent, the 401(k)
type plan was their only retirement plan.
---------------------------------------------------------------------------
\2\ Some private-sector employees contribute to 403(b) tax-
sheltered annuities instead of 401(k) plans.
---------------------------------------------------------------------------
Pension coverage varies substantially among full-time,
privately employed workers. Differences depend on the age of
the worker, job earnings, the industry of employment, and the
size of the firm.
Younger workers are much less likely to be covered by a
pension than middle aged and older workers. Coverage rates rise
steadily from 21 percent for those under age 25 to about 60
percent for those between ages 40 and 60 before falling off
somewhat. This pattern holds for both men and women. However,
the jump in coverage for middle aged men is slightly larger
than the increase for middle aged women (see table 13-4).
Higher paying jobs are more likely to offer pensions. Just
8 percent of full-time private wage and salary workers earning
less than $10,000 per year in 1993 were covered compared to 81
percent of those earning $50,000 or more (see table 13-5).
Coverage may be higher for higher paying jobs because of the
greater value of the pension tax benefits to workers in higher
tax brackets and because of the declining replacement rate of
Social Security at higher earnings levels.
TABLE 13-3.--EMPLOYER SPONSORSHIP AND EMPLOYEE COVERAGE UNDER PENSION OR
RETIREMENT PLAN, PRIVATE WAGE AND SALARY WORKERS
[Percent]
------------------------------------------------------------------------
Total Full time Part time
------------------------------------------------------------------------
Employer sponsorship:
Employer sponsors plan....... 58 63 37
Basic pension only....... 24 24 23
Basic and 401(k) type.... 14 16 4
401(k) type only......... 21 23 10
Employer does not sponsor.... 35 32 49
Does not know................ 7 5 14
Employee coverage:
Employee covered under plan.. 43 50 12
Basic pension only....... 20 23 7
Basic and 401(k) type.... 8 10 2
401(k) type only......... 15 17 4
Employee is not covered...... 50 44 73
Does not know................ 7 6 14
--------------------------------------
Number of private wage
and salary workers (in
thousands)............ 88,679 72,752 15,927
------------------------------------------------------------------------
Source: U.S. Department of Labor, 1994, tables A2, B1, B2.
TABLE 13-4.--COVERAGE UNDER EMPLOYER-SPONSORED PENSION OR RETIREMENT
PLANS FOR FULL-TIME PRIVATE WAGE AND SALARY WORKERS
------------------------------------------------------------------------
Percent covered
Age (in years) --------------------------------------
Total Men Women
------------------------------------------------------------------------
Under 25......................... 21 19 22
25-29............................ 41 41 42
30-34............................ 50 50 51
35-39............................ 54 57 51
40-44............................ 58 61 54
45-49............................ 63 66 59
50-54............................ 61 60 62
55-59............................ 59 60 57
60-64............................ 56 59 52
65 or older...................... 46 54 34
--------------------------------------
Total...................... 50 51 48
------------------------------------------------------------------------
Source: U.S. Department of Labor, 1994, table B5.
TABLE 13-5.--COVERAGE UNDER EMPLOYER-SPONSORED PENSION OR RETIREMENT
PLANS FOR FULL-TIME PRIVATE WAGE AND SALARY WORKERS BY WORKERS' WAGES
------------------------------------------------------------------------
Percent covered
Wages --------------------------------------
Total Men Women
------------------------------------------------------------------------
Under $10,000.................... 8 7 9
$10,000-$14,999.................. 27 21 31
$15,000-$19,999.................. 42 35 49
$20,000-$24,999.................. 57 51 65
$25,000-$29,999.................. 62 61 64
$30,000-$34,999.................. 67 66 71
$35,000-$39,999.................. 73 74 72
$40,000-$49,999.................. 78 79 77
$50,000-$74,999.................. 81 81 80
$75,000 or over.................. 81 82 78
--------------------------------------
Total \1\.................. 50 51 48
------------------------------------------------------------------------
\1\ Total includes workers not responding on wages, not shown
separately.
Source: U.S. Department of Labor, 1994, table B11.
Industries with high pension coverage include
manufacturing, mining, financial services, and communications
and public utilities. Coverage rates exceed 60 percent for
full-time private wage and salary workers in each of these
industries (U.S. Department of Labor, 1994, pp. B-8 & B-9). In
contrast, coverage rates are under 35 percent in agriculture,
retail trade, and construction. Part of the difference among
industries appears to be due to differences in firm size.
Coverage is much lower for smaller firms. Smaller firms are
less likely to offer comprehensive fringe benefit packages as
part of total compensation. Only 13 percent of full-time
private wage and salary workers in firms with fewer than 10
employees are covered. The rate rises with employer size but
does not reach 50 percent (the average across all firm sizes)
until firms have 100 or more employees (table 13-6).
Significant differences in coverage also are apparent
between full-time private wage and salary workers and other
wage and salary workers. Coverage is much lower among part-time
workers and much higher among public employees. Among part-
time, private wage and salary workers, 12 percent are covered.
Seventy-seven percent of public sector wage and salary workers
are covered including 85 percent of those who are full-time
workers (see table 13-7).
Trends in Coverage
At the outset of World War II, private employer pensions
were offered by about 12,000 firms. Pensions spread rapidly
during and after the war, encouraged by high marginal tax rates
and wartime wage controls that exempted pension benefits. By
1972, when the first comprehensive survey was undertaken, 48
percent of full-time private employees were covered. Subsequent
surveys found that coverage reached 50 percent in 1979, but by
1983 had fallen back to 48 percent. The decline continued in
the 1980s, reaching 46 percent in 1988 (Woods, 1989, p. 17). By
1993, coverage had returned to 50 percent.
TABLE 13-6.--COVERAGE UNDER EMPLOYER-SPONSORED PENSION OR RETIREMENT
PLANS FOR FULL-TIME PRIVATE WAGE AND SALARY WORKERS BY SIZE OF FIRM
------------------------------------------------------------------------
Percent covered
Firm size (number of workers) --------------------------------------
Total Men Women
------------------------------------------------------------------------
Fewer than 10.................... 13 12 14
10-24............................ 25 23 28
25-49............................ 30 32 27
50-99............................ 42 46 37
100-249.......................... 53 57 49
250-499.......................... 62 66 57
500-999.......................... 62 66 58
1,000 or more.................... 73 76 70
--------------------------------------
Total \1\.................... 50 51 48
------------------------------------------------------------------------
\1\ Total includes workers not responding or for whom firm size is
unknown, not shown separately.
Source: U.S. Department of Labor, 1994, table B9.
TABLE 13-7.--COVERAGE OF WAGE AND SALARY WORKERS UNDER EMPLOYER-
SPONSORED PENSION OR RETIREMENT PLAN, BY PRIVATE OR PUBLIC SECTOR
------------------------------------------------------------------------
Percent covered
Sector --------------------------------------
Total Full time Part time
------------------------------------------------------------------------
All wage and salary workers...... 49 56 15
Men.......................... 51 56 9
Women........................ 46 56 17
Private sector................... 43 50 12
Men.......................... 46 51 8
Women........................ 39 48 15
Public sector.................... 77 85 30
Men.......................... 80 86 22
Women........................ 74 84 33
------------------------------------------------------------------------
Source: U.S. Department of Labor, 1994, table B1.
The decline in coverage in the 1980s was concentrated among
younger men. The coverage rate among older men has fallen less
dramatically, and among women it has risen at some ages and
fallen at others.
The decline in pension coverage has occurred at the same
time that employers have been shifting from defined benefit
plans. Defined benefit plans provided basic plan coverage for
87 percent of private wage and salary workers in 1975 (Turner &
Beller, 1989, pp. 65 & 357). This proportion dropped to 83
percent by 1980 and to 71 percent by 1985. This shifting
composition has largely been the result of rapid growth in
primary defined contribution plans. Employee stock ownership
plans and 401(k) plans have been among the most rapidly growing
defined contribution plans.
INDIVIDUAL RETIREMENT PLANS
Legislative History
ERISA added section 219 to the Internal Revenue Code,
providing a tax deduction for certain contributions to
individual retirement arrangements (IRAs) and permitting the
deferral of tax on amounts held in such arrangements until
withdrawal. Active participants in employer plans were not
permitted to make deductible IRA contributions.
The Economic Recovery Tax Act of 1981 expanded eligibility
to individuals who were active participants and increased the
amount of the permitted deduction. The Tax Reform Act of 1986
limited the full IRA deduction to individuals with income below
certain levels and to individuals who are not active
participants in employer plans. Individuals who are not
entitled to the full IRA deduction may make nondeductible
contributions to an IRA. The Small Business Job Protection Act
of 1996 increased contributions that can be made to the IRA of
a nonworking spouse. The Health Insurance Portability and
Accountability Act provided that the early withdrawal tax does
not apply to withdrawals from IRAs: (1) for medical expenses
that would be deductible (i.e., to the extent that total
medical expenses exceed 7.5 percent of adjusted gross income);
and (2) for health insurance expenses of unemployed
individuals.
The Taxpayer Relief Act of 1997, effective for years
beginning after December 31, 1997, made the following changes
to the IRA provisions: (1) the income limits on deductible IRA
contributions that apply to active participants in an employer-
sponsored retirement plan were increased; (2) the nonworking
spouse of an active participant in an employer-sponsored
retirement plan may make a deductible contribution of up to
$2,000 to an IRA; (3) a new tax-free nondeductible IRA, the
Roth IRA, was added; and (4) the 10-percent early withdrawal
tax was waived for distributions from IRAs for education and
first-time home buyer expenses.
Explanation of Provision
Deductible IRAs
An individual who is an active participant in an employer-
sponsored retirement plan may deduct annual IRA contributions
up to the lesser of $2,000 or 100 percent of compensation if
the individual's adjusted gross income (AGI) does not exceed
certain limits.
The full $2,000 IRA deduction limit is phased out for
married individuals over the following levels of AGI: for 1998,
$50,000-$60,000; for 1999, $51,000-$61,000; for 2000, $52,000-
$62,000; for 2001, $53,000-$63,000; for 2002, $54,000-$64,000;
for 2003, $60,000-$70,000; for 2004, $65,000-$75,000; for 2005,
$70,000-$80,000; for 2006, $75,000-$85,000; and for 2007 and
thereafter, $80,000-$100,000. The phase-out range for married
individuals filing separate returns is $0-$10,000. A couple is
not treated as married if the spouses file separate returns and
do not live together at any time during the year. The phase-out
range for single individuals is: for 1998, $30,000-$40,000; for
1999, $31,000-$41,000; for 2000, $32,000-$42,000; for 2001,
$33,000-$43,000; for 2002, $34,000-$44,000; for 2003, $40,000-
$50,000; for 2004, $45,000-$55,000; for 2005 and thereafter,
$50,000-$60,000.
For years beginning after 1997, an individual who is not
an active participant, but whose spouse is, may make a full
$2,000 deductible IRA contribution if the AGI for the couple
does not exceed $150,000. The deduction limit is phased out for
AGI between $150,000 and $160,000. An individual who is not an
active participant in an employer-sponsored retirement plan may
deduct IRA contributions up to the limits described above
without limitation based on income.
The investment income of IRA accounts is not taxed until
withdrawn. Withdrawn amounts attributable to deductible
contributions and all earnings are includable in income. A 10-
percent additional income tax is levied unless the withdrawal:
(1) is made after the IRA owner attains age 59\1/2\ or dies;
(2) is made on account of the disability of the IRA owner; (3)
is one of a series of substantially equal periodic payments
made not less frequently than annually over the life or life
expectancy of the IRA owner (or the IRA owner and his or her
beneficiary); or (4) is made to pay medical expenses in excess
of 7.5 percent of AGI or for insurance premiums for unemployed
individuals; or (5) is made after 1997 for first-time home
buyer expenses (subject to a $10,000 lifetime cap) or for
qualified higher education expenses.
Roth IRAs
For years beginning after December 31, 1997, an individual
may make nondeductible contributions up to the lesser of $2,000
or 100 percent of compensation to a Roth IRA if the
individual's AGI does not exceed $95,000 for an unmarried
individual, or $150,000 for a married couple filing a joint
return. The maximum contribution is phased out between AGI
ranges of $95,000-$110,000 for unmarried individuals and of
$150,000-$160,000 for married individuals filing a joint
return. No more than $2,000 of contributions can be made to all
an individual's IRAs for a taxable year.
Qualified distributions from a Roth IRA are not includable
in income. Qualified distributions are distributions: (1) made
after the 5-year taxable period beginning with the first
taxable year for which a contribution is made, and (2) which
are made on or after the date the individual attains age 59\1/
2\, are made to a beneficiary on or after the death of the
individual, are attributable to the individual's being
disabled, or are for a qualified special purpose distribution.
A qualified special purpose distribution is a distribution for
first-time home buyer expenses, as described above.
Distributions that are not qualified distributions are
includable in income, to the extent earnings are included in
the distribution, and are subject to the 10-percent tax on
early withdrawal, unless an exception applies, as described
above for deductible IRAs.
Taxpayers with AGI of less than $100,000 may convert an
IRA to a Roth IRA at any time. If the conversion is made before
January 1, 1999, the amounts that would have been includable in
income had the amounts converted been withdrawn are includable
in income ratably over 4 years. The 10-percent tax on early
withdrawals does not apply to conversions of IRAs to Roth IRAs.
Nondeductible IRAs
An individual may make nondeductible contributions to an
IRA to the extent the individual does not or cannot make
deductible contributions to an IRA or contributions to a Roth
IRA. Earnings on contributions to a nondeductible IRA
accumulate tax free, and are includable in income when
withdrawn. The 10-percent early withdrawal tax applies to such
earnings, subject to the exceptions for deductible and Roth
IRAs as described above.
Effect of Provision
Use of IRAs expanded significantly when eligibility was
expanded in 1982 to all persons with earnings and contracted
correspondingly in 1987 when deductibility was restricted for
higher income taxpayers who were covered by an employer-
provided pension. The number of taxpayers claiming a deductible
IRA contribution jumped from 3.4 million in 1981 to 12.0
million in 1982 and to 15.5 million in 1986. In 1987, only 7.3
million taxpayers reported deductible contributions. Since
then, the number has continued to fall (see table 13-8).
TABLE 13-8.--USE OF DEDUCTIBLE IRAs, 1980-95
------------------------------------------------------------------------
Number of tax
returns Total IRA
Year deducting IRA deductions
contributions (billions)
(millions)
------------------------------------------------------------------------
1980.................................. 2.6 $3.4
1981.................................. 3.4 4.8
1982.................................. 12.0 28.3
1983.................................. 13.6 32.1
1984.................................. 15.2 35.4
1985.................................. 16.2 38.2
1986.................................. 15.5 37.8
1987.................................. 7.3 14.1
1988.................................. 6.4 11.9
1989.................................. 5.8 10.8
1990.................................. 5.2 9.9
1991.................................. 4.7 9.0
1992.................................. 4.5 8.7
1993.................................. 4.4 8.5
1994.................................. 4.3 8.4
1995.................................. 4.3 8.3
------------------------------------------------------------------------
Source: Internal Revenue Service, Statistics of Income, various years.
Upper-income taxpayers facing higher marginal tax rates
receive more benefit per dollar of IRA deduction than do low-
income taxpayers facing lower marginal tax rates. When IRAs
were available to all workers, the percentage of taxpayers
contributing to an IRA was substantially higher among taxpayers
with higher income. For example, in 1985, 13.6 percent of
taxpayers with AGI between $10,000 and $30,000 contributed to
an IRA compared with 74.1 percent of taxpayers with AGI between
$75,000 and $100,000.
The decline in IRA use between 1985 and 1990 among those
with AGI between $10,000 and $30,000 appears to be larger than
the reduction required by the change in law since the
restrictions on deductible contributions apply only to a small
fraction of taxpayers with AGI below $30,000.
Eligibility percentages and the real value of the IRA
contribution limits decline over time because present law does
not index the contribution limits or the income eligibility
limits for inflation. For example, the real value of a $2,000
contribution has declined more than 30 percent since 1986
because of inflation.
Congress established IRAs to allow workers not covered by
employer pension plans to have tax-advantaged retirement
saving. Nonetheless, since 1981 IRA participation rates have
been higher among those covered by an employer-provided pension
plan than those without one, and many of those who are not
covered by a pension plan do not contribute to an IRA. In 1987,
10 percent of full-time private-sector earners without pension
coverage contributed to an IRA, while 15 percent of those with
coverage contributed (Woods, 1989, p. 9).
EXCLUSION OF SOCIAL SECURITY AND RAILROAD RETIREMENT BENEFITS
Legislative History
The exclusion from gross income for Social Security
benefits was not initially established by statute. Prior to the
Social Security Amendments of 1983, the exclusion was based on
a series of administrative rulings issued by the Internal
Revenue Service in 1938 and 1941.\3\
---------------------------------------------------------------------------
\3\ See Internal Revenue Service, Internal Revenue Bulletin, 1938-
1, Income Tax Unit 3154, p. 114; 1938-2, Income Tax Unit 3229, p. 136;
and 1941-1, Income Tax Unit 3447, p. 191.
---------------------------------------------------------------------------
Under the Social Security Amendments of 1983, a portion of
the Social Security benefits paid to higher income taxpayers is
included in gross income. In 1993, the Omnibus Budget
Reconciliation Act increased the amount of benefits subject to
tax and increased the rate of tax for some benefit recipients.
The exclusion from gross income of benefits paid under the
Railroad Retirement System was enacted in the Railroad
Retirement Act of 1935. A portion of the benefits payable under
the Railroad Retirement System (generally, tier 1 benefits) is
equivalent to Social Security benefits. The tax treatment of
tier 1 railroad retirement benefits was modified in the Social
Security Amendments of 1983 to conform to the tax treatment of
Social Security benefits. Other railroad retirement benefits
are taxable in the same manner as employer-provided retirement
benefits. The Consolidated Omnibus Budget Reconciliation Act of
1985 provided that tier 1 benefits are taxable in the same
manner as Social Security benefits only to the extent that
Social Security benefits otherwise would be payable. Other tier
1 benefits are taxable in the same manner as all other railroad
retirement benefits (for further details, see section 5).
