13-1

SECTION 13 - TAX PROVISIONS RELATED TO RETIREMENT, 

HEALTH, POVERTY, EMPLOYMENT, DISABILITY AND OTHER 

SOCIAL ISSUES 

CONTENTS 

Introduction 

Net Exclusion of Pension Contributions and Earnings 

Individual Retirement Arrangements 

Exclusion of Social Security and Railroad Retirement Benefits 

Exclusion of Employer Contributions for Medical Insurance Premiums and 

 Medical Care 

Tax Credit for Health Insurance of Eligible Individuals 

Medical Savings Accounts 

Health 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 Tuition Programs and Coverdell Education Savings 

 Accounts 

Student Loan Interest Deduction 

Qualified Tuition 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 

Tax Credit and Exclusion for Adoption Expenses 

Child Tax Credit 

Effect of Tax Provisions on the Income and Taxes of the Elderly and the 

Poor 

References
13-2

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. 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 (AGI) 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) alternative 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 AGI. 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 Aid to Families with Dependent 

Children (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 2003 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 

2002 forecast of the Congressional Budget Office. 
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TABLE 13-1 -- DISTRIBUTION BY INCOME CLASS OF ALL 

RETURNS, TAXABLE RETURNS, ITEMIZED RETURNS, AND 

INDIVIDUAL INCOME TAX LIABILITY FOR TAXABLE YEAR 2003 

Income class1 All 

returns2

Taxable 

returns 

Itemized 

returns 

Individual 

income tax 

liability 

Below $10,000 21,365 957 280 -6,813 

$10,000-$20,000 25,881 8,340 1,027 -10,358 

$20,000-$30,000 21,135 10,251 2,108 1,110 

$30,000-$40,000 17,274 11,866 3,137 17,003 

$40,000-$50,000 12,776 10,007 3,620 24,438 

$50,000-$75,000 23,139 20,868 9,904 82,140 

$75,000-$100,000 13,574 13,337 8,953 86,609 

$100,000-$200,000 13,241 13,185 11,080 190,989 

$200,000 and over 3,490 3,485 3,281 369,055 

 Total 151,876 92,295 43,390 754,173 1

 The income concept used to place tax returns into classes is adjusted gross income plus: (1) 

tax-exempt interest; (2) employer contributions for health plans and life insurance; (3) employer 

share of FICA tax; (4) workers' compensation; (5) nontaxable Social Security benefits; (6) 

insurance value of Medicare benefits; (7) alternative minimum tax preference items; and (8) 

excluded income of U.S. citizens living abroad. 

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 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 37 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
TABLE 13-2 -- ESTIMATED TAX BASE EXCEPTIONS AND CREDITS UNDER THE PRESENT INCOME 

TAX FOR VARIOUS ITEMS,1 CALENDAR YEARS 2003-2007 

[In billions of dollars]

Item 2003 2004 2005 2006 2007 2003-07 

Tax base exceptions related to: Retirement: 

Net exclusion of pension contributions and earnings 279.1 360.0 410.1 435.4 450.3 1,934.9 Keogh plans 11.4 15.6 18.6 20.2 21.3 87.2 

Individual retirement plans 42.7 56.7 67.5 74.3 81.3 322.3 

Exclusion of Social Security and railroad retirement benefits in excess 

of employee share of payroll tax2 305.5 311.6 313.2 320.9 331.0 1,582.2 

Health: 

Exclusions of employer contributions for medical care, health 

insurance premiums and long-term care insurance premiums3 561.9 618.3 677.4 732.9 485.8 3,076.3 

Exclusion of Medicare benefits: 

Medicare Part 165.2 175.5 187.5 199.0 209.6 936.8 Medicare Part B 113.5 118.5 126.8 137.0 147.8 643.6 

Deductibility of medical expenses4 47.1 50.7 52.3 54.5 55.8 260.4 

Deductibility of health insurance expenses of the self employed5 19.6 21.6 23.6 25.5 27.3 117.7 

Exclusion of accelerated death benefits 2.8 3.4 3.8 4.1 4.4 18.5 

 Health savings accounts 0.0 0.0 2.2 2.4 2.6 7.2 Poverty: 

Exclusion of public assistance and SSI cash benefits 52.6 53.8 55.3 57.1 59.0 277.7 

Employment: 