Explanation of Provision
For taxpayers whose modified adjusted gross income exceeds
certain limits, a portion of Social Security and tier 1
railroad retirement benefits is included in taxable income.
Modified adjusted gross income is adjusted gross income plus
interest on tax-exempt bonds plus 50 percent of Social Security
and tier 1 railroad retirement benefits. A two-tier structure
applies. The base tier is $25,000 for unmarried individuals and
$32,000 for married couples filing joint returns, and zero for
married persons filing separate returns who do not live apart
at all times during the taxable year. The amount of benefits
includable in income is the lesser of 50 percent of the Social
Security and tier 1 railroad retirement benefits or 50 percent
of the excess of the taxpayer's combined income over the base
amount.
The second tier applies to taxpayers with modified adjusted
gross income of at least $34,000 (unmarried taxpayers) or
$44,000 (married taxpayers filing joint returns). For these
taxpayers, the amount of benefits includable in gross income is
the lesser of 85 percent of Social Security benefits or the sum
of 85 percent of the amount by which modified adjusted gross
income exceeds the second-tier thresholds, and the smaller of
the amount included under prior law or $4,500 (unmarried
taxpayers) or $6,000 (married taxpayers filing jointly). The
portion of tier 1 railroad retirement benefits potentially
includable in taxable income under the above formula is the
amount of benefits the taxpayer would have received if covered
under Social Security. Pursuant to section 72(r) of the
Internal Revenue Code of 1986, all other benefits payable under
the Railroad Retirement System are includable in income when
received to the extent they exceed employee contributions.
Effect of Provision
About 23 percent of all Social Security recipients pay
taxes on their benefits. This percentage is likely to increase
over time because the thresholds are not adjusted annually for
past inflation or other factors.
EXCLUSION OF EMPLOYER CONTRIBUTION FOR MEDICAL INSURANCE PREMIUMS AND
MEDICAL CARE
Legislative History
In 1943, the Internal Revenue Service (IRS) ruled that
employer contributions to group health insurance policies were
not taxable to the employee. Employer contributions to
individual health insurance policies, however, were declared to
be taxable income in an IRS revenue ruling in 1953.
Section 106 of the Internal Revenue Code, enacted in 1954,
reversed the 1953 IRS ruling. As a result, employer
contributions to all accident or health plans generally are
excluded from gross income and therefore are not subject to
tax. Under section 105 of the Internal Revenue Code, benefits
received under an employer's accident or health plan generally
are not included in the employee's income.
In the Revenue Act of 1978, Congress added section 105(h)
to tax the benefits payable to highly compensated employees
under a self-insured medical reimbursement plan if the plan
discriminated in favor of highly compensated employees.
Explanation of Provision
Gross income of an employee generally excludes employer-
provided coverage under an accident or health plan. The
exclusion applies to coverage provided to former employees,
their spouses, or dependents. Amounts excluded include those
received by an employee for personal injuries or sickness if
the amounts are paid directly or indirectly to reimburse the
employee for expenses incurred for medical care. However, this
exclusion does not apply in the case of amounts paid to a
highly compensated individual under a self-insured medical
reimbursement plan if the plan violates the nondiscrimination
rules of section 105(h).
Present law permits employers to prefund medical benefits
for retirees. Postretirement medical benefits may be prefunded
by the employer in two basic ways: (1) through a separate
account in a tax-qualified pension plan (sec. 401(h)); or (2)
through a welfare benefit fund (secs. 419 and 419A). Generally,
the amounts contributed are excluded from the income of the
plan or participants. Although amounts held in a section 401(h)
account are accorded tax-favored treatment similar to assets
held in a pension trust, the benefits provided under a section
401(h) account are required to be incidental to the retirement
benefits provided by the plan. Amounts contributed to welfare
benefit funds are subject to certain deduction limitations
(secs. 419 and 419A). In addition, the fund is subject to
income tax relating to any set-aside to provide postretirement
medical benefits.
Effect of Provision
The exclusion for employer-provided health coverage
provides an incentive for compensation to be furnished to the
employee in the form of health coverage, rather than in cash
subject to current taxation. For example, an employer designing
a compensation package for an employee would be indifferent
between paying the employee one dollar in cash and purchasing
one dollar's worth of health insurance for the employee.\4\ On
the other hand, because the employee is likely to pay Federal
and State income taxes and payroll taxes on cash compensation
and no tax on health insurance contributions made on his
behalf, the employee would likely prefer that some compensation
be in the form of health insurance. Employees subject to tax at
the highest marginal tax rates have the greatest incentive to
receive compensation in nontaxable forms.
---------------------------------------------------------------------------
\4\ To the extent the employer bears a portion of the payroll tax,
the employer may actually prefer to provide compensation through health
insurance (which is not subject to payroll tax).
---------------------------------------------------------------------------
The tax preference that the exclusion provides is
substantial and has resulted in widespread access to health
coverage. A majority of the population now receives health
insurance as a consequence of their own employment or of a
family member's employment. In 1996, for 58 percent of the
population, employment-based health insurance was the primary
source of health coverage, while 5 percent purchased insurance
privately, 13 percent received Medicare benefits, and 9 percent
received Medicaid benefits. According to a special analysis of
data from the Current Population Survey conducted by the CBO,
15 percent of the population had no health insurance.
Health coverage through employer-based plans tends to be
more prevalent in the finance, government, manufacturing, and
mining sectors of the economy, among medium and large firms,
for more highly paid workers, and among those over age 30 (see
table 13-9).
MEDICAL SAVINGS ACCOUNTS
The Health Insurance Portability and Accountability Act of
1996 included provisions for medical savings accounts (MSAs),
effective for years beginning after December 31, 1996. Within
limits, contributions to an MSA are deductible if made by an
eligible individual and are excludable from income and
employment taxes if made by the employer (other than
contributions made through a cafeteria plan). Earnings on
amounts in an MSA are not currently taxable. Distributions from
an MSA for medical expenses are not includable in gross income.
Distributions from an MSA that are not for medical expenses are
includable in gross income and are subject to an additional tax
of 15 percent, unless the distribution is made after death,
disability, or age 65.
Beginning in 1997, MSAs are available to employees covered
under an employer-sponsored high deductible health plan of a
small employer and to self-employed individuals covered under a
high deductible health plan (regardless of the size of the
entity for which the self-employed individual performs
services). A small employer is defined as an employer with 50
or fewer employees.
In order to be eligible for an MSA contribution, an
otherwise eligible individual must be covered under a high
deductible health plan and no other health plan. A high
deductible health plan is a plan with an annual deductible of
at least $1,500 and no more than $2,250 in the case of
individual coverage (and at least $3,000 and no more than
$4,500 in the case of family coverage). The dollar limits are
indexed for inflation. High deductible plans must also meet
certain limits on out-of-pocket expenses.
The number of taxpayers benefiting annually from an MSA
contribution is limited to a threshold level (generally,
750,000 taxpayers). If it is determined in a year that the
threshold level has been exceeded (called a cutoff year), then,
in general, for succeeding years during the 4-year pilot period
1997-2000, only those individuals who (1) made an MSA
contribution or had an employer MSA contribution for the year
or a preceding year (i.e., are active MSA participants) or (2)
are employed by a participating employer, would be eligible for
an MSA contribution. In determining whether the threshold for
any year has been exceeded, MSAs of previously uninsured
individuals are not taken into account.
After December 31, 2000, no new contributions may be made
to MSAs except by or on behalf of an individual who previously
had MSA contributions and employees who are employed by a
participating employer. Self-employed individuals who made
contributions to an MSA during the period 1997-2000 also may
continue to make contributions after 2000.
TABLE 13-9.--PRIMARY SOURCE OF HEALTH INSURANCE FOR WORKERS UNDER AGE 65 BY DEMOGRAPHIC CATEGORY, MARCH 1996
----------------------------------------------------------------------------------------------------------------
Percentage distribution by source of insurance
Number of -----------------------------------------------
Category workers Own or
(millions) other Individual Public No
employer policy insurance \1\ insurance
----------------------------------------------------------------------------------------------------------------
Industry:
Agriculture..................................... 3.0 45.4 15.5 3.6 35.5
Construction.................................... 8.0 61.2 6.8 2.0 29.9
Finance......................................... 7.8 83.6 5.0 1.4 10.1
Government...................................... 5.6 92.3 1.8 0.8 5.1
Manufacturing................................... 20.4 82.9 2.2 1.6 13.3
Mining.......................................... 0.6 81.8 3.1 2.0 13.1
Retail trade.................................... 18.0 63.3 5.4 4.7 26.7
Services:
Professional................................ 28.6 83.0 4.5 1.9 10.7
Other....................................... 13.9 61.7 7.4 4.1 26.8
Transportation.................................. 8.5 81.9 3.2 1.4 13.5
Wholesale trade................................. 4.7 78.6 4.8 1.4 15.2
Wage rate \2\:
Below $5.00..................................... 5.4 50.2 4.5 6.8 38.5
$5.00-$9.99..................................... 39.1 68.7 3.8 3.6 24.0
$10.00-$14.99................................... 25.8 85.6 3.1 0.8 10.5
$15.00 or more.................................. 29.6 92.9 1.8 0.1 5.2
Family income as percentage of poverty level:
Under 100....................................... 8.9 25.6 5.0 20.1 49.2
100-199......................................... 19.4 52.6 5.9 5.9 35.6
200-299......................................... 22.3 72.3 5.5 1.9 20.3
300 or more..................................... 75.4 86.5 4.4 0.5 8.6
Firm size (number of employees):
Fewer than 10................................... 25.2 51.0 14.1 4.0 30.9
10-24........................................... 11.7 63.7 5.7 3.5 27.0
25-99........................................... 16.1 74.0 3.1 3.2 19.8
100-499......................................... 17.6 81.2 2.0 2.5 14.4
500-999......................................... 7.5 82.9 2.4 2.6 12.1
1,000 or more................................... 48.0 85.8 1.8 2.4 9.9
Age (years):
Under 30........................................ 31.1 62.9 3.9 5.7 27.5
30-39........................................... 37.5 75.4 4.1 2.8 17.7
40-49........................................... 33.3 80.0 4.9 1.8 13.2
50-64........................................... 24.1 80.4 7.0 1.2 11.3
-----------------------------------------------------------
All workers................................. 126.0 74.5 4.9 3.0 17.7
----------------------------------------------------------------------------------------------------------------
\1\ Public insurance includes Medicaid, Medicare, and coverage provided by the Department of Veterans Affairs.
\2\ Wage is the hourly wage for hourly employees and earnings per week divided by hours worked for nonhourly
employees. The figures exclude individuals for whom an hourly wage could not be determined.
Source: Congressional Budget Office estimates based on the March 1994 Current Population Survey.
CAFETERIA PLANS
Legislative History
Under present law, compensation generally is includable in
gross income when received. An exception applies if an employee
may choose between cash and certain employer-provided
nontaxable benefits under a cafeteria plan.
Prior to 1978, ERISA provided that an employer contribution
made before January 1, 1977 to a cafeteria plan in existence on
June 27, 1974, had to be included in an employee's gross income
only to the extent that the employee actually elected taxable
benefits. If a plan did not exist on June 27, 1974, the
employer contribution was to be included in income to the
extent the employee could have elected taxable benefits. The
Revenue Act of 1978 set up permanent rules for plans that offer
an election between taxable and nontaxable benefits.
The Deficit Reduction Act of 1984 (Public Law 98-369)
clarified the types of employer-provided benefits that could be
provided through a cafeteria plan, added a 25-percent
concentration test, and required annual reporting to the IRS by
employers.
The Tax Reform Act of 1986 also modified the rules relating
to cafeteria plans in several respects.
Explanation of Provision
A participant in a cafeteria plan (sec. 125) is not treated
as having received taxable income solely because the
participant had the opportunity to elect to receive cash or
certain nontaxable benefits. In order to meet the requirements
of section 125, the plan must be in writing, must include only
employees (including former employees) as participants, and
must satisfy certain nondiscrimination requirements.
In general, a nontaxable benefit may be provided through a
cafeteria plan if the benefit is excludable from the
participant's gross income by reason of a specific provision of
the Code. These include employer-provided health coverage,
group-term life insurance coverage, and benefits under
dependent care assistance programs. A cafeteria plan may not
provide qualified scholarships or tuition reduction,
educational assistance, miscellaneous employer-provided fringe
benefits, or deferred compensation except through a qualified
cash or deferred arrangement.
If the plan discriminates in favor of highly compensated
individuals regarding eligibility to participate, to make
contributions, or to receive benefits under the plan, then the
exclusion does not apply. For purposes of these
nondiscrimination requirements, a highly compensated individual
is an officer, a shareholder owning more than 5 percent of the
employing firm, a highly compensated individual determined
under the facts and circumstances of the case, or a spouse or
dependent of the above individuals.
Effect of Provision
The optimal compensation of employees (in a tax planning
sense) would require that employers and employees arrive at the
compensation package that provides the largest aftertax benefit
to the employee at minimum aftertax cost to the employer (see
Scholes & Wolfson, 1992, chapter 10). Both the potential
taxation of compensation provided to employees and the
deductibility of compensation provided by the employer would be
considered. If only income taxes were considered, employers
would be indifferent between the payment of $1 in salary or
wages and the payment of $1 in fringe benefits to an employee,
because both types of compensation are fully deductible. When
the employer payments for FICA and FUTA taxes are considered,
however, the employer might actually find it less costly to
compensate an employee with a dollar's worth of fringe benefit
not subject to FICA and FUTA taxes rather than a dollar of wage
or salary payments that are subject to these taxes.
The employee, however, would prefer to be compensated in
the form that provides the highest aftertax value. An
additional dollar of salary or wage paid to the employee will
be subject to tax. If a fringe benefit is excludable from the
employee's income, the employee pays no tax on receipt of the
benefit. Consequently, the employee receives greater
compensation via the fringe benefit. This differential
treatment of salary or wage payments and excludable fringe
benefits implies that compensation packages designed to
minimize the joint tax liability of employers and employees
could include substantial amounts of excludable fringe
benefits.
Employees may have different preferences about the
allocation of their compensation. For example, an employee with
no dependents may place little value on employer-provided life
insurance. Cafeteria plans permit employees some discretion as
to the provided benefits, and will tend to be preferred to
benefit plans in which all employees of the firm receive the
identical benefit package.
Cafeteria plans are a growing part of compensation plans,
particularly for larger employers. The Bureau of Labor
Statistics estimated that in 1995, 55 percent of employees at
large- and medium-sized firms were eligible for some type of
cafeteria plan. This figure has grown from an estimated 5
percent in 1986 (U.S. Bureau of Labor Statistics, 1993).
Smaller firms generally do not offer cafeteria plans to their
workers. For example, in 1994, only 19 percent of the workers
in small, private establishments (nonfarm establishments with
fewer than 100 employees) were eligible to participate in a
cafeteria plan (U.S. Bureau of Labor Statistics, 1994). The
lower figure for smaller firms reflects in part the less
generous fringe benefit packages provided by smaller firms.
Like any income exclusion, the exclusion from gross income
for cafeteria plan benefits can lead to disparities in the tax
system. Employees with the same total compensation can have
taxable incomes that are substantially different because of the
form in which compensation is received. The exclusion for
cafeteria plan benefits also may be used in some cases to avoid
the 7.5 percent of AGI floor on deductible medical expenses.
The use of cafeteria plans reduces the aftertax cost of health
care to employees using these plans, which could cause these
employees to purchase a larger amount of health care services.
On the other hand, cafeteria plans could encourage employers to
increase the share of premiums, copayments, and deductibles
paid by employees, resulting in increased employee awareness of
the costs of their health plans. This incentive could result in
reduced health care costs.
HEALTH CARE CONTINUATION RULES
Legislative History
The Consolidated Omnibus Budget Reconciliation Act of 1985
added sections 106(b), 162(i)(2), and 162(k) to the Internal
Revenue Code under which certain group health plans are
required to offer health coverage to certain employees and
former employees, as well as to their spouses and dependents.
Parallel requirements were added to title I of ERISA and the
Public Health Services Act. If an employer failed to satisfy
the health care continuation rules, the employer was denied a
deduction for contributions to its group health plans and
highly compensated employees were required to include in
taxable income the employer-provided value of the coverage
received under such plans.
The Technical and Miscellaneous Revenue Act of 1988 made
several changes to the health care continuation rules. Sections
106(b), 162(i)(2), and 162(k) were repealed and replaced by
section 4980B. Section 4980B imposes an excise tax on the
employer or other responsible party who fails to satisfy the
rules instead of denying deductions and the exclusion. The
Health Insurance Portability and Accountability Act of 1996
made some changes to the health care continuation rules in
cases of disability.
Explanation of Provision
The health care continuation rules in section 4980B require
that an employer provide qualified beneficiaries with the
opportunity to participate for a specified period in the
employer's health plan after that participation otherwise would
have terminated. If the employee elects such continuation
coverage, the employee may be required to pay for the coverage.
The amount the employee can be required to pay is subject to
certain limits.
The qualifying events that may trigger rights to
continuation coverage are: (1) the death of the employee; (2)
the voluntary or involuntary termination of the employee's
employment (other than by reason of gross misconduct); (3) a
reduction of the employee's hours; (4) the divorce or legal
separation of the employee; (5) the employee becoming entitled
to benefits under Medicare; and (6) a dependent child of the
employee ceasing to be a dependent under the employer's plan.
The maximum period of continuation coverage is 36 months,
except in the case of termination of employment or reduction of
hours for which the maximum period is 18 months. The 18-month
period is extended to 29 months in certain cases involving the
disability of the qualified beneficiary. Certain events, such
as the failure by the qualified beneficiary to pay the required
premium, may trigger an earlier cessation of the continuation
coverage.
A beneficiary has a prescribed period of time during which
to elect continuation coverage after the employee receives
notice from the plan administrator of the right to continuation
coverage.
GROUP HEALTH PLAN REQUIREMENTS
The Health Insurance Portability and Accountability Act of
1996 imposes certain requirements regarding health coverage
portability through limitations on preexisting condition
exclusions, prohibitions on excluding individuals from coverage
based on health status, and guaranteed renewability of health
insurance coverage. An excise tax is imposed with respect to
failures of a group health plan to comply with the
requirements. The tax is usually imposed on the employer
sponsoring the plan. The amount of the tax is generally equal
to $100 per day for each day during which the failure occurs
until the failure is corrected. The maximum tax that can be
imposed is the lesser of 10 percent of the employer's payments
during the taxable year in which the failure occurred under
group health plans or $500,000. The Secretary of the Treasury
may waive all or part of the tax to the extent that payment of
the tax would be excessive relative to the failure involved
(see discussion of health care continuation rules).
TAX BENEFITS FOR ACCELERATED DEATH BENEFITS AND LONG-TERM CARE
INSURANCE
Legislative History
Accelerated death benefits
If a contract meets the definition of a life insurance
contract, gross income does not include insurance proceeds that
are paid pursuant to the contract by reason of the death of the
insured (sec. 101(a)). In addition, the undistributed
investment income (inside buildup) earned on premiums credited
under the contract is not subject to current taxation to the
owner of the contract. The exclusion under section 101 applies
regardless of whether the death benefits are paid as a lump sum
or otherwise.
If a contract fails to be treated as a life insurance
contract under section 7702(a), inside buildup on the contract
is generally subject to tax (sec. 7702(g)).
To qualify as a life insurance contract for Federal income
tax purposes, a contract must be a life insurance contract
under the applicable State or foreign law and must satisfy
either of two alternative tests: (1) a cash value accumulation
test, or (2) a test consisting of a guideline premium
requirement and a cash value corridor requirement (sec.
7702(a)). A contract satisfies the cash value accumulation test
if the cash surrender value of the contract may not at any time
exceed the net single premium that would have to be paid at
such time to fund future benefits under the contract. A
contract satisfies the guideline premium and cash value
corridor tests if the premiums paid under the contract do not
at any time exceed the greater of the guideline single premium
or the sum of the guideline level premiums, and if the death
benefit under the contract is not less than a varying statutory
percentage of the cash surrender value of the contract.
Long-term care insurance
Prior to the Health Insurance Portability and
Accountability Act of 1996, tax law generally did not provide
explicit rules relating to the tax treatment of long-term care
insurance contracts or long-term care services. Thus, the
treatment of long-term care contracts and services was unclear.
Prior and present law provide rules relating to medical
expenses and accident or health insurance.
Amounts received by a taxpayer under accident or health
insurance for personal injuries or sickness generally are
excluded from gross income to the extent that the amounts
received are not attributable to medical expenses that were
allowed as a deduction for a prior taxable year (sec. 104).
Explanation of Provision
Accelerated death benefits
The Health Insurance Portability and Accountability Act of
1996 provides an exclusion from gross income as an amount paid
by reason of the death of an insured for amounts received under
a life insurance contract and for amounts received for the sale
or assignment of a life insurance contract to a qualified
viatical settlement provider, provided that the insured under
the life insurance contract is either terminally ill or
chronically ill.
The exclusion does not apply in the case of an amount paid
to any taxpayer other than the insured, if such taxpayer has an
insurable interest by reason of the insured being a director,
officer, or employee of the taxpayer, or by reason of the
insured being financially interested in any trade or business
carried on by the taxpayer.
A terminally ill individual is defined as one who has been
certified by a physician as having an illness or physical
condition that reasonably can be expected to result in death
within 24 months of the date of certification.
A chronically ill individual has the same meaning as
provided under the long-term care rules (see below). In the
case of a chronically ill individual, the exclusion with
respect to amounts paid under a life insurance contract and
amounts paid in a sale or assignment to a viatical settlement
provider applies if the payment received is for costs incurred
by the payee (not compensated by insurance or otherwise) for
qualified long-term care services for the insured person for
the period, and two other requirements (similar to requirements
applicable to long-term care insurance contracts) are met.
The first requirement is that under the terms of the
contract giving rise to the payment, the payment is not a
payment or reimbursement of expenses reimbursable under
Medicare (except where Medicare is a secondary payor under the
arrangement, or the arrangement provides for per diem or other
periodic payments without regard to expenses for qualified
long-term care services). No provision of law shall be
construed or applied so as to prohibit the offering of such a
contract giving rise to such a payment on the basis that the
contract coordinates its payments with those provided under
Medicare. The second requirement is that the arrangement
complies with the consumer protection provisions applicable to
long-term care insurance contracts and issuers that are
specified in Treasury regulations.
Long-term care insurance
Exclusion of long-term care insurance proceeds.--The Health
Insurance Portability and Accountability Act of 1996 provides
that a long-term care insurance contract generally is treated
as an accident and health insurance contract. Amounts (other
than policyholder dividends or premium refunds) received under
a long-term care insurance contract generally are excludable as
amounts received for personal injuries and sickness, subject to
a dollar cap on aggregate payments under per diem contracts. A
reporting requirement applies to payors of excludable amounts.
The amount of the dollar cap on aggregate payments under
per diem contracts with respect to any one chronically ill
individual (who is not also terminally ill) is $175 per day
($63,875 annually) as indexed, reduced by the amount of
reimbursements and payments received by anyone for the cost of
qualified long-term care services for the chronically ill
individual. If more than one payee receives payments with
respect to any one chronically ill individual, then everyone
receiving periodic payments with respect to the same insured is
treated as one person for purposes of the dollar cap. The
amount of the dollar cap is used first by the chronically ill
person, and any remaining amount is to be allocated in
accordance with Treasury regulations. If payments under such
contracts exceed the dollar cap, then the excess is excludable
only to the extent of actual costs (in excess of the dollar
cap) incurred for long-term care services. Amounts in excess of
the dollar cap, with respect to which no actual costs were
incurred for long-term care services, are fully includable in
income without regard to rules relating to return of basis
under section 72. A grandfather rule applies to any per diem-
type contract issued to a policyholder on or before July 31,
1996.
Exclusion for employer-provided long-term care coverage.--A
plan of an employer providing coverage under a long-term care
insurance contract generally is treated as an accident and
health plan. Thus, employer-provided long-term care coverage is
generally excludable from income and wages and deductible by
the employer. Employer-provided coverage under a long-term care
insurance contract is not, however, excludable by an employee
if provided through a cafeteria plan; similarly, expenses for
long-term care services cannot be reimbursed under a flexible
spending arrangement.
Definition of long-term care insurance contract.--A long-
term care insurance contract is defined as any insurance
contract that provides only coverage of qualified long-term
care services and that meets other requirements. The other
requirements are that: (1) the contract is guaranteed
renewable; (2) the contract does not provide for a cash
surrender value or other money that can be paid, assigned,
pledged or borrowed; (3) refunds (other than refunds on the
death of the insured or complete surrender or cancellation of
the contract) and dividends under the contract may be used only
to reduce future premiums or increase future benefits; and (4)
the contract generally does not pay or reimburse expenses
reimbursable under Medicare (except where Medicare is a
secondary payor, or the contract makes per diem or other
periodic payments without regard to expenses).
A contract does not fail to be treated as a long-term care
insurance contract solely because it provides for payments on a
per diem or other periodic basis without regard to expenses
incurred during the period.
Medicare duplication rules.--No provision of law may be
applied to prohibit the offering of a long-term care insurance
contract on the basis that the contract coordinates its
benefits with those provided under Medicare.
Definition of qualified long-term care services.--Qualified
long-term care services means necessary diagnostic, preventive,
therapeutic, curing, treating, mitigating and rehabilitative
services, and maintenance or personal care services that are
required by a chronically ill individual and that are provided
pursuant to a plan of care prescribed by a licensed health care
practitioner.
Chronically ill individual.--A chronically ill individual
is one who has been certified within the previous 12 months by
a licensed health care practitioner as: (1) being unable to
perform (without substantial assistance) at least two
activities of daily living for at least 90 days due to a loss
of functional capacity; (2) having a similar level of
disability as determined by the Secretary of the Treasury in
consultation with the Secretary of Health and Human Services;
or (3) requiring substantial supervision to protect such
individual from threats to health and safety due to severe
cognitive impairment. Activities of daily living are eating,
toileting, transferring, bathing, dressing and continence. For
purposes of determining whether an individual is chronically
ill, the number of activities of daily living that are taken
into account under the long-term care insurance contract may
not be less than five.
Expenses for long-term care services treated as medical
expenses.--Unreimbursed expenses for qualified long-term care
services provided to the taxpayer or the taxpayer's spouse or
dependents are treated as medical expenses for purposes of the
itemized deduction for medical expenses (subject to the
present-law floor of 7.5 percent of adjusted gross income). For
this purpose, amounts received under a long-term care insurance
contract (regardless of whether the contract reimburses
expenses or pays benefits on a per diem or other periodic
basis) are treated as reimbursement for expenses actually
incurred for medical care.
For purposes of the deduction for medical expenses,
qualified long-term care services do not include services
provided to an individual by a relative or spouse (directly, or
through a partnership, corporation, or other entity), unless
the relative is a licensed professional with respect to such
services, or by a related corporation (within the meaning of
Code section 267(b) or 707(b)).
Long-term care insurance premiums treated as medical
expenses.--Long-term care insurance premiums that do not exceed
specified dollar limits are treated as medical expenses for
purposes of the itemized deduction for medical expenses.
Consumer protection provisions.--Certain consumer
protection provisions apply with respect to the terms of a
long-term care insurance contract, for purposes of determining
whether the contract is a qualified long-term care insurance
contract. In addition, certain consumer protection provisions
apply to issuers of long-term care insurance contracts.
DEDUCTION FOR HEALTH INSURANCE EXPENSES OF SELF-EMPLOYED INDIVIDUALS
Self-employed individuals may currently deduct 40 percent
of their health insurance expenses for themselves and their
spouses and dependents. The deduction also applies to certain
long-term care premiums treated as medical expenses. Under the
Taxpayer Relief Act of 1997, the deduction for health insurance
of self-employed individuals will increase as follows: the
deduction will be 45 percent in 1998 and 1999; 50 percent in
2000 and 2001; 60 percent in 2002; 80 percent in 2003-5; 90
percent in 2006; and 100 percent in 2007 and thereafter.
EXCLUSION OF MEDICARE BENEFITS
Legislative History
The exclusion from income of Medicare benefits has never
been expressly established by statute. A 1970 IRS ruling, Rev.
Rul. 70-341, 1970-2 C.B. 31, provided that the benefits under
part A of Medicare are not includable in gross income because
they are disbursements made to further the social welfare
objectives of the Federal Government. The Internal Revenue
Service relied on a similar ruling, Rev. Rul. 70-217, 1970-1
C.B. 13, with respect to the excludability of Social Security
disability insurance benefits in reaching this conclusion. (For
background on the exclusion of Social Security benefits, see
above section on pension contributions.) Rev. Rul. 70-341 also
held that benefits under part B of Medicare are excludable as
amounts received through accident and health insurance (though
the subsidized portion of part B also may be excluded under the
same theory applicable to the exclusion of part A benefits).
Explanation of Provision
Benefits under part A and part B of Medicare are excludable
from the gross income of the recipient. In general, part A pays
for certain inpatient hospital care, skilled nursing facility
care, home health care, and hospice care for eligible
individuals (generally the elderly and the disabled). Part B
covers certain services of a physician and other medical
services for elderly or disabled individuals who elect to pay
the required premium.
DEDUCTIBILITY OF MEDICAL EXPENSES
Legislative History
An itemized deduction for unreimbursed medical expenses
above a specified floor has been allowed since 1942. From 1954
through 1982, the floor under the medical expense deduction was
3 percent of the taxpayer's adjusted gross income (AGI); a
separate floor of 1 percent of AGI applied to expenditures for
medicine and drugs.
In the Tax Equity and Fiscal Responsibility Act of 1982
(TEFRA), the floor was increased to 5 percent of AGI (effective
for 1983 and thereafter) and was applied to the total of all
eligible medical expenses, including prescription drugs and
insulin. TEFRA made nonprescription drugs ineligible for the
deduction and eliminated the separate floor for drug costs.
The Tax Reform Act of 1986 increased the floor under the
medical expense deduction to 7.5 percent of AGI, beginning in
1987.
Explanation of Provision
Individuals who itemize deductions may deduct amounts they
pay during the taxable year, if not reimbursed by insurance or
otherwise, for medical care of the taxpayer and of the
taxpayer's spouse and dependents, to the extent that the total
of such expenses exceeds 7.5 percent of AGI (sec. 213).
Medical care expenses eligible include: (1) health
insurance (including aftertax employee contributions to
employer health plans); (2) diagnosis, treatment, or prevention
of disease, or for the purpose of affecting any structure or
function of the body; (3) transportation primarily for and
essential to medical care; (4) lodging away from home primarily
for and essential to medical care, up to $50 per night; and (5)
prescription drugs and insulin.
Expenses paid for the general improvement of health, such
as fees for exercise programs, are not eligible for the
deduction unless prescribed by a physician to treat a specific
illness. A deduction is not allowed for cosmetic surgery or
similar procedures that do not meaningfully promote the proper
function of the body or treat disease. However, such expenses
are deductible if the cosmetic procedure is necessary to
correct a deformity arising from a congenital abnormality, an
injury resulting from an accident, or disfiguring disease.
Medical expenses are not subject to the general limitation
on itemized deductions applicable to taxpayers with adjusted
gross incomes above a certain limit ($121,200 for 1997 and
adjusted annually for inflation).
Effect of Provision
The Tax Code allows taxpayers to claim an itemized
deduction if unreimbursed medical expenses absorb a substantial
portion of income and thus adversely affect the taxpayer's
ability to pay taxes. In order to limit the deduction to
extraordinary expenses, medical expenses are deductible only to
the extent that they exceed 7.5 percent of the taxpayer's AGI.
Table 13-10 shows the effect on medical expense deductions
of the increases in the floor on medical deductions. In the
absence of those increases, one would have expected the number
of taxpayers claiming the deduction to have increased because
of inflation of medical costs. However, increasing the floor
should reduce the number of taxpayers claiming the deduction
because many taxpayers with relatively modest expenses no
longer qualify. The average deduction in excess of the 7.5
percent of AGI floor has increased substantially, from $769 in
1980 to $5,039 in 1995. Both increases in the floor (to 5
percent in 1983 and to 7.5 percent in 1987) substantially
reduced the number of taxpayers claiming deductions.
Taxpayers in higher tax rate brackets receive more of a
benefit from each dollar of deductible medical expense than do
taxpayers in lower tax rate brackets. However, because the
floor automatically rises with a taxpayer's income, higher
income taxpayers are able to deduct a smaller amount (if any)
of medical expenses above their floor than are low-income
taxpayers incurring the same aggregate amount of medical
expenses.
TABLE 13-10.--TAX RETURNS CLAIMING DEDUCTIBLE MEDICAL AND DENTAL EXPENSES, 1980-95
----------------------------------------------------------------------------------------------------------------
Returns claiming medical and dental
expenses in excess of the AGI floor
Total --------------------------------------
number of Expenses in
Year returns Number of excess of Average
filed (in returns the AGI amount over
millions) (in floor (in the floor
millions) billions)
----------------------------------------------------------------------------------------------------------------
1980........................................................ 93.9 19.5 $15.0 $769
1981........................................................ 95.4 21.4 17.9 836
1982........................................................ 95.3 22.0 21.7 986
1983........................................................ 96.3 9.7 18.1 1,859
1984........................................................ 99.4 10.7 21.5 2,009
1985........................................................ 101.7 10.8 22.9 2,127
1986........................................................ 103.0 10.5 25.1 2,382
1987........................................................ 107.0 5.4 17.2 3,202
1988........................................................ 110.1 4.8 18.0 3,741
1989........................................................ 112.1 5.1 20.9 4,079
1990........................................................ 113.7 5.1 21.5 4,215
1991........................................................ 114.7 5.3 23.7 4,444
1992........................................................ 113.6 5.5 25.7 4,675
1993........................................................ 114.6 5.5 26.5 4,829
1994........................................................ 115.9 5.2 26.4 5,044
1995........................................................ 118.2 5.4 27.0 5,039
----------------------------------------------------------------------------------------------------------------
Source: Internal Revenue Service.
In 1995, approximately 5,351,000 taxpayers claimed itemized
medical expenses in excess of the medical deductions floor (7.5
percent of adjusted gross income). Of that number, 79 percent
had incomes of less than $50,000 (see table 13-11). However,
taxpayers with incomes over $50,000 received far more than half
of the total tax savings attributable to medical expense
deductions.
TABLE 13-11.--DISTRIBUTION OF ITEMIZED DEDUCTIONS FOR MEDICAL EXPENSES,
1995
------------------------------------------------------------------------
Average Returns Total amount
Income class (thousands) \1\ deduction (thousands) (billions) \2\
------------------------------------------------------------------------
0-$10......................... $5,819 471 $2.7
$10-$20....................... 5,736 1,140 6.5
$20-$30....................... 3,799 1,035 3.9
$30-$40....................... 4,015 888 3.6
$40-$50....................... 4,086 679 2.8
$50-$75....................... 4,992 790 3.9
$75-$100...................... 7,146 220 1.6
$100-$200..................... 12,038 114 1.4
$200 and over................. 38,442 13 0.5
-----------------------------------------
Total.................... 5,039 5,351 27.0
------------------------------------------------------------------------
\1\ The income concept is defined in the introduction to this chapter.
\2\ Amounts in excess of the floor on itemized medical deductions (7.5
percent of adjusted gross income).