Exclusion of employer-provided dependent care6 3.5 3.7 3.9 4.1 4.3 19.5 

Employee stock ownership plans (ESOPs) 5.4 5.6 5.8 6.1 6.3 29.2 

Exclusion for benefits provided under cafeteria plans7 85.8 94.6 103.5 111.7 119.5 515.1 

Elderly and Disabled: 

Exclusion of workers’ compensation and special benefits for disabled 

coal miners: 

Workers’ compensation 33.2 36.0 37.4 38.5 39.8 184.9 Special benefits for disabled coal miners 0.3 0.3 0.3 0.3 0.3 1.4 

Additional standard deduction for elderly and blind 12.8 13.6 14.4 15.1 15.8 71.7 
Housing: 

Deductibility of mortgage interest 362.9 376.8 392.1 409.5 426.3 1,967.6 Deductibility of property tax on owner-occupied housing 154.4 165.4 176.1 186.5 196.3 878.7 Exclusion of interest on State and local government bonds for owner-  occupied housing 3.3 3.3 3.4 3.4 3.5 17.0 Depreciation of rental housing in excess of alternative depreciation  system 12.6 13.6 15.0 16.9 19.5 77.6 Exclusion of interest on State and local government bonds for rental  housing 0.7 0.7 0.7 0.7 0.8 3.6 

Families: 

 Qualified State tuition programs and Coverdell Education Savings  Accounts 0.2 0.2 0.2 0.3 0.3 1.2 

Student loan interest deduction 0.6 0.7 0.8 0.8 0.8 3.7 Employer-provided adoption expenses 8 8 8 8 8 0.1 

Tax credits related to: 

 Poverty: 

 Earned income tax credit:9

 Nonrefundable portion 2.7 2.8 3.1 3.1 3.2 14.9 

 Employment: 

 Dependent care credit 3.4 3.3 2.5 2.3 2.2 13.7  Work opportunity tax credit 0.4 0.2 0.1 8 8 0.8 

 Welfare-to-Work tax credit 0.1 0.1 8 8 8 0.3 

 Elderly and Disabled: 

 Tax credit for elderly and disabled 8 8 8 8 8 0.1 

 Housing: 

 Low-income housing tax credit 4.1 4.3 4.5 4.7 4.9 22.5 

 Families: 

 Child tax credit9 44.1 44.1 32.1 31.5 30.9 182.7 

 HOPE Credit and Lifetime Learning Credit 4.3 4.3 4.3 4.3 4.3 21.5  Adoption credit 0.1 0.1 0.1 0.2 0.2 0.7 
TABLE 13-2 -- ESTIMATED TAX BASE EXCEPTIONS AND CREDITS UNDER THE PRESENT INCOME TAX 

FOR VARIOUS ITEMS,1 CALENDAR YEARS 2003-2007-continued 

[In billions of dollars] 1 Estimates of exclusions and deductions represent changes in the tax base; they do not measure changes in tax liability. Tax effects of provisions ar

not comparable. 

2 In addition to OASDI benefits for retired workers, these figures also include disability insurance benefits, and benefits for dependents and survivor3 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 (60 percent of health insurance expenses in 2001, 70 percent in 2002, and 100 percent in 2003 through 

2005). 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. 9 The amount of child tax credit and earned income tax credit used to offset taxes other than income tax or paid out in refunds is: $40.9 billion in 

2003, $41.5 billion in 2004, $39.6 billion in 2005, $39.8 billion in 2006, and $40.0 billion in 2007. Note- Details may not add to totals due to rounding. Source: Joint Committee on Taxation. 
13-7 

minimum participation, coverage, vesting, benefit accrual, and funding. Many 

revisions of these rules have been made since 1974. 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 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 employee stock 

ownership plans 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 

generally 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 defined 

benefit plans to ensure the solvency of such 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 includible in the income of the employer or subject to the tax on 

reversions. 
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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 

 In general a plan is not a qualified plan unless a participant's employerprovided benefit vests at least as rapidly as under one of two alternative 

minimum vesting schedules (sec. 411). More rapid vesting applies to employer 

matching contributions. In addition, elective contributions to a section 401(k) 

plan and after-tax employee contributions must be fully vested at all times. 

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 the employee 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 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 two employees 

(or if there is only one employee, such employee) (sec. 401(a)(26)). 