Source: Internal Revenue Service.
EARNED INCOME CREDIT
Legislative History
The earned income credit (EIC Code sec. 32), enacted in
1975, generally equals a specified percentage of wages up to a
maximum dollar amount. The maximum amount applies over a
certain income range and then diminishes to zero over a
specified phaseout range. The income ranges and percentages
have been revised several times since original enactment,
expanding the credit (see table 13-12).
In 1987, the credit was indexed for inflation. In 1990 and
again in 1993, Congress enacted substantial expansions of the
credit. Auxiliary credits were added for very young children
and for health insurance premiums paid on behalf of a
qualifying child in 1990. These were repealed in 1993. Also in
1993, eligibility for the credit was expanded to include
childless workers. The Personal Responsibility and Work
Opportunity Reconciliation Act of 1996 incorporated new rules
relating to taxpayer identification numbers and the modified
AGI phaseout of the credit in addition to amending the credit's
unearned income test (described below). The Taxpayer Relief Act
of 1997 also included provisions to improve compliance. The
provisions: (1) deny the EIC for 10 years to taxpayers who
fraudulently claimed the EIC, 2 years for EIC claims which are
a result of reckless or intentional disregard of rules or
regulations); (2) require EIC recertification for a taxpayer
who is denied the EIC; (3) imposes due diligence requirements
on paid preparers of returns involving the EIC; (4) requires
information sharing between the Treasury Department and State
and local governments regarding child support orders; and (5)
allows expanded use of Social Security Administration records
to enforce the tax laws, including the EIC. The Balanced Budget
Act of 1997 also increased the IRS authorization to improve
enforcement of the EIC.
TABLE 13-12.--EARNED INCOME CREDIT PARAMETERS, 1975-97
[Dollar amounts unadjusted for inflation]
----------------------------------------------------------------------------------------------------------------
Mininum Phaseout range
Credit income Phaseout -------------------
Calendar year rate for Maximum rate
(percent) maximum credit (percent) Beginning Ending
credit income income
----------------------------------------------------------------------------------------------------------------
1975-78............................................. 10.00 $4,000 $400 10.00 $4,000 $8,000
1979-84............................................. 10.00 5,000 500 12.50 6,000 10,000
1985-86............................................. 14.00 5,000 550 12.22 6,500 11,000
1987................................................ 14.00 6,080 851 10.00 6,920 15,432
1988................................................ 14.00 6,240 874 10.00 9,840 18,576
1989................................................ 14.00 6,500 910 10.00 10,240 19,340
1990................................................ 14.00 6,810 953 10.00 10,730 20,264
1991:
One child......................................... 16.70 7,140 1,192 11.93 11,250 21,250
Two children...................................... 17.30 7,140 1,235 12.36 11,250 21,250
1992:
One child......................................... 17.60 7,520 1,324 12.57 11,840 22,370
Two children...................................... 18.40 7,520 1,384 13.14 11,840 22,370
1993:
One child......................................... 18.50 7,750 1,434 13.21 12,200 23,050
Two children...................................... 19.50 7,750 1,511 13.93 12,200 23,050
1994:
No children....................................... 7.65 4,000 306 7.65 5,000 9,000
One child......................................... 26.30 7,750 2,038 15.98 11,000 23,755
Two children...................................... 30.00 8,425 2,528 17.68 11,000 25,296
1995:
No children....................................... 7.65 4,100 314 7.65 5,130 9,230
One child......................................... 34.00 6,160 2,094 15.98 11,290 24,396
Two children...................................... 36.00 8,640 3,110 20.22 11,290 26,673
1996:
No children....................................... 7.65 4,220 323 7.65 5,280 9,500
One child......................................... 34.00 6,330 2,152 15.98 11,610 25,078
Two children...................................... 40.00 8,890 3,556 21.06 11,610 28,495
1997:
No children....................................... 7.65 4,340 332 7.65 5,430 9,770
One child......................................... 34.00 6,500 2,210 15.98 11,930 25,750
Two children...................................... 40.00 9,140 3,656 21.06 11,930 29,290
----------------------------------------------------------------------------------------------------------------
Source: Joint Committee on Taxation.
Explanation of Provision
The EIC is available to low-income working taxpayers.
Three separate schedules apply.
Taxpayers with one qualifying child may claim a credit in
1997 of 34 percent of their earnings up to $6,500, resulting in
a maximum credit of $2,210. The maximum credit is available for
those with earnings between $6,500 and $11,930. At $11,930 of
earnings the credit begins to phase down at a rate of 15.98
percent of earnings above $11,930. The credit is phased down to
0 at $25,750 of earnings.
Taxpayers with more than one qualifying child may claim a
credit in 1997 of 40 percent of earnings up to $9,140,
resulting in a maximum credit of $3,656. The maximum credit is
available for those with earnings between $9,140 and $11,930.
At $11,930 of earnings the credit begins to phase down at a
rate of 21.06 percent of earnings above $11,930. The credit is
phased down to $0 at $29,290 of earnings.
Taxpayers with no qualifying children may claim a credit
if they are over age 24 and below age 65. The credit is 7.65
percent of earnings up to $4,340, resulting in a maximum credit
of $332. The maximum is available for those with incomes
between $4,340 and $5,430. At $5,430 of earnings, the credit
begins to phase down at a rate of 7.65 percent of earnings
above that amount, resulting in a $0 credit at $9,770.
All income thresholds are indexed for inflation annually.
In order to be a qualifying child, an individual must satisfy a
relationship test, a residency test, and an age test. The
relationship test requires that the individual be a child,
stepchild, a descendant of a child, or a foster or adopted
child of the taxpayer. The residency test requires that the
individual have the same place of abode as the taxpayer for
more than half the taxable year. The household must be located
in the United States. The age test requires that the individual
be under 19 (24 for a full-time student) or be permanently and
totally disabled.
An individual is not eligible for the earned income credit
if the aggregate amount of disqualified income of the taxpayer
for the taxable year exceeds $2,200. This threshold is indexed.
Disqualified income is the sum of:
1. Interest (taxable and tax exempt),
2. Dividends,
3. Net rent and royalty income (if greater than zero),
4. Capital gains net income, and
5. Net passive income (if greater than zero) that is not self-
employment income.
For taxpayers with earned income (or modified AGI, if
greater) in excess of the beginning of the phaseout range, the
maximum earned income credit amount is reduced by the phaseout
rate multiplied by the amount of earned income (or modified
AGI, if greater) in excess of the beginning of the phaseout
range. For taxpayers with earned income (or modified AGI, if
greater) in excess of the end of the phaseout range, no credit
is allowed.
The definition of modified AGI used for phasing out the
earned income credit disregards certain losses. The losses
disregarded are:
1. Net capital losses (if greater than zero),
2. Net losses from trusts and estates,
3. Net losses from nonbusiness rents and royalties, and
4. Seventy-five percent of the net losses from businesses,
computed separately with respect to sole
proprietorships (other than in farming), sole
proprietorships in farming, and other businesses.
The definition of modified AGI also includes tax-exempt
interest and nontaxable distributions from pensions, annuities,
and individual retirement accounts (but only if not called over
into similar vehicles during the applicable rollover period).
Individuals are ineligible for the credit if they do not
include their taxpayer identification number and their
qualifying child's number (and, if married, their spouse's
taxpayer identification number) on their tax return. Solely for
these purposes and for purposes of the present-law
identification test for a qualifying child, a taxpayer
identification number is defined as a Social Security number
issued to an individual by the Social Security Administration
other than a number issued under section 205(c)(2)(B)(i)(II)
(or that portion of sec. 205(c)(2)(B)(i)(III) relating to it)
of the Social Security Act regarding the issuance of a number
to an individual applying for or receiving federally funded
benefits.
If an individual fails to provide a correct taxpayer
identification number, such omission will be treated as a
mathematical or clerical error by the Internal Revenue Service.
Similarly, if an individual who claims the credit with respect
to net earnings from self-employment fails to pay the proper
amount of self-employment tax on such net earnings, the failure
will be treated as a mathematical or clerical error for
purposes of the amount of credit allowed.
The EIC is relatively unique because it is a refundable
tax credit; i.e., if the amount of the credit exceeds the
taxpayer's Federal income tax liability, the excess is payable
to the taxpayer as a direct transfer payment. In this sense,
the EIC is like other Federal programs that provide poor and
low-income families with public benefits. However, the EIC
differs from other Federal programs in that its benefits
require earnings.
Under an advance payment system, available since 1979,
eligible taxpayers may elect to receive the credit in their
paychecks, rather than waiting to claim a refund on their tax
return filed by April 15 of the following year. In 1993,
Congress required that the IRS begin to notify eligible
taxpayers of the advance payment option.
Interaction with Means-Tested Programs
The treatment of the EIC for purposes of AFDC and food
stamp benefit computations has varied since inception of the
credit. When enacted in 1975, the credit was not considered
income in determining AFDC and food stamp benefits, and the
credit could not be received on an advance basis. From January
1979 through September 1981, the credit was treated as earned
income when actually received.
From October 1981 to September 1984, the amount of the
credit was treated as earned income and was imputed to the
family even though it may not have been received as an advance
payment. Pursuant to the Deficit Reduction Act of 1984, the
credit was treated as earned income only when received, either
as an advance payment or as a refund after the conclusion of
the year.
Under the Family Support Act of 1988, States generally were
required to disregard any advance payment or refund of the EIC
when calculating AFDC eligibility or benefits. However, the
credit was counted against the gross income eligibility
standard (185 percent of the State need standard) for both
applicants and recipients.
OBRA 1990 specified that, effective January 1, 1991, the
EIC was not to be taken into account as income (for the month
in which the payment is received or any following month) or as
a resource (for the month in which the payment is received or
the following month) for determining the eligibility or amount
of benefit for AFDC, Medicaid, SSI, food stamps, or low-income
housing programs.
Effect of Provision
More than 18.5 million taxpayers are expected to take
advantage of the EIC in 1997 (see table 13-13). Their claims
are expected to total $26.8 billion, 81 percent of which will
be refunded as direct payments to these families. As table 13-
13 also shows, approximately 69 percent of the tax relief or
direct spending from the EIC accrues to taxpayers who file as
singles or heads of households.
Table 13-14 shows the total amount of earned income credit
received for each of the calendar years since the inception of
the program, the number of recipient families, the amount of
the credit received as refunded payments, and the average
amount of credit received per family.
EXCLUSION OF PUBLIC ASSISTANCE AND SSI BENEFITS
Legislative History
While there is no specific statutory authorization, a
number of revenue rulings under Code section 61 have held that
specific types of public assistance payments are excludable
from gross income. Revenue rulings generally exclude government
transfer payments from income because they are considered to be
general welfare payments. In addition, taxing benefits provided
in kind, rather than in cash, would require valuation of these
benefits, which could create administrative difficulties.
Explanation of Provision
The Federal Government provides tax-free public assistance
benefits to individuals either by cash payments or by provision
of certain goods and services at reduced cost or free of
charge. Cash payments come mainly from the Aid to Families with
Dependent Children (AFDC) and Supplemental Security Income
(SSI) Programs. Inkind payments include food stamps, Medicaid,
and housing assistance. None of these payments is subject to
income tax.
DEPENDENT CARE TAX CREDIT
Legislative History
Under section 21 of the Internal Revenue Code, taxpayers
are allowed an income tax credit for certain employment-related
expenses for dependent care. The Internal Revenue Code of 1954
provided a deduction to gainfully employed women, widowers, and
legally separated or divorced men for certain employment-
related dependent care expenses. The deduction was limited to
$600 per year and phased out for families with incomes between
$4,500 and $5,100.
The Revenue Act of 1964 made husbands with incapacitated
wives eligible for the dependent care deduction and raised the
threshold for the income phaseout from $4,500 to $6,000.
TABLE 13-13.--DISTRIBUTION OF TAX PROVISIONS: EARNED INCOME CREDIT, 1997
----------------------------------------------------------------------------------------------------------------
Joint returns Head of household and All returns
-------------------------- single returns -------------------------
Income class --------------------------
Number Amount Number Amount Number Amount
----------------------------------------------------------------------------------------------------------------
$0-$10,000........................ 681 $924 4,495 $4,816 5,175 $5,740
$10,000-$20,000................... 1,615 3,592 4,824 9,270 6,439 12,862
$20,000-$30,000................... 2,038 2,873 3,067 3,900 5,106 6,773
$30,000-$40,000................... 920 711 730 602 1,650 1,313
$40,000-$50,000................... 112 93 18 18 130 111
$50,000-$75,000................... 29 35 5 12 33 47
$75,000 and over.................. 0 0 0 0 0 0
-----------------------------------------------------------------------------
Total....................... 5,394 8,229 13,139 18,618 18,534 26,847
-----------------------------------------------------------------------------
Percent distribution by type of
return........................... 29.1 30.7 70.9 69.3 100.0 100.0
----------------------------------------------------------------------------------------------------------------
Note.--Number of returns in thousands; amount of credit in millions.
Source: Joint Committee on Taxation.
TABLE 13-14.--EARNED INCOME CREDIT: NUMBER OF RECIPIENTS AND AMOUNT OF CREDIT, 1975-2000
----------------------------------------------------------------------------------------------------------------
Number of Total Refunded
recipient amount of portions of Average
Year families credit credit credit per
(thousands) (millions) (millions) family
----------------------------------------------------------------------------------------------------------------
1975........................................................ 6,215 $1,250 $900 $201
1976........................................................ 6,473 1,295 890 200
1977........................................................ 5,627 1,127 880 200
1978........................................................ 5,192 1,048 801 202
1979........................................................ 7,135 2,052 1,395 288
1980........................................................ 6,954 1,986 1,370 286
1981........................................................ 6,717 1,912 1,278 285
1982........................................................ 6,395 1,775 1,222 278
1983........................................................ 7,368 1,795 1,289 224
1984........................................................ 6,376 1,638 1,162 257
1985........................................................ 7,432 2,088 1,499 281
1986........................................................ 7,156 2,009 1,479 281
1987........................................................ 8,738 3,391 2,930 450
1988........................................................ 11,148 5,896 4,257 529
1989........................................................ 11,696 6,595 4,636 564
1990........................................................ 12,542 7,542 5,266 601
1991........................................................ 13,665 11,105 8,183 813
1992........................................................ 14,097 13,028 9,959 924
1993........................................................ 15,117 15,537 12,028 1,028
1994 \1\.................................................... 19,017 21,105 16,598 1,110
1995 \2\.................................................... 19,335 25,956 20,829 1,342
1996 \2\.................................................... 18,525 25,935 20,826 1,400
1997 \2\.................................................... 18,652 26,919 21,684 1,443
1998 \2\.................................................... 18,788 27,677 22,452 1,473
1999 \2\.................................................... 18,954 28,728 23,416 1,516
2000 \2\.................................................... 19,212 29,921 24,380 1,557
----------------------------------------------------------------------------------------------------------------
\1\ Preliminary.
\2\ Projected.
Source: For 1975-94, Internal Revenue Service; for 1995-2000, Joint Committee on Taxation.
The Revenue Act of 1971: (1) made any individual who
maintained a household and was gainfully employed eligible for
the deduction; (2) modified the definition of a dependent; (3)
raised the deduction limit to $4,800 per year; (4) increased
from $6,000 to $18,000 the income level at which the deduction
began to phase out; (5) allowed the deduction for household
services in addition to direct dependent care; and (6) limited
the deduction with respect to services outside the taxpayer's
household.
The Tax Reduction Act of 1975 increased from $18,000 to
$35,000 the income level at which the deduction began to be
phased out.
The Tax Reform Act of 1976 replaced the deduction with a
nonrefundable credit. This change broadened eligibility to
those who do not itemize deductions and provided relatively
greater benefit to low-income taxpayers. In addition, the act
eased the rules related to family status and simplified the
computation.
In the Economic Recovery Tax Act of 1981, Congress provided
a higher ceiling on creditable expenses, a larger credit for
low-income individuals, and modified rules relating to care
provided outside the home.
The Family Support Act of 1988 reduced to 13 the age of a
child for whom the dependent care credit may be claimed,
reduced the amount of eligible expenses by the amount of
expenses excludable from that taxpayer's income under the
dependent care exclusion, lowered from 5 to 2 the age at which
a taxpayer identification number had to be submitted for
children for whom the credit was claimed, and disallowed the
credit unless the taxpayer reports on her tax return the
correct name, address, and taxpayer identification number
(generally, an employer identification number or a Social
Security number) of the dependent care provider.
The Small Business Protection Act of 1996 required a TIN
for all children for whom a dependent care credit may be
claimed.
Explanation of Provision
A taxpayer may claim a nonrefundable credit against income
tax liability for up to 30 percent of a limited amount of
employment-related dependent care expenses. Eligible
employment-related expenses are limited to $2,400 if there is
one qualifying dependent or $4,800 if there are two or more
qualifying dependents. Generally, a qualifying individual is a
dependent under the age of 13 or a physically or mentally
incapacitated dependent or spouse.
Employment-related dependent care expenses are expenses for
the care of a qualifying individual incurred to enable the
taxpayer to be gainfully employed, other than expenses incurred
for an overnight camp. For example, amounts paid for the
services of a housekeeper generally qualify if such services
are performed at least partly for the benefit of a qualifying
individual; amounts paid for a chauffeur or gardener do not
qualify.
Expenses that may be taken into account in computing the
credit generally may not exceed an individual's earned income
or, in the case of married taxpayers, the earned income of the
spouse with the lesser earnings. Thus, if one spouse is not
working, no credit generally is allowed. Also, the amount of
expenses eligible for the dependent care credit is reduced,
dollar for dollar, by the amount of expenses excludable from
that taxpayer's income under the dependent care exclusion
(discussed below).
The 30-percent credit rate is reduced, but not below 20
percent, by 1 percentage point for each $2,000 (or fraction
thereof) of adjusted gross income (AGI) above $10,000. Because
married couples are required to file a joint return to claim
the credit, a married couple's combined AGI is used for
purposes of this computation.
Effect of Provision
From 1976 to 1994, the number of families that claimed the
dependent care credit increased from 2.7 to 6.0 million, the
aggregate amount of credits claimed increased from $0.5 to $2.5
billion, and the average amount of credit claimed per family
increased from $206 to $420 (see table 13-15). In 1997, 6.1
million families are expected to claim an average credit of
$448, for a total of $2.7 billion.
TABLE 13-15.--DEPENDENT CARE TAX CREDIT: NUMBER OF FAMILIES AND AMOUNT
OF CREDIT, 1976-98
------------------------------------------------------------------------
Number of
returns Aggregate Average
claiming amount of credit
Year dependent credit claimed per
credit claimed return
(thousands) (millions)
------------------------------------------------------------------------
1976............................. 2,660 $548 $206
1977............................. 2,910 521 179
1978............................. 3,431 654 191
1979............................. 3,833 793 207
1980............................. 4,231 956 226
1981............................. 4,578 1,148 251
1982............................. 5,004 1,501 300
1983............................. 6,367 2,051 322
1984............................. 7,456 2,649 351
1985............................. 8,417 3,127 372
1986............................. 8,950 3,398 380
1987............................. 8,520 3,438 404
1988............................. 9,023 3,813 423
1989............................. 6,028 2,440 405
1990............................. 6,144 2,549 415
1991............................. 5,896 2,521 427
1992............................. 5,980 2,527 433
1993............................. 6,090 2,559 419
1994............................. 6,012 2,526 420
1995............................. 5,964 2,518 445
1996............................. 6,003 2,663 444
1997 \1\......................... 6,063 2,714 448
1998 \2\......................... 6,124 2,770 452
------------------------------------------------------------------------
\1\ Preliminary.
\2\ Projected.
Source: Joint Committee on Taxation.
Changes made in the Family Support Act of 1988 reduced the
use of the credit in 1989. The number of families who claimed
the credit dropped by about one-third and the amount of credit
claimed declined by $1.373 billion.
Data for 1995 from the Internal Revenue Service show that
about 13 percent of the benefit from the credit accrues to
families with AGI of less than $20,000; about 47 percent to
families with AGI between $20,000 and $50,000; and about 40
percent to families with AGI above $50,000.
HOPE CREDIT AND LIFETIME LEARNING CREDIT
The Taxpayer Relief Act of 1997 established the HOPE credit
and the lifetime learning credit as nonrefundable credits
against Federal income tax liability for qualified tuition and
fees required for the attendance of an eligible student at an
eligible educational institution.
The HOPE credit rate is 100 percent of the first $1,000 of
qualified tuition and fees per eligible student per year, and
50 percent of the next $1,000 of qualified tuition and fees per
eligible student per year. The HOPE credit is available only
for the first 2 years of postsecondary education. The qualified
tuition and fees must be incurred on behalf of the taxpayer,
the taxpayer's spouse, or a dependent. Charges and fees
associated with meals, lodging, books, student activities,
athletics, insurance, transportation, and similar personal,
living, or family expenses are not eligible for the credit. An
eligible student for purposes of the HOPE credit is a student
enrolled in a degree, certificate, or other program on at least
a half-time basis. Eligible educational institutions are
defined by reference to section 481 of the Higher Education Act
of 1965. Such institutions generally are accredited
postsecondary educational institutions offering credit toward a
bachelor's degree, an associate's degree, or another recognized
postsecondary credential. Certain proprietary institutions and
postsecondary vocational institutions are also eligible
educational institutions. The HOPE credit is effective for
expenses paid after December 31, 1997, for education furnished
in academic periods beginning after such date. For taxable
years beginning after 2001, the $1,500 maximum HOPE credit
amount will be indexed for inflation.
The lifetime learning credit rate is 20 percent of up to
$5,000 in qualified tuition and fees for a maximum credit of
$1,000. For expenses paid after December 31, 2002, up to
$10,000 in qualified tuition and fees will be eligible for the
20-percent credit, for a maximum credit of $2,000. In contrast
to the HOPE credit, the lifetime learning credit is available
for an unlimited number of years of education. Also in contrast
to the HOPE credit, which requires a half-time or greater
enrollment status, the lifetime learning credit is available
with respect to any course of instruction at an eligible
educational institution to acquire or improve job skills,
regardless of enrollment status. Qualified tuition and fees are
defined in the same manner as under the HOPE credit provisions.
As with the HOPE credit, eligible students are the taxpayer,
the taxpayer's spouse, or a dependent. In contrast to the HOPE
credit, the maximum amount of the lifetime learning credit that
may be claimed on a taxpayer's return will not vary with the
number of students in the taxpayer's family. The lifetime
learning credit is effective for expenses paid after June 30,
1998, for education furnished in academic periods beginning
after such date. The maximum lifetime learning credit amount is
not indexed for inflation.
Eligibility for the HOPE credit and the lifetime learning
credit is phased out ratably for taxpayers with modified AGI
between $40,000 and $50,000 ($80,000 and $100,000 for joint
returns). These phaseout ranges are indexed for inflation for
taxable years beginning after 2001. For a taxable year, a
taxpayer may elect with respect to an eligible student either
the HOPE credit, the lifetime learning credit, or the exclusion
from gross income for certain distributions from an education
IRA. For purposes of both the HOPE credit and the lifetime
learning credit, if a parent claims a child as a dependent,
then only the parent may claim the credit.
QUALIFIED STATE TUITION PROGRAMS AND EDUCATION IRAs
The Taxpayer Relief Act of 1997 modified section 529 of
the Tax Code, which governs the tax treatment of qualified
State tuition programs. Section 529 was enacted as part of the
Small Business Job Protection Act of 1996, and provides tax-
exempt status and deferral of tax on earnings of qualified
State tuition programs. The Taxpayer Relief Act of 1997 also
provides that taxpayers may establish education IRAs.
Qualified State tuition programs are programs established
and maintained by a State under which persons may: (1) purchase
tuition credits on behalf of a designated beneficiary that
entitle the beneficiary to a waiver or payment of qualified
higher education expenses of the beneficiary; or (2) make
contributions to an account that is established for the purpose
of meeting qualified higher education expense of a designated
beneficiary. Qualified higher education expenses are defined as
tuition, fees, books, supplies, and equipment required for the
enrollment of or attendance at a college or university (or
certain vocational schools). The Taxpayer Relief Act of 1997
expanded the definition of qualified expenses to include room
and board expenses. Contributions to State tuition programs are
not deductible. Earnings on qualified State tuition programs
are includable in income only when ultimately distributed.
Distributions from a qualified State tuition program also
entitle the distributee to claim either the HOPE or the
lifetime learning credit with respect to education expenses
paid with such distributions, assuming the other requirements
for claiming the HOPE credit or the lifetime learning credit
are satisfied. There are no income limits for participation in
qualified State tuition programs, though contributions must be
limited by the program to amounts no greater than an amount
necessary to provide for the education of the beneficiary. The
program must also impose a more than de minimis penalty on
earnings not used for qualified expenses.
An education IRA is a trust or custodial account created
exclusively for the purpose of paying qualified higher
education expenses of a named beneficiary. Contributions to an
education IRA are not deductible; earnings on contributions are
not currently includable in income. Contributions to education
IRAs are limited to $500 per year per beneficiary. However, no
contribution may be made by any person to an education IRA
established on behalf of a beneficiary during any taxable year
in which any contributions are made by anyone to a qualified
State tuition program on behalf of the same beneficiary. The
contribution limit is phased out ratably for contributors with
modified AGI between $95,000 and $110,000 ($150,000 and
$160,000 for joint returns). Qualified expenses are the same as
those for the qualified State tuition programs, with the
exception that room and board expenses are qualified expenses
only if the student is enrolled on at least a half-time basis.
Withdrawals of earnings from education IRAs are excludable from
income provided that such withdrawals are used to pay for
qualified higher education expenses. If the earnings are not
used for qualified expenses, they are includable in income and
are also subject to an additional 10-percent penalty tax. A
taxpayer may not simultaneously claim an exclusion from income
for distributions from an education IRA and claim either the
HOPE credit or the lifetime learning credit.
STUDENT LOAN INTEREST DEDUCTION
The Taxpayer Relief Act of 1997 provided for the above-
the-line deductibility of interest on qualified education
loans. The deduction is allowed only with respect to interest
paid during the first 60 months in which interest payments are
required. A qualified education loan is generally defined as
any indebtedness incurred to pay for the qualified higher
education expenses of the taxpayer, the taxpayer's spouse, or
any dependent of the taxpayer as of the time the indebtedness
was incurred in attending either postsecondary educational
institutions and certain vocational schools defined by
reference to section 481 of the Higher Education Act of 1965,
or institutions conducting internship or residency programs
leading to a degree or certificate from an institution of
higher education, a hospital, or a health care facility
conducting postgraduate training. Qualified higher education
expenses are defined as the student's cost of attendance as
defined in section 472 of the Higher Education Act of 1965
(generally, tuition, fees, room and board, and related
expenses), reduced by: (1) any amount excluded under section
135 (i.e., U.S. saving bonds used to pay higher education
tuition and fees); (2) any amount distributed from an education
IRA and excluded from gross income; and (3) the amount of any
scholarship or fellowship grants excludable from gross income
under section 117, as well as any other tax-free education
benefits, such as employer-provided educational assistance that
is excludable from the employee's gross income under section
127.
The maximum deduction is phased in gradually, with a
$1,000 maximum in 1998, $1,500 in 1999, $2,000 in 2000, and
$2,500 in 2001. The maximum deduction is not indexed for
inflation, and the deduction is phased out ratably for
individual taxpayers with modified AGI of $40,000-$55,000
($60,000-$75,000 for joint returns). These income ranges will
be indexed for inflation occurring after the year 2002, and
rounded down to the closest multiple of $5,000. This provision
is effective for interest payments due and paid after December
31, 1997, on any qualified education loan.
EXCLUSION FOR EMPLOYER-PROVIDED DEPENDENT CARE
Legislative History
The value of certain employer-provided dependent care is
excluded from the employee's gross income. The Economic
Recovery Tax Act of 1981 added this exclusion (sec. 129) and
amended Code sections 3121(a)(18) and 3306(b)(13) to exclude
such employer-provided dependent care from wages for purposes
of the Federal Insurance Contributions Act (FICA) and the
Federal Unemployment Tax Act (FUTA). The Tax Reform Act of 1986
modified the nondiscrimination rules and limited the exclusion
to $5,000 a year ($2,500 in the case of a separate return by a
married individual). The Family Support Act of 1988 required
the amount of employer-provided dependent care excluded from
the taxpayer's income to reduce, dollar for dollar, the amount
of expenses eligible for the dependent care tax credit.
Explanation of Provision
Amounts paid or incurred by an employer for dependent care
assistance provided to an employee generally are excluded from
the employee's gross income if the assistance is furnished
under a program meeting certain requirements. These
requirements include that the program be described in writing,
satisfy certain nondiscrimination rules, and provide for
notification to all eligible employees. The type of dependent
care eligible for the exclusion is the same as the type
eligible for the dependent care credit.
The dependent care exclusion is limited to $5,000 per year
except that a married taxpayer filing a separate return may
exclude only $2,500. Amounts excluded from gross income
generally are excludable from wages for employment tax
purposes. Dependent care expenses excluded from income are not
eligible for the dependent care tax credit.
Effect of Provision
The exclusion provides an incentive to taxpayers with
expenses for dependent care to seek compensation in the form of
dependent care assistance rather than in cash subject to
taxation. This incentive is of greater value to employees in
higher tax brackets.
Many employees covered by the exclusion for employer-
provided dependent care also are eligible to use the dependent
care tax credit. While the limitations on the exclusion and the
credit differ, the credit generally is less valuable than the
exclusion for taxpayers who are above the 15-percent tax
bracket.
According to a survey of private firms with 100 or more
workers conducted by the U.S. Bureau of Labor Statistics
(1993), nearly one-tenth of full-time workers at these firms
were eligible for child care benefits provided by the employer
in the form of on-site or near-site child care facilities or
through direct reimbursement of employee expenses. A more
prevalent form of providing dependent care benefits is through
reimbursement accounts, which may cover other nontaxable fringe
benefits, such as out-of-pocket health care expenses, in
addition to dependent care. Slightly over one-third of full-
time employees at large- and medium-sized firms were eligible
for such accounts in 1991.
WORK OPPORTUNITY TAX CREDIT
The work opportunity tax credit is available on an elective
basis for employers hiring individuals from one or more of
eight targeted groups. The targeted groups are: (1) families
eligible to receive benefits under the Title IV-A Temporary
Assistance for Needy Families Program (TANF; the successor to
the Aid to Families with Dependent Children Program); (2)
qualified ex-felons; (3) vocational rehabilitation referrals;
(4) qualified summer youth employees; (5) qualified veterans;
(6) youths who reside in an empowerment zone or enterprise
community; (7) families receiving food stamps; and (8) persons
receiving certain Supplemental Security Income (SSI) benefits.
The credit generally is equal to 40 percent (25 percent for
employment of 400 hours or less) of qualified wages. Qualified
wages consist of wages attributable to service rendered by a
member of a targeted group during the 1-year period beginning
with the day the individual begins work for the employer. For a
vocational rehabilitation referral, however, the period will
begin on the day the individual begins work for the employer on
or after the beginning of the individual's vocational
rehabilitation plan as under prior law.
Generally, no more than $6,000 of wages during the first
year of employment is permitted to be taken into account with
respect to any individual. Thus, the maximum credit per
individual is $2,400. With respect to qualified summer youth
employees, the maximum credit is 40 percent of up to $3,000 of
qualified first-year wages, for a maximum credit of $1,200.
In general, an individual is not to be treated as a member
of a targeted group unless: (1) on or before the day the
individual begins work for the employer, the employer received
in writing a certification from the designated local agency
that the individual is a member of a specific targeted group;
or (2) on or before the day the individual is offered work with
the employer, a prescreening notice is completed with respect
to that individual by the employer and within 21 days after the
individual begins work for the employer, the employer submits
such notice, signed by the employer and the individual under
penalties of perjury, to the designated local agency as part of
a written request for certification. The prescreening notice
will contain the information provided to the employer by the
individual that forms the basis of the employer's belief that
the individual is a member of a targeted group.
No credit is allowed for wages paid unless the eligible
individual is employed by the employer for at least 120 hours.
The credit percentage is 25 percent for employment of 400 hours
or less, assuming that the minimum employment period is
satisfied with respect to that employee. For employment of more
than 400 hours, the credit percentage is 40 percent.
The credit is effective for wages paid or incurred to a
qualified individual who begins work for an employer after
September 30, 1996, and before July 1, 1998.
WELFARE-TO-WORK TAX CREDIT
The Code provides to employers a tax credit on the first
$20,000 of eligible wages paid to qualified long-term family
assistance (TANF) recipients during the first 2 years of
employment. The credit is 35 percent of the first $10,000 of
eligible wages in the first year of employment and 50 percent
of the first $10,000 of eligible wages in the second year of
employment. The maximum credit is $8,500 per qualified
employee.
Qualified long-term family assistance recipients are: (1)
members of a family that has received TANF benefits for at
least 18 consecutive months ending on the hiring date; (2)
members of a family that has received TANF benefits for a total
of at least 18 months (whether or not consecutive) after the
date of enactment of this credit if they are hired within 2
years after the date that the 18-month total is reached; and
(3) members of a family who are no longer eligible for TANF
because of either Federal or State time limits, if they are
hired within 2 years after the Federal or State time limits
made the family ineligible for family assistance.
Eligible wages include cash wages paid to an employee plus
amounts paid by the employer for the following: (1) educational
assistance excludable under a section 127 program (or that
would be excludable but for the expiration of sec. 127); (2)
health plan coverage for the employee, but not more than the
applicable premium defined under section 4980B(f)(4); and (3)
dependent care assistance excludable under section 129.
The welfare to work credit is effective for wages paid or
incurred to a qualified individual who begins work for an
employer on or after January 1, 1998 and before May 1, 1999.
EXCLUSION OF WORKERS' COMPENSATION AND SPECIAL BENEFITS FOR DISABLED
COAL MINERS
Legislative History
Workers' compensation benefits generally are not taxable
under section 104(a)(1) of the Internal Revenue Code of 1986.
Workers' compensation benefits are treated as Social Security
benefits to the extent that they reduce Social Security
benefits received (see above). This exclusion from gross income
was first codified in the Revenue Act of 1918. The Ways and
Means Committee report for that act suggests that such payments
were not subject to tax even prior to the 1918 act.
Payments made to coal miners or their survivors for death
or disability resulting from pneumoconiosis (black lung
disease) under the Federal Coal Mine Health and Safety Act of
1969 (as amended) are excluded from gross income. Payments made
as a result of claims filed before December 31, 1972 originally
were excluded from Federal income tax by the Federal Coal Mine
Health and Safety Act of 1969. Later payments are excluded from
gross income because they are considered to be in the nature of
workers' compensation (Rev. Rul. 72-400, 1972-2 C.B. 75).
Explanation of Provision
Gross income does not include amounts received as workers'
compensation for personal injuries or sickness. This exclusion
also applies to benefits paid under a workers' compensation act
to a survivor of a deceased employee.
Benefits for disabled coal miners (black lung benefits) are
not includable in gross income.
There are two types of black lung programs. The first
involves Federal payments to coal miners and their survivors
due to death or disability, payable for claims filed before
July 1, 1973 (December 31, 1973, in the case of survivors).
This program provided total annual payments of around $672
million to approximately 143,000 beneficiaries in December 1995
(Social Security Administration, 1996).