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)). 
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Limitations on Contributions and Benefits

 The maximum annual benefit that may be provided by a defined benefit 

pension plan (payable at age 65) is the lesser of 100 percent of average 

compensation, or $160,000 for 2003 (sec. 415(b)). The dollar limit is adjusted 

annually for inflation. The dollar limit is reduced if payments of benefits begin 

before age 62 and increased if benefits begin after age 65. The maximum 

contributions that may be made to a defined contribution plan with respect to a 

participant is the lesser of 100 percent of the participant’s compensation, or 

$40,000 for 2003 (sec.415(c)). The dollar limit is adjusted annually for 

inflation. 

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. Certain 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 after-tax 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)). 

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 
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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. 

Other Employer-Sponsored Retirement Arrangements 

 Certain other types of employer-sponsored retirement plans provide tax 

benefits similar to those provided under qualified retirement plans, including 

tax-sheltered annuities (sec. 403(b) annuities), eligible deferred compensation 

plans of State and local governmental employers (governmental sec. 457 plans), 

and simplified employee pensions, referred to as “SEPs” (sec. 408(k)). Each of 

these arrangements is subject to different requirements, including contribution 

limits. These arrangements are not subject to many of the requirements 

applicable to qualified plans. 

Saver’s Credit 

 The Economic Growth and Tax Relief Reconciliation Act, “EGTRRA,” 

provides a temporary nonrefundable tax credit for eligible taxpayers for 

qualified retirement saving contributions, effective for taxable years beginning 

after December 31, 2001, and before January 1, 2007. The credit is available 

with respect to (1) elective deferrals to 401(k) loans, tax-sheltered annuities, 

governmental 457 plans, SIMPLE retirement plans, or SEPs; (2) contributions to 

a traditional or Roth IRA; and (3) voluntary after-tax employee contributions to 

a tax sheltered annuity or qualified retirement plan. The amount of any 

contribution eligible for the credit is reduced by certain distributions received 

from these arrangements. 

The maximum annual contribution eligible for the credit is $2,000. The 

credit rate varies from 10 percent to 50 percent, depending on the adjusted gross 

income (AGI) of the taxpayer. Taxpayers filing joint returns with AGI of 

$50,000 or less, head of household returns of $37,500 or less, and single returns 

of $25,000 or less are eligible for the credit. The AGI limits applicable to single 

taxpayers apply to married taxpayers filing separate tax returns. The credit is in 

addition to any deduction or exclusion that would otherwise apply with respect 

to the contribution. The credit offsets minimum tax liability as well as regular 

tax liability. The credit is available to individuals who are 18 or over, other than 

individuals who are full-time students or claimed as a dependent on another 

taxpayer’s return. 

 

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 
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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. 

 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 most recent data 

regarding pension coverage is the March 2003 Current Population Survey. The 

data referred to below come from that survey unless otherwise noted. 

 As of March 2003, 57 percent of the nonelderly full-time wage and salary 

workers employed in the private sector reported that they worked in firms with 

an employer-sponsored pension plan in 2002 (Table 13-3). Slightly less than 

half (46 percent) of the full-time wage and salary workers employed in the 

private sector were covered by an employer-sponsored pension plan. 

 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 19 percent for 

those under age 25 to about 60 percent for those between ages 40 and 60 before 

falling off substantially for those over age 65. 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 (Table 13-4). 

 Higher paying jobs are more likely to offer pensions. Just 10 percent of 

full-time private wage and salary workers earning less than $10,000 per year in 

2002 were covered compared to 68 percent or more of those earning $50,000 or 

more (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. 

 

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. 
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TABLE 13-3 -- EMPLOYER SPONSORSHIP AND EMPLOYEE 

PARTICIPATION IN RETIREMENT PLANS, 2002 

[Private sector wage and salary workers]

Percent covered 

 Total Full-time Part-time 

Employer sponsorship 

Employer sponsors plans 52 57 33 

Employer does not sponsor plan 48 43 67 

Employee participation 

Employee participates 39 46 13 

Employee does not participate 61 54 87 

Number of workers, in thousands 118,146 94,611 23,535 

Source: Congressional Research Service analysis of the Census Bureau's March 2003 Current 

Population Survey. 

TABLE 13-4 -- PARTICIPATION IN EMPLOYER-SPONSORED 

RETIREMENT PLANS AMONG PRIVATE-SECTOR WAGE AND SALARY 

WORKERS EMPLOYED FULL-TIME IN 2002, 

BY WORKERS’ AGE 

Percent participating Worker's Age Total Men Women 

Under 25 19 19 20 

25-29 37 36 38 

30-34 44 44 44 

35-39 49 49 49 

40-44 53 53 52 

45-49 55 57 53 

50-54 58 60 55 

55-59 57 59 54 

60-64 54 54 53 

65 or older 36 35 38 

All workers 46 47 45 

Source: Congressional Research Service analysis of the Census Bureau's March 2003 Current 

Population Survey. 