The second program requires coal mine operators to ensure
payment of black lung benefits for claims filed on or after
July 1, 1973 (December 31, 1973, in the case of survivors) in a
federally mandated workers' compensation program. Benefits
include medical treatment as well as cash payments. These
benefits are paid from a trust fund financed by an excise tax
on coal production if there is no responsible operator (an
operator for whom the miner worked for at least 1 year) or if
the responsible operator is in default. This program provided
total annual payments of around $610 million to approximately
156,550 claimants in 1986 (U.S. Department of Labor, 1989,
tables 3 & 6).
ADDITIONAL STANDARD DEDUCTION FOR THE ELDERLY AND BLIND
Legislative History
From 1954 through 1986, an additional personal exemption
was allowed for a taxpayer or a spouse who was 65 years or
older at the close of the year. An additional personal
exemption also was allowed for a taxpayer or a spouse who was
blind.
The Tax Reform Act of 1986 repealed the additional personal
exemption for the elderly and blind and replaced it with an
additional standard deduction amount. These additional standard
deduction amounts are adjusted for inflation.
Explanation of Provision
The additional standard deduction amount for the elderly or
the blind is $800 in 1997 for an elderly or a blind individual
who is married (whether filing jointly or separately) or is a
surviving spouse, and $1,600 for such an individual who is both
elderly and blind. The additional amount is $1,000 for a head
of household who is elderly or blind ($2,000, if both), and for
a single individual (i.e., an unmarried individual other than a
surviving spouse or head of household) who is elderly or blind.
The definitions of elderly and blind status have not been
changed since 1954. An elderly person is an individual who is
at least 65 years of age. Blindness is defined in terms of the
ability to correct a deficiency in distance vision or the
breadth of the area of vision. An individual is blind only if
central vision acuity is not better than 20/200 in the better
eye with correcting lenses, or if visual acuity is better than
20/200 but is accompanied by a limitation in the fields of
vision such that the widest diameter of the visual field
subtends an angle no greater than 20 degrees.
Effect of Provision
The additional standard deduction increases the tax
threshold for elderly and blind taxpayers. For example, the
additional amount is $1,600 for two elderly individuals filing
a joint return, raising the tax threshold in 1997 from $12,200
to $13,800.
In 1995, about 10.8 million taxpayers claimed the extra
standard deduction. About 85 percent of the 10.8 million
beneficiaries had incomes of less than $40,000.
TAX CREDIT FOR THE ELDERLY AND CERTAIN DISABLED INDIVIDUALS
Legislative History
The present tax credit for individuals who are age 65 or
over, or who have retired on permanent and total disability,
was enacted in the Social Security Amendments of 1983 (Code
sec. 22). This credit replaced the previous credit for the
elderly, which had been enacted in the Tax Reform Act of 1976.
Prior to that provision, the tax law provided a retirement
income credit, which initially was enacted in the Internal
Revenue Code of 1954.
Explanation of Provision
Individuals who are age 65 or older may claim a
nonrefundable income tax credit equal to 15 percent of a base
amount. The credit also is available to an individual,
regardless of age, who is retired on disability and who was
permanently and totally disabled at retirement. For this
purpose, an individual is considered permanently and totally
disabled if he is unable to engage in any substantial gainful
activity by reason of any medically determinable physical or
mental impairment that can be expected to result in death, or
that has lasted or can be expected to last for a continuous
period of not less than 12 months. The individual must furnish
proof of disability to the IRS.
The maximum base amount for the credit is $5,000 for
unmarried elderly or disabled individuals and for married
couples filing a joint return if only one spouse is eligible;
$7,500 for married couples filing a joint return with both
spouses eligible; or $3,750 for married couples filing separate
returns. For a nonelderly, disabled individual the initial base
amount is the lesser of the applicable specified amount or the
individual's disability income for the year. Consequently, the
maximum credit available is $750 (15 percent of $5,000), $1,125
(15 percent of $7,500), or $562.50 (15 percent of $3,750).
The maximum base amount is reduced by the amount of certain
nontaxable income of the taxpayer, such as nontaxable pension
and annuity income or nontaxable Social Security, railroad
retirement, or veterans' nonservice-related disability
benefits. In addition, the base amount is reduced by one-half
of the taxpayer's AGI in excess of certain limits: $7,500 for a
single individual, $10,000 for married taxpayers filing a joint
return, or $5,000 for married taxpayers filing separate
returns. These computational rules reflect that the credit is
designed to provide tax benefits to individuals who receive
only taxable retirement or disability income, or who receive a
combination of taxable retirement or disability income plus
Social Security benefits that generally are comparable to the
tax benefits provided to individuals who receive only Social
Security benefits (including Social Security disability
benefits).
Effect of Provision
In 1995, $48 million in elderly and disabled credit was
claimed. Though the number of families claiming the credit has
fallen significantly, the average credit granted has been
relatively stable since the credit was modified by the Social
Security Amendments of 1983, as shown in table 13-16.
TABLE 13-16.--CREDIT FOR THE ELDERLY AND DISABLED, 1976-96
------------------------------------------------------------------------
Number of
families Total
that amount of Average
Year received credit credit per
credit (millions) return
(thousands)
------------------------------------------------------------------------
1976............................. 1,011 $206 $204
1977............................. 569 93 163
1978............................. 689 145 210
1979............................. 607 132 217
1980............................. 562 135 240
1981............................. 474 124 262
1982............................. 483 131 271
1983............................. 423 116 275
1984............................. 475 107 225
1985............................. 460 106 230
1986............................. 430 86 200
1987............................. 354 67 189
1988............................. 357 69 193
1989............................. 320 65 202
1990............................. 342 63 183
1991............................. 285 57 200
1992............................. 240 51 213
1993............................. 223 49 220
1994............................. 222 47 210
1995 \1\......................... 252 48 191
1996 \2\......................... 193 40 206
------------------------------------------------------------------------
\1\ Preliminary.
\2\ Projected.
Source: Joint Committee on Taxation.
TAX PROVISIONS RELATED TO HOUSING
Owner-Occupied Housing
Legislative history
Deductibility of mortgage interest.--Prior to the Tax
Reform Act of 1986, all interest payments on indebtedness
incurred for personal use (e.g., to purchase consumption goods)
were deductible in computing taxable income. The 1986 act
amended section 163(h) of the Internal Revenue Code to disallow
deductions for all personal interest except for interest on
indebtedness secured by a first or second home.
In the Omnibus Budget Reconciliation Act of 1987, Congress
further restricted the deductibility of mortgage interest. Only
two classes of interest were distinguished as deductible:
interest on acquisition indebtedness and interest on home
equity indebtedness. Acquisition indebtedness, defined as
indebtedness secured by a residence and used to acquire or
improve the residence by which it is secured, was limited to
$1,000,000 ($500,000 in the case of a married individual filing
a separate return). Home equity indebtedness, defined as any
nonacquisition indebtedness secured by a residence (for
example, a home equity loan), was limited to the lesser of
$100,000 ($50,000 for married taxpayers filing separately) or
the excess of the fair market value of the residence over the
acquisition indebtedness.
Exclusion of capital gains for certain taxpayers.--In the
Revenue Act of 1964, Congress introduced section 121 of the
Internal Revenue Code of 1954, which permitted a one-time
exclusion of all or part of the gain on the sale of a principal
residence by older individuals. This exclusion was limited to
homeowners who had lived in the property as a principal
residence for 5 out of the last 8 years before the property's
sale or exchange. Furthermore, full exclusion was permitted
only for houses that sold for $20,000 or less.
The parameters of this exclusion have been modified and
expanded a number of times. Most recently, the Taxpayer Relief
Act of 1997 significantly expanded the exclusion (e.g., the age
55 requirement was repealed).
Explanation of provisions
Homeowners may deduct a number of expenses related to
housing as itemized deductions in computing taxable income.
These include payments of interest on qualified residence debt,
certain interest on home equity loans, certain payments of
points (i.e., up front interest payments) on the purchase of a
house, and payments of real property taxes. Interest on
acquisition debt of $1,000,000 or less is fully deductible, as
is any interest on debt secured by a residence that was
incurred on or before October 13, 1987. Interest on home equity
indebtedness of $100,000 is fully deductible for regular tax
purposes, as long as the total amount of debt (acquisition plus
home equity indebtedness) does not exceed the fair market value
of the house. Interest on home equity indebtedness exceeding
$100,000 (and incurred after October 13, 1987) or exceeding the
difference between the fair market value of the home and the
acquisition indebtedness is not deductible. Interest paid on
home equity loans is generally not deductible in computing the
alternative minimum tax.
Under present law, a taxpayer generally is able to exclude
up to $250,000 ($500,000 if married filing a joint return) of
gain realized on the sale or exchange of a principal residence.
The exclusion is allowed each time a taxpayer selling or
exchanging a principal residence meets the eligibility
requirements, but generally no more frequently than once every
2 years.
To be eligible for the exclusion, a taxpayer must have
owned the residence and occupied it as a principal residence
for at least 2 of the 5 years prior to the sale or exchange. A
taxpayer who fails to meet these requirements by reason of a
change of place of employment, health, or other unforeseen
circumstances is able to exclude the fraction of the $250,000
($500,000 if married filing a joint return) equal to the
fraction of 2 years that these requirements are met.
Effects of provisions
Preliminary tax return information for 1995 indicates that
28 million taxpayers claimed the deduction for mortgage
interest. Reliable data are not yet available on how many
claimed the one-time exclusion.
The favorable treatment of owner-occupied housing may
affect both the home ownership rate and the share of total
investment in housing in the United States.
The home ownership tax provisions may benefit neighborhoods
because they encourage home ownership and home improvement. The
United States has maintained a high rate of home ownership--65
percent of all American households own the homes they live in
(U.S. Bureau of the Census, 1995, p. 733, table 1225).
The tax advantages for owner-occupied housing encourage
people to invest in homes instead of taxable business
investments. This shift may reduce investment in business
assets in the United States. One study suggested that housing
capital is 25 percent higher and other capital is 12 percent
lower than it would be if tax policy provided equal treatment
for all forms of capital (Mills, 1987). Currently, about one-
third of net private investment goes into owner-occupied
housing, so even a modest shift of investment to other assets
could have sizable effects.
Low-Income Housing Credit
Legislative history
The low-income rental housing tax credit was first enacted
in the Tax Reform Act of 1986. The Omnibus Budget
Reconciliation Act of 1989 substantially modified the credit.
The Omnibus Budget Reconciliation Act of 1993 modified the
credit again and made it permanent.
Explanation of provision
A tax credit may be claimed by owners of residential rental
property used for low-income rental housing. The credit is
claimed annually, generally for a period of 10 years. New
construction and rehabilitation expenditures for low-income
housing projects are eligible for a maximum 70-percent present
value credit, claimed annually for 10 years. The acquisition
cost of existing projects that meet the substantial
rehabilitation requirements and the cost of newly constructed
projects receiving other Federal subsidies are eligible for a
maximum 30-percent present value credit, also claimed annually
for 10 years. These credit percentages are adjusted monthly
based on an Applicable Federal Rate.
The credit amount is based on the qualified basis of the
housing units serving the low-income tenants. A residential
rental project will qualify for the credit only if: (1) 20
percent or more of the aggregate residential rental units in
the project are occupied by individuals with 50 percent or less
of area median income; or (2) 40 percent or more of the
aggregate residential rental units in the project are occupied
by individuals with 60 percent or less of area median income.
These income figures are adjusted for family size. Maximum
rents that may be charged families in units on which a credit
is claimed depend on the number of bedrooms in the unit. The
rent limitation is 30 percent of the qualifying income of a
family deemed to have a size of 1.5 persons per bedroom (e.g.,
a two-bedroom unit has a rent limitation based on the
qualifying income for a family of three).
Credit eligibility also depends on the existence of a 30-
year extended low-income use agreement for the property. If
property on which a low-income housing credit is claimed ceases
to qualify as low-income rental housing or is disposed of
before the end of a 15-year credit compliance period, a portion
of the credit may be recaptured. The 30-year extended use
agreement creates a State law right to enforce low-income use
for an additional 15 years after the initial 15-year recapture
period.
In order for a building to be a qualified low-income
building, the building owner generally must receive a credit
allocation from the appropriate credit authority. An exception
is provided for property that is substantially financed with
the proceeds of tax-exempt bonds subject to the State's
private-activity bond volume limitation. The low-income housing
credit is allocated by State or local government authorities
subject to an annual limitation for each State based on State
population. The annual credit allocation per State is $1.25 per
resident.
Effect of provision
Comprehensive data from tax returns concerning the low-
income housing tax credit are unavailable. Table 13-17 presents
data from a survey of State credit allocating agencies. These
data indicate that annual allocation of available credit
authority generally has been 67 percent or greater. Year-to-
year variations in credit allocation probably reflect changes
in Federal law affecting the credit and changing economic
conditions affecting the construction and housing markets. For
example, 1990 was the first year following substantial
modification to the credit and included a temporary period
during which State credit allocating agencies were limited to
allocating authority of $0.9375 per capita rather than the
$1.25 per capita of present and prior law.
TABLE 13-17.--ALLOCATION OF THE LOW-INCOME HOUSING CREDIT, 1987-96
------------------------------------------------------------------------
Authority Allocated Allocated
Years (millions) (millions) (percent)
------------------------------------------------------------------------
1987............................. $313.1 $62.9 20.1
1988............................. 311.5 209.8 67.4
1989............................. 314.2 307.2 97.8
1990............................. 317.7 213.1 67.0
1991 \1\......................... 497.3 400.6 80.6
1992 \1\......................... 476.8 332.7 70.0
1993 \1\......................... 546.4 424.7 77.7
1994 \1\......................... 523.7 495.5 94.7
1995 \1\......................... 432.6 410.9 95.0
1996 \1\......................... 391.6 379.9 97.0
------------------------------------------------------------------------
\1\ Increased authority includes credits unallocated from prior years
carried over to the current year.
Source: Survey of State allocating agencies conducted by the National
Council of State Housing Agencies (1996).
An allocation percentage of less than 100 percent does not
imply that some credits available for allocation to low-income
housing projects go unused. Since 1990, States are permitted to
carry forward unused credit subsequently made available for
allocation by other States. Thus, the amount allocated in any 1
year could be less than the States' authority, but such
authority may ultimately be allocated.
TAX CREDIT AND EXCLUSION FOR ADOPTION EXPENSES
The Small Business Job Protection Act of 1996 (Public Law
104-188), signed into law on August 20, 1996, includes two tax
provisions designed to reduce economic barriers to adoption.
First, a tax credit of up to $5,000 (or $6,000 in the case of
families adopting special-needs children from the United
States) is created to help defray one-time adoption expenses.
The credit is phased out for families with incomes above
$75,000, and is unavailable to families with incomes above
$115,000. Second, employees may receive an income tax exclusion
of up to $5,000 per child (or $6,000 in the case of special-
needs children) for employer-provided adoption assistance. The
effective date for both provisions is January 1, 1997. The
credit for foreign special-needs adoptions and the exclusion
are not available after December 31, 2001.
CHILD TAX CREDIT
The Taxpayer Relief Act of 1997 provided for a $500 ($400
for taxable year 1998) tax credit for each qualifying child
under the age of 17. A qualifying child is defined as an
individual for whom the taxpayer can claim a dependency
exemption and who is a son or daughter of the taxpayer (or a
descendant of either), a stepson or stepdaughter of the
taxpayer, or an eligible foster child of the taxpayer. For
taxpayers with modified adjusted gross income in excess of
certain thresholds, the allowable child credit is phased out.
Generally, the maximum amount of the child credit for each
taxable year cannot exceed the excess of the taxpayer's regular
tax liability over the taxpayer's tentative minimum tax
liability (determined without regard to the alternative minimum
foreign tax credit). In the case of a taxpayer with three or
more qualifying children, the maximum amount of the child
credit for each taxable year cannot exceed the greater of: (1)
the general rule (described above), or (2) an amount equal to
the excess of the sum of the taxpayer's regular income tax
liability (net of applicable credits other than the earned
income credit) and the employee share of FICA (and one-half of
the taxpayer's SECA tax liability, if applicable) reduced by
the earned income credit. In the case of a taxpayer with three
or more qualifying children, the excess of the amount allowed
in (2) over the amount computed in (1) is a refundable credit.
For taxpayers with modified AGI in excess of certain
thresholds, the child credit is phased out. The phaseout rate
is $50 for each $1,000 of modified AGI (or fraction thereof) in
excess of the threshold. For these purposes modified AGI is
computed by increasing the taxpayer's AGI by the amount
otherwise excluded under Code sections 911, 931, and 933
(relating to the exclusion of income of U.S. citizens or
residents living abroad; residents of Guam, American Samoa, and
the Northern Mariana Islands; and residents of Puerto Rico,
respectively). For married taxpayers filing joint returns, the
threshold is $110,000. For taxpayers filing single or head of
household returns, the threshold is $75,000. For married
taxpayers filing separate returns, the threshold is $55,000.
These thresholds are not indexed for inflation.
THE EFFECT OF TAX PROVISIONS ON THE INCOME AND TAXES OF THE ELDERLY AND
THE POOR
Tables 13-18 and 13-19 present values of the personal
exemptions, standard deductions, additional standard deductions
for the elderly and the blind, and taxable income brackets for
1990-2002. The figures for 1998-2002 are based on Congressional
Budget Office projections. As might be expected, the value to
taxpayers of personal exemptions, standard deductions, and
additional standard deductions for the elderly and the blind
grows steadily over the 10-year period.
Hypothetical Tax Calculations for Selected Families
Table 13-20 presents examples of tax liabilities for
hypothetical taxpayers. The table presents 1997 Federal income
and payroll tax burdens. The worker is assumed to bear both the
employer and employee shares of FICA tax (7.65 percent for
each). Taxpayers claim the earned income credit, if eligible,
and they claim the standard deduction, except where noted in
the footnotes. Income sources are listed in the table's
footnotes for each example.
Tax Treatment of the Elderly
Present law contains several provisions that reduce, or in
some cases eliminate, the burden of Federal income tax on
senior citizens. These provisions are: the exemption from
income taxation of some or all of an individual's Social
Security benefits; a tax credit for certain taxpayers who do
not receive substantial Social Security income; and an
additional standard deduction for taxpayers age 65 and older.
These are described in detail in preceding portions of this
section.
As a result of these favorable tax provisions, the tax
threshold (the level of income, excluding Social Security, at
which tax liability is incurred) for elderly taxpayers is very
close to or above the poverty level. For example, in 1996, a
single elderly individual with $5,000 in Social Security
benefits can have up to $7,200 in other income without
incurring tax liability (or total income of $12,200). An
elderly married couple filing jointly with $5,000 in excluded
Social Security benefits has a tax threshold of $13,500 (or
total income of $18,500). By comparison, the poverty levels in
1995 for a single elderly person and an elderly couple were
$7,309 and $9,221, respectively (U.S. Bureau of the Census,
1995). Table 13-21 displays similar information for other years
and for varying amounts of Social Security benefits.
TABLE 13-18.--ACTUAL PERSONAL EXEMPTIONS, STANDARD DEDUCTIONS, AND TAXABLE INCOME LEVELS, 1990-97
----------------------------------------------------------------------------------------------------------------
Exemption, deduction, or income
level 1990 1991 1992 1993 1994 1995 1996 1997
----------------------------------------------------------------------------------------------------------------
Personal exemptions............. $2,050 $2,150 $2,300 $2,350 $2,450 $2,500 $2,550 $2,650
Standard deductions:
Joint....................... 5,450 5,700 6,000 6,200 6,350 6,550 6,700 6,900
Single...................... 3,250 3,400 3,600 3,700 3,800 3,900 4,000 4,150
Head of household........... 4,750 5,000 5,250 5,450 5,600 5,750 5,900 6,050
Additional standard deductions
for elderly/blind:
Joint (each individual)..... 650 650 700 700 750 750 800 800
Single/head of household.... 800 850 900 900 950 950 1,000 1,000
Taxable income levels:
Joint returns:
15-percent rate ends at..... 32,450 34,000 35,800 36,900 38,000 39,000 40,100 41,200
28-percent rate ends at..... 78,400 82,150 86,500 89,150 91,850 94,250 96,900 99,600
31-percent rate ends at..... ........ ........ ........ 140,000 140,000 143,600 147,700 151,750
Single returns:
15-percent rate ends at..... 19,450 20,350 21,450 22,100 22,750 23,350 24,000 24,650
28-percent rate ends at..... 47,050 49,300 51,900 53,500 55,100 56,550 58,150 59,750
31-percent rate ends at..... ........ ........ ........ 115,000 115,000 117,950 121,300 124,650
Heads of household:
15-percent rate ends at..... 26,050 27,300 28,750 29,600 30,500 31,250 32,150 33,050
28-percent rate ends at..... 67,200 70,450 74,150 76,400 78,700 80,750 83,050 85,350
31-percent rate ends at..... ........ ........ ........ 127,500 127,500 130,800 134,500 138,200
39.6-percent rate ends at... ........ ........ ........ 250,000 250,000 256,500 263,750 271,050
----------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.
TABLE 13-19.--PROJECTED PERSONAL EXEMPTIONS, STANDARD DEDUCTIONS, AND TAXABLE INCOME LEVELS, 1998-2007
--------------------------------------------------------------------------------------------------------------------------------------------------------
Exemption, deduction, or income level 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
--------------------------------------------------------------------------------------------------------------------------------------------------------
Personal exemptions................................. $2,700 $2,800 $2,900 $2,950 $3,050 $3,150 $3,250 $3,350 $3,450 $3,550
Standard deductions:
Joint........................................... 7,100 7,300 7,550 7,750 8,000 8,250 8,500 8,750 9,000 9,300
Single.......................................... 4,250 4,400 4,500 4,650 4,800 4,950 5,100 5,250 5,400 5,550
Head of household............................... 6,250 6,450 6,650 6,800 7,050 7,250 7,450 7,700 7,900 8,150
Additional standard deductions for elderly/blind:
Joint (each individual)......................... 850 850 900 900 950 950 1,000 1,050 1,050 1,100
Single/head of household........................ 1,050 1,100 1,100 1,150 1,200 1,200 1,250 1,300 1,350 1,350
Taxable income levels:
Joint returns:
15-percent rate ends at......................... 42,400 43,650 44,950 46,250 47,650 49,100 50,550 52,100 53,700 55,350
28-percent rate ends at......................... 102,500 105,500 108,600 111,800 115,150 118,600 122,200 125,900 129,750 133,750
31-percent rate ends at......................... 156,200 160,750 165,500 170,400 175,450 180,750 186,200 191,850 197,750 203,850
Single returns:
15-percent rate ends at......................... 25,400 26,150 26,900 27,700 28,550 29,400 30,250 31,200 32,150 33,150
28-percent rate ends at......................... 61,500 63,300 65,150 67,100 69,100 71,150 73,300 75,550 77,850 80,250
31-percent rate ends at......................... 128,300 132,050 135,950 139,950 144,150 148,450 152,950 157,600 162,450 167,450
Heads of household:
15-percent rate ends at......................... 34,000 35,000 36,050 37,100 38,200 39,350 40,550 41,800 43,050 44,400
28-percent rate ends at......................... 87,850 90,400 93,050 95,800 98,650 101,650 104,700 107,900 111,200 114,650
31-percent rate ends at......................... 142,250 146,400 150,700 155,150 159,800 164,000 169,550 174,750 180,100 185,650
39.6-percent rate ends at....................... 278,900 287,050 295,550 304,300 313,350 322,750 332,500 342,650 353,150 364,050
--------------------------------------------------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.
TABLE 13-20.--EXAMPLES OF FEDERAL INCOME AND PAYROLL TAX LIABILITIES OF HYPOTHETICAL TAXPAYERS, 1997
----------------------------------------------------------------------------------------------------------------
Overall Overall
Income FICA tax Total tax effective tax marginal tax
Type of filing unit and income tax liability liability rate rate
liability (percent) \1\ (percent) \1\
----------------------------------------------------------------------------------------------------------------
Joint filer--3 exemptions: \2\
$10,000..................................... -$2,210 $1,530 -$680 -6.3 14.2
$30,000..................................... 2,273 4,590 6,863 21.3 28.1
$50,000 \3\.................................. 4,808 7,650 12,458 23.1 28.1
$100,000 \4\................................. 14,818 11,010 25,828 24.5 30.5
Head of household--2 exemptions: \2\
$10,000...................................... -2,210 1,530 -680 -6.3 14.2
$30,000...................................... 2,798 4,590 7,388 22.9 28.1
$50,000 \3\.................................. 5,420 7,650 13,070 24.3 40.2
$100,000 \4\................................. 16,620 11,010 27,630 26.2 30.5
Elderly couple filing joint return:
$10,000 \5\.................................. 0 0 0 0.0 \6\ 0.0
$30,000 \7\.................................. 630 0 630 2.1 \8\ 15.0
$50,000 \9\.................................. 4,530 1,530 6,060 11.9 40.0
Elderly single filer:
$10,000 \10\................................. 0 0 0 0.0 \6\ 0.0
$30,000 \11\................................. 2,205 0 2,205 7.4 \12\ 22.5
$50,000 \13\................................. 8,297 3,060 11,357 22.0 40.2
----------------------------------------------------------------------------------------------------------------
\1\ The average tax rate is total tax liability divided by income plus the employer share of FICA. The marginal
rate computations also count the employer share of FICA tax as income to the employee (for both payroll and
income tax purposes). Unless otherwise noted, all calculations assume the taxpayer takes the standard
deduction rather than itemized deductions.
\2\ Assumes one child, one earner, and all income is wage income.
\3\ Assumes taxpayer claims itemized deductions of $10,000.
\4\ Assumes taxpayer claims itemized deductions of $20,000.
\5\ All income is Social Security.
\6\ If the marginal dollar of income is assumed to consist of wage income, the marginal tax rate would be 14.2
percent. This represents the FICA tax liability on this income.
\7\ Of the total, $12,000 is Social Security, $12,000 is a taxable pension, and $6,000 is taxable interest.
\8\ If the marginal dollar of income is assumed to consist of wage income, the marginal tax rate would be 28.1
percent, representing both the income tax liability and the FICA tax liability on this income.
\9\ Same as above plus additional $10,000 of taxable interest and $10,000 of wages.
\10\ Of the total, $7,500 is Social Security and $2,500 is taxable pension.
\11\ Of the total, $7,500 is Social Security, $7,500 is taxable pension, and $15,000 is taxable interest.
\12\ If the marginal dollar of income is assumed to consist of wage income, the marginal tax rate would be 35.1
percent, representing both the income tax liability (22.5-percent marginal rate reflects the inclusion of 50
cents of Social Security benefits as taxable for each additional dollar of AGI) and the FICA tax liability on
this income.
\13\ Same as above plus $20,000 of wages.
Source: Joint Committee on Taxation.
TABLE 13-21.--INCOME TAX THRESHOLDS FOR ELDERLY INDIVIDUALS WITH VARIOUS
AMOUNTS OF SOCIAL SECURITY INCOME, 1990-2007
------------------------------------------------------------------------
Amount of Social Security income
Year and filing status -------------------------------------------
None $2,500 $5,000 $7,500
------------------------------------------------------------------------
1990:
Single.................... $9,900 $8,233 $6,100 $6,100
Joint..................... 15,567 13,900 12,233 10,850
1991:
Single.................... 10,100 8,433 6,400 6,400
Joint..................... 15,867 14,200 12,533 11,300
1992:
Single.................... 10,367 8,700 6,800 6,800
Joint..................... 16,333 14,667 13,000 12,000
1993:
Single.................... 10,467 8,800 6,950 6,950
Joint..................... 16,533 14,867 13,200 12,300
1994:
Single.................... 10,633 8,967 7,200 7,200
Joint..................... 16,833 15,167 13,500 12,750
1995:
Single.................... 10,733 9,067 7,350 7,350
Joint..................... 17,033 15,367 13,700 13,050
1996:
Single.................... 10,867 9,200 7,550 7,550
Joint..................... 17,267 15,600 13,933 13,400
1997:
Single.................... 11,033 9,367 7,800 7,800
Joint..................... 17,533 15,867 14,200 13,800
1998 \1\:
Single.................... 11,167 9,500 8,000 8,000
Joint..................... 17,800 16,133 14,467 14,200
1999 \1\:
Single.................... 11,367 9,700 8,300 8,300
Joint..................... 18,067 16,400 14,733 14,600
2000 \1\:
Single.................... 11,500 9,833 8,500 8,500
Joint..................... 18,433 16,767 15,100 15,150
2001 \1\:
Single.................... 11,667 10,000 8,750 8,750
Joint..................... 18,633 16,967 15,300 15,450
2002 \1\:
Single.................... 11,867 10,200 9,050 9,050
Joint..................... 19,000 17,333 15,667 16,000
2003 \1\:
Single.................... 12,033 10,367 9,300 9,300
Joint..................... 19,300 17,633 15,967 16,450
2004 \1\:
Single.................... 12,233 10,567 9,600 9,600
Joint..................... 19,667 18,000 16,333 17,000
2005 \1\:
Single.................... 12,433 10,767 9,900 9,900
Joint..................... 20,033 18,367 16,700 17,550
2006 \1\:
Single.................... 12,633 10,967 10,200 10,200
Joint..................... 20,333 18,667 17,000 18,000
2007 \1\:
Single.................... 12,800 11,133 10,450 10,450
Joint..................... 20,733 19,067 17,400 18,600
------------------------------------------------------------------------
\1\ Projections.
Source: Congressional Budget Office.
The combination of these tax provisions means that an
estimated 51 percent of elderly individuals will have no tax
liability for 1998 (see table 13-22).
Distribution of Family Income and Taxes
Table 13-22 presents estimates of the distribution of
families and individuals by the Federal individual income tax
rate brackets for calendar year 1998. As shown in the bottom
panel, almost 33 million families pay no Federal income taxes.
There are 55 million families with 134 million individuals who
are in the 15-percent bracket. These families on average had
income of $37,645 and paid Federal taxes of $2,474 per family.
There are approximately 4 million families that face marginal
income tax rates of 31 percent or above.
Table 13-23 is a more complicated version of table 13-22.
It illustrates for various types of wage earners the additional
(marginal) Federal tax these wage earners will pay if they earn
one more dollar of wages. For purposes of this table, marginal
tax rates include both Federal income and payroll taxes. The
majority of single wage earners have income below $30,000 per
year and face marginal tax rates of 20.0-24.9 percent. In
addition, the phaseout of certain deductions or exclusions
under the Code (e.g., the personal exemption phaseout) and the
overall limitation on itemized deductions also have the effect
of imposing additional dollars of tax liability on a taxpayer
as the taxpayer's income increases. Hence, effective marginal
tax rates can exceed the sum of the statutory individual income
tax rate and payroll tax rate.
TABLE 13-22.--DISTRIBUTION OF FAMILIES AND PERSONS BY MARGINAL FEDERAL INCOME TAX RATE, PROJECTED 1998
----------------------------------------------------------------------------------------------------------------
Families (in Persons (in Families
thousands) thousands) ----------------------
-------------------------------------- Average
Family type and marginal tax rate (percent) Average Federal
Number Percent Number Percent pretax income
income tax
----------------------------------------------------------------------------------------------------------------
With children:
0.............................................. 9,916 25.4 37,446 24.8 $11,804 -$1,407
15............................................. 20,041 51.3 77,591 51.4 45,735 2,623
28............................................. 7,674 19.6 30,211 20.0 98,722 11,377
31............................................. 783 2.0 3,085 2.0 179,456 29,126
36............................................. 361 0.9 1,510 1.0 265,265 50,216
39.6........................................... 304 0.8 1,274 0.8 749,899 201,894
------------------------------------------------------------
Total...................................... 39,078 100.0 151,116 100.0 57,707 5,838
============================================================
With aged head:
0.............................................. 11,273 50.5 16,269 45.5 15,292 -7
15............................................. 8,038 36.0 13,937 39.0 38,222 2,054
28............................................. 2,325 10.4 4,303 12.0 86,015 10,327
31............................................. 436 2.0 716 2.0 150,662 24,454
36............................................. 175 0.8 331 0.9 293,016 57,054
39.6........................................... 93 0.4 174 0.5 997,948 202,334
------------------------------------------------------------
Total...................................... 22,339 100.0 35,729 100.0 39,799 3,575
============================================================
Other families:
0.............................................. 9,592 18.4 12,231 14.9 6,978 -110
15............................................. 26,942 51.5 42,531 51.8 32,422 2,567
28............................................. 13,291 25.4 22,976 28.0 75,353 9,749
31............................................. 1,544 3.0 2,528 3.1 141,044 23,018
36............................................. 551 1.1 1,058 1.3 254,622 50,215
39.6........................................... 355 0.7 748 0.9 905,846 223,378
------------------------------------------------------------
Total...................................... 52,275 100.0 82,073 100.0 50,145 6,506
============================================================
All families:
0.............................................. 30,780 27.1 65,946 24.5 11,578 -490
15............................................. 55,021 48.4 134,059 49.9 38,118 2,512
28............................................. 23,290 20.5 57,490 21.4 84,117 10,343
31............................................. 2,763 2.4 6,330 2.4 153,445 24,975
36............................................. 1,087 1.0 2,899 1.1 264,333 51,316
39.6........................................... 751 0.7 2,195 0.8 854,156 212,091
------------------------------------------------------------
Total...................................... 113,692 100.0 268,918 100.0 50,711 5,700
----------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office tax simulation model.