TABLE 13-5 -- PARTICIPATION IN EMPLOYER-SPONSORED 

RETIREMENT PLANS AMONG PRIVATE-SECTOR WAGE AND SALARY 

WORKERS EMPLOYED FULL TIME IN 2002, BY WORKER'S EARNINGS 

Percent participating Worker's Earnings Total Men Women 

Under $10,000 10 10 10 

$10,000-14,999 16 13 19 

$15,000-19,999 27 22 31 

$20,000-24,999 35 29 42 

$25,000-29,999 45 39 52 

$30,000-34,999 51 47 56 

$35,000-39,999 56 54 58 

$40,000-49,999 62 61 65 

$50,000-74,999 68 67 70 

$75,000 or more 70 69 73 

All workers 46 47 45 

Source: Congressional Research Service analysis of the Census Bureau's March 2003 Current 

Population Survey. 
13-13 

 Coverage is much lower for smaller firms. Smaller firms are less likely 

to offer comprehensive fringe benefit packages as part of total compensation. 

Only 19 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 46 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, 13 percent are 

covered. Seventy-two percent of public sector wage and salary workers are 

covered including 80 percent of those who are full-time workers (Table 13-7). 

TABLE 13-6 -- PARTICIPATION IN EMPLOYER-SPONSORED 

RETIREMENT PLANS AMONG PRIVATE-SECTOR WAGE AND 

SALARY WORKERS EMPLOYED FULL TIME IN 2002, BY SIZE OF 

FIRM 

Percent participating Size of firm (Number of workers) Total Men Women 

Fewer than 10 19 18 19 

10-24 28 30 27 

25-99 41 42 39 

100-499 50 51 49 

500-999 57 60 55 

1,000 or more 62 65 59 

All workers 46 47 45 

Source: Congressional Research Service analysis of the Census Bureau's March 2003 Current 

Population Survey. 

 

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 in 1979, 1983, 1988, and 1993 showed that coverage remained fairly 

constant, never falling below 46 percent or rising above 50 percent. However, 

the survey in 1998 showed a drop in coverage to 43 percent. The most recent 

survey in 2003 showed coverage at 46 percent (Table 13-3). 

 For workers with pension coverage, there has been a shift away from 

defined benefit plans. Of the private wage and salary workers covered by a 

pension plan in 1975, 87 percent were covered by a defined benefit plan (Turner 

& Beller, 1989, pp. 65 & 357). This proportion dropped to 83 percent by 1980 

and to 71 percent by 1985. This proportion dropped even lower to 65 percent in 

1993 (Department of Labor, 1994, tables A2, B1, B2). This shifting composition 

has largely been the result of rapid growth in primary defined contribution plans. 
13-14 

Employee stock ownership plans and 401(k) plans have been among the most 

rapidly growing defined contribution plans. 

TABLE 13-7 -- PARTICIPATION IN EMPLOYER-SPONSORED 

RETIREMENT PLANS AMONG ALL WAGE AND SALARY 

WORKERS IN 2002, BY SECTOR OF EMPLOYMENT 

Percent participating Sector of employment Total Full-time Part-time 

All wage and salary workers 45 52 15 

Men 46 51 10 

Women 43 52 18 

Private sector 39 46 13 

Men 42 47 9 

Women 37 45 15 

Public sector 72 80 30 

Men 74 80 21 

Women 69 79 33 

Source: Congressional Research Service analysis of the Census Bureau's March 2003 Current 

Population Survey. 

 INDIVIDUAL RETIREMENT ARRANGEMENTS “IRAS” 

LEGISLATIVE HISTORY 

 

 ERISA added section 219 to the Internal Revenue Code, providing a tax 

deduction for certain contributions to 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 

AGI); 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 
13-15 

withdrawal tax was waived for distributions from IRAs for education and firsttime home buyer expenses. 

 The annual limit on aggregate IRA contributions was increased again by 

The Economic Growth and Tax Relief Reconciliation Act of 2001 

(“EGTRRA”).2

 EGTRRA also allows individuals who have attained age 50 to 

make additional catch-up contributions to an IRA. 

EXPLANATION OF PROVISION 

Traditional IRAs

 An individual who is an active participant in an employer-sponsored 

retirement plan may deduct