TABLE 13-23.--DISTRIBUTION OF EARNERS \1\ BY INCOME AND MARGINAL TAX RATES ON WAGES, PROJECTED 1998
--------------------------------------------------------------------------------------------------------------------------------------------------------
Income in thousands of 1998 dollars
------------------------------------------------------------------------------------------ All
Family type and marginal tax rate (percent) Less incomes
than 10 10-20 20-30 30-40 40-50 50-75 75-100 100-200 200+
--------------------------------------------------------------------------------------------------------------------------------------------------------
Single earners:
Less than 0..................................... 2,305 193 8 2 0 2 0 0 0 2,511
0-4.9........................................... 1,502 75 12 0 0 0 0 0 0 1,589
5.0-9.9......................................... 4,525 782 13 0 0 0 0 0 0 5,319
10-14.9......................................... 0 0 0 0 0 0 0 0 0 0
15.0-19.9....................................... 877 32 0 0 0 0 0 0 0 908
20-24.9......................................... 1,949 9,966 8,468 3,519 530 64 0 0 0 24,496
25.0-29.9....................................... 0 346 5 0 1 217 237 9 0 815
30-34.9......................................... 1,589 336 6 0 0 54 343 365 0 2,694
35.0-39.9....................................... 0 1,070 879 2,466 2,538 2,552 154 120 74 9,853
40-44.9......................................... 0 486 853 40 0 0 0 17 102 1,498
45.0-49.9....................................... 0 0 0 0 0 0 0 10 18 28
---------------------------------------------------------------------------------------------------
Total....................................... 12,747 13,285 10,245 6,027 3,070 2,889 734 521 195 49,712
===================================================================================================
Mean marginal tax rate.......................... 5.6 23.3 25.7 28.1 33.4 34.8 32.5 35.0 41.2 21.5
Mean marginal income tax rate................... -2.1 15.7 18.0 20.4 25.8 27.8 29.8 32.7 39.2 14.0
Mean marginal Social Security tax rate.......... 7.6 7.6 7.6 7.6 7.6 7.1 2.8 2.3 2.1 7.5
===================================================================================================
Married earners:
Less than 0..................................... 919 252 41 6 1 0 0 0 0 1,219
0-4.9........................................... 139 49 21 5 2 0 0 0 0 216
5.0-9.9......................................... 639 1,057 123 47 2 0 0 0 0 1,868
10-14.9......................................... 0 0 0 0 0 0 0 0 0 0
15.0-19.9....................................... 158 60 18 7 6 59 3 0 0 311
20-24.9......................................... 0 1,217 3,420 9,300 9,515 12,489 67 5 0 36,013
25.0-29.9....................................... 0 1,208 468 28 6 229 1,365 1,421 0 4,726
30-34.9......................................... 0 5 4 109 184 21 8 1,587 38 1,957
35.0-39.9....................................... 0 451 1,132 61 32 8,577 8,566 5,215 112 24,147
40-44.9......................................... 4 147 2,697 171 6 6 1 159 1,285 4,477
45.0-49.9....................................... 4 0 0 2 2 0 2 59 703 773
---------------------------------------------------------------------------------------------------
Total....................................... 1,863 4,446 7,926 9,736 9,757 21,381 10,012 8,446 2,139 75,707
===================================================================================================
Mean marginal tax rate.......................... -11.0 20.0 31.9 23.1 22.8 27.9 34.7 34.7 43.2 27.7
Mean marginal income tax rate................... -18.7 12.4 24.3 15.5 15.2 20.4 27.9 29.3 39.5 20.6
Mean marginal Social Security tax rate.......... 7.6 7.6 7.6 7.6 7.6 7.6 6.8 5.3 3.7 7.1
===================================================================================================
Earners with children:
Less than 0..................................... 3,000 419 48 8 0 1 0 0 0 3,476
0-4.9........................................... 2 22 19 2 2 0 0 0 0 47
5.0-9.9......................................... 763 1,281 44 35 1 0 0 0 0 2,125
10-14.9......................................... 0 0 0 0 0 0 0 0 0 0
15.0-19.9....................................... 0 0 0 2 1 52 3 0 0 58
20-24.9......................................... 0 468 1,054 6,377 6,095 8,519 56 1 0 22,570
25.0-29.9....................................... 0 1,545 469 28 4 168 982 791 0 3,988
30-34.9......................................... 0 0 0 26 20 9 8 926 13 1,001
35.0-39.9....................................... 0 1,213 1,631 47 64 3,781 4,651 2,590 89 14,065
40-44.9......................................... 0 597 3,409 207 6 6 1 96 652 4,975
45.0-49.9....................................... 0 0 0 2 2 0 0 36 279 320
---------------------------------------------------------------------------------------------------
Total....................................... 3,765 5,544 6,673 6,735 6,196 12,535 5,700 4,439 1,033 52,623
===================================================================================================
Mean marginal tax rate.......................... -22.6 22.8 37.2 23.3 22.8 26.7 34.4 34.5 43.1 25.0
Mean marginal income tax rate................... -30.2 15.2 29.6 15.7 15.2 19.1 27.9 29.4 39.7 17.8
Mean marginal Social Security tax rate.......... 7.6 7.6 7.6 7.6 7.6 7.5 6.6 5.1 3.4 7.2
===================================================================================================
All earners ages 21-64 without Social Security
earnings:
Less than 0..................................... 3,224 446 49 8 1 2 0 0 0 3,730
0-4.9........................................... 1,641 125 33 5 2 0 0 0 0 1,805
6.0-9.9......................................... 5,163 1,838 136 47 2 0 0 0 0 7,187
10-14.9......................................... 0 0 0 0 0 0 0 0 0 0
15.0-19.9....................................... 1,035 91 18 7 6 59 3 0 0 1,220
20-24.9......................................... 1,949 11,182 11,888 12,819 10,045 12,552 67 5 0 60,509
25.0-29.9....................................... 0 1,555 473 28 8 446 1,602 1,430 0 5,541
30-34.9......................................... 1,589 340 11 109 184 75 351 1,952 38 4,651
35.0-39.9....................................... 0 1,521 2,011 2,527 2,570 11,129 8,720 5,335 186 34,000
40-44.9......................................... 4 633 3,550 211 6 6 1 176 1,388 5,975
45.0-49.9....................................... 4 0 0 2 2 0 2 69 721 801
---------------------------------------------------------------------------------------------------
Total....................................... 14,610 17,732 18,170 15,763 12,827 24,270 10,746 8,968 2,333 125,419
===================================================================================================
Mean marginal tax rate.......................... 3.5 22.5 28.4 25.0 25.4 28.8 34.6 34.7 43.0 25.2
Mean marginal income tax rate................... -4.2 14.8 20.8 17.4 17.7 21.2 28.1 29.5 39.5 18.0
Mean marginal Social Security tax rate.......... 7.6 7.6 7.6 7.6 7.6 7.5 6.5 5.2 3.5 7.3
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ In thousands.
Source: Congressional Budget Office tax simulation model.
Federal Tax Treatment of Families in Poverty
During the 1970s and early 1980s, inflation gradually
increased the tax burdens of the poor and lowered the real
income level at which a poor family became liable for income
taxation. Legislation passed by Congress reversed or slowed
this trend, but in the absence of indexing, inflation during
this period gradually offset these legislative efforts. One
measure of this trend is the degree to which the income at
which a poor family begins to pay income taxes (termed the tax
threshold, or the tax entry point) exceeds or falls below the
poverty threshold. A second measure is the actual amount of tax
liability incurred by a family with income at the poverty line.
Table 13-24 shows the income tax threshold, the poverty
level, and the tax threshold as a percent of the poverty level
for a married couple with two children in selected years. These
figures demonstrate that before 1975 a family of four was
generally liable for Federal income tax if the family's income
was significantly below the poverty line. In 1975, following
the enactment of the EIC, a
TABLE 13-24.--RELATIONSHIP BETWEEN INCOME TAX THRESHOLD AND POVERTY
LEVEL FOR A FAMILY OF FOUR, SELECTED YEARS 1959-2007
------------------------------------------------------------------------
Tax
threshold
Income tax Poverty as a
Year threshold level percent of
poverty
level
------------------------------------------------------------------------
1959............................. $2,667 $2,978 89.7
1960............................. 2,667 3,022 88.3
1965............................. 3,000 3,223 93.1
1970............................. 3,600 3,968 90.7
1975............................. 6,692 5,500 121.7
1980............................. 8,626 8,414 102.5
1984............................. 8,783 10,610 82.8
1990............................. 16,296 13,359 122.0
1991............................. 17,437 13,924 125.2
1992............................. 18,548 14,335 129.4
1993............................. 19,187 14,763 130.0
1994............................. 21,098 14,625 144.3
1995............................. 22,362 15,570 143.6
1996............................. 23,672 16,020 147.8
1997............................. 24,386 16,479 148.0
1998............................. 25,039 16,969 147.6
1999............................. 25,798 17,470 147.7
2000............................. 26,006 17,980 148.0
2001............................. 27,333 18,521 147.6
2002............................. 28,170 19,072 147.7
2003............................. 29,035 19,654 147.7
2004............................. 29,923 20,257 147.7
2005............................. 30,833 20,880 147.7
2006............................. 31,760 21,523 147.6
2007............................. 32,742 22,187 147.6
------------------------------------------------------------------------
Source: Congressional Budget Office.
family of four incurred no tax liability until its income
exceeded the poverty threshold by 22 percent. Over the next
decade this margin eroded; by 1984, a poor family of four
incurred income tax liability when its income was 17 percent
below the poverty line. By 1993, changes in the tax law
resulted in no tax liability for a typical family of four until
its income exceeded the poverty threshold by nearly 30 percent.
Table 13-25 shows the income tax burden and payroll tax
burden of households with incomes at the poverty line for
families of different sizes. As a result of the refundable EIC,
the table reflects that many individuals receive a substantial
credit that more than offsets total income, and in many cases
Social Security, taxes paid.
TABLE 13-25.--POVERTY LEVELS, TAX THRESHOLDS, AND FEDERAL TAX AMOUNTS FOR DIFFERENT FAMILY SIZES WITH EARNINGS
EQUAL TO THE POVERTY LEVEL, 1991-2007
----------------------------------------------------------------------------------------------------------------
Family size
Poverty or tax measure and year -------------------------------------------------------------
1 2 3 4 5 6
----------------------------------------------------------------------------------------------------------------
Poverty level:
1991.......................................... $6,932 $8,865 $10,860 $13,924 $16,456 $18,587
1992.......................................... 7,143 9,137 11,186 14,335 16,592 19,137
1993.......................................... 7,363 9,414 11,522 14,763 17,449 19,718
1994.......................................... 7,547 9,661 11,821 15,141 17,900 20,235
1995.......................................... 7,759 9,924 12,150 15,570 18,022 20,786
1996.......................................... 7,982 10,211 12,501 16,020 18,542 21,386
1997.......................................... 8,211 10,504 12,859 16,479 19,074 21,999
1998.......................................... 8,456 10,816 13,242 16,969 19,641 22,654
1999.......................................... 8,705 11,135 13,632 17,470 20,220 23,322
2000.......................................... 8,959 11,460 14,030 17,980 20,811 24,003
2001.......................................... 9,229 11,805 14,453 18,521 21,437 24,725
2002.......................................... 9,504 12,157 14,883 19,072 22,075 25,461
2003.......................................... 9,794 12,528 15,337 19,654 22,749 26,238
2004.......................................... 10,094 12,912 15,807 20,257 23,446 27,043
2005.......................................... 10,404 13,309 16,293 20,880 24,167 27,874
2006.......................................... 10,725 13,719 16,795 21,523 24,912 28,733
2007.......................................... 11,055 14,142 17,313 22,187 25,680 29,619
Income tax threshold:
1991.......................................... 5,550 10,000 16,179 17,437 18,616 19,794
1992.......................................... 5,900 10,600 17,217 18,548 19,774 21,000
1993.......................................... 6,050 10,900 17,841 19,187 20,405 21,624
1994.......................................... 7,179 11,250 18,887 21,098 22,222 23,347
1995.......................................... 7,356 11,550 19,387 22,362 23,426 24,491
1996.......................................... 7,546 11,800 19,884 23,672 24,733 25,793
1997.......................................... 7,800 12,200 20,488 24,386 25,488 26,590
1998.......................................... 7,994 12,500 21,031 25,039 26,162 27,285
1999.......................................... 8,257 12,900 21,678 25,798 26,963 28,128
2000.......................................... 8,494 13,350 22,355 26,606 27,813 29,019
2001.......................................... 8,735 13,650 22,956 27,333 28,561 29,788
2002.......................................... 9,008 14,100 23,670 28,170 29,439 30,708
2003.......................................... 9,289 14,550 24,400 29,035 30,345 31,656
2004.......................................... 9,573 15,000 25,141 29,923 31,274 32,626
2005.......................................... 9,860 15,450 25,902 30,833 32,226 33,620
2006.......................................... 10,154 15,900 26,691 31,760 33,195 34,630
2007.......................................... 10,451 16,400 27,515 32,742 34,219 35,696
Income tax at poverty level:
1991.......................................... 207 0 -1,192 -905 -591 -328
1992.......................................... 187 0 -1,324 -1,053 -711 -422
1993.......................................... 197 0 -1,434 -1,154 -780 -464
1994.......................................... 83 0 -1,907 -1,795 -1,308 -895
1995.......................................... 91 0 -1,957 -2,245 -1,749 -1,190
1996.......................................... 99 0 -2,010 -2,627 -2,096 -1,497
1997.......................................... 93 0 -2,065 -2,698 -2,152 -1,535
1998.......................................... 105 0 -2,119 -2,770 -2,208 -1,573
1999.......................................... 101 0 -2,182 -2,849 -2,270 -1,616
2000.......................................... 105 0 -2,246 -2,935 -2,339 -1,667
2001.......................................... 112 0 -2,312 -3,023 -2,409 -1,717
2002.......................................... 112 0 -2,382 -3,112 -2,479 -1,766
2003.......................................... 114 0 -2,453 -3,203 -2,552 -1,817
2004.......................................... 118 0 -2,525 -3,299 -2,627 -1,870
2005.......................................... 123 0 -2,601 -3,399 -2,706 -1,926
2006.......................................... 129 0 -2,683 -3,500 -2,786 -1,982
2007.......................................... 137 0 -2,765 -3,609 -2,874 -2,044
Payroll tax at poverty level:
1991.......................................... 530 678 831 1,065 1,259 1,422
1992.......................................... 547 699 856 1,098 1,298 1,466
1993.......................................... 563 720 881 1,129 1,335 1,508
1994.......................................... 577 739 904 1,158 1,369 1,548
1995.......................................... 594 759 929 1,191 1,379 1,590
1996.......................................... 611 781 956 1,226 1,418 1,636
1997.......................................... 628 804 984 1,261 1,459 1,683
1998.......................................... 647 827 1,013 1,298 1,503 1,733
1999.......................................... 666 852 1,043 1,336 1,547 1,784
2000.......................................... 685 877 1,073 1,375 1,592 1,836
2001.......................................... 706 903 1,106 1,417 1,640 1,891
2002.......................................... 727 930 1,139 1,459 1,689 1,948
2003.......................................... 749 958 1,173 1,504 1,740 2,007
2004.......................................... 772 988 1,209 1,550 1,794 2,069
2005.......................................... 796 1,018 1,246 1,597 1,849 2,132
2006.......................................... 820 1,049 1,285 1,647 1,906 2,198
2007.......................................... 846 1,082 1,324 1,697 1,965 2,266
Combined tax at poverty level:
1991.......................................... 738 678 -362 160 668 1,094
1992.......................................... 734 699 -467 45 587 1,044
1993.......................................... 760 720 -552 -25 555 1,044
1994.......................................... 661 739 -1,003 -637 62 653
1995.......................................... 685 759 -1,027 -1,054 -371 400
1996.......................................... 709 781 -1,054 -1,402 -678 139
1997.......................................... 721 804 -1,081 -1,437 -692 148
1998.......................................... 751 827 -1,106 -1,472 -705 160
1999.......................................... 767 852 -1,140 -1,512 -723 168
2000.......................................... 791 877 -1,173 -1,560 -747 169
2001.......................................... 818 903 -1,207 -1,607 -769 175
2002.......................................... 839 930 -1,244 -1,652 -790 182
2003.......................................... 864 958 -1,280 -1,700 -811 191
2004.......................................... 890 988 -1,316 -1,749 -834 199
2005.......................................... 919 1,018 -1,355 -1,801 -857 207
2006.......................................... 950 1,049 -1,398 -1,853 -881 216
2007.......................................... 983 1,082 -1,441 -1,912 -909 222
Combined tax at poverty level as a percent of
poverty level:
1991.......................................... 10.6 7.6 -3.3 1.1 4.1 5.9
1992.......................................... 10.3 7.7 -4.2 0.3 3.5 5.5
1993.......................................... 10.3 7.7 -4.8 -0.2 3.2 5.3
1994.......................................... 8.8 7.7 -8.5 -4.2 0.3 3.2
1995.......................................... 8.8 7.7 -8.5 -6.8 -2.1 1.9
1996.......................................... 8.9 7.7 -8.4 -8.8 -3.7 0.6
1997.......................................... 8.8 7.7 -8.4 -8.7 -3.6 0.7
1998.......................................... 8.9 7.7 -8.4 -8.7 -3.6 0.7
1999.......................................... 8.8 7.7 -8.4 -8.7 -3.6 0.7
2000.......................................... 8.8 7.7 -8.4 -8.7 -3.6 0.7
2001.......................................... 8.9 7.7 -8.3 -8.7 -3.6 0.7
2002.......................................... 8.8 7.7 -8.4 -8.7 -3.6 0.7
2003.......................................... 8.8 7.7 -8.3 -8.6 -3.6 0.7
2004.......................................... 8.8 7.7 -8.3 -8.6 -3.6 0.7
2005.......................................... 8.8 7.7 -8.3 -8.6 -3.5 0.7
2006.......................................... 8.9 7.7 -8.3 -8.6 -3.5 0.8
2007.......................................... 8.9 7.7 -8.3 -8.6 -3.5 0.7
----------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.
REFERENCES
Congressional Budget Office. (1997, January). Economic and
budget outlook: Fiscal years 1998-2007. Washington, DC:
Author.
Internal Revenue Service. (various years). Internal revenue
bulletin. Washington, DC: U.S. Government Printing
Office.
Internal Revenue Service. (various years). Statistics of
Income. Washington, DC: Author.
Joint Committee on Taxation, U.S. Congress. (1996). Estimates
of Federal tax expenditures for fiscal years 1997-2001
(JCS-11-96). Washington, DC: U.S. Government Printing
Office.
Mills, E.S. (1987, March-April). Dividing up the investment
pie: Have we overinvested in housing? Philadelphia
Business Review, pp. 13-23.
National Council of State Housing Agencies. (1996). State HSA
fact book: 1996 NCSHA annual survey results.
Washington, DC: Author.
Scholes, M., & Wolfson, M. (1992). Taxes and business strategy:
A planning approach. New York: Prentice-Hall.
Social Security Administration. (1996). Black lung benefits
program highlights. Annual Statistical Supplement to
the Social Security Bulletin. Washington, DC: Author.
Turner, J.A., & Beller, D. (1989). Trends in pensions.
Washington, DC: U.S. Department of Labor.
U.S. Bureau of the Census. (1995). Statistical abstract of the
United States: 1995 (115th Ed.). Washington, DC: U.S.
Government Printing Office.
U.S. Bureau of Labor Statistics. (1993). Employee benefits in
medium and large private establishments. Washington,
DC: Department of Labor.
U.S. Bureau of Labor Statistics. (1994). Employee benefits in
small private establishments. Washington, DC:
Department of Labor.
U.S. Department of Labor. (1989, January). Annual report on
administration of black lung benefits during calendar
year 1986. Washington, DC: Author.
U.S. Department of Labor. (1994). Pension and health benefits
of American workers: New findings from the April 1993
current population survey. Washington, DC: Author.
Woods, J.R. (1989). Pension coverage among private wage and
salary workers: Preliminary findings from the 1988
survey of employee benefits. Social Security Bulletin,
52(10), pp. 2-19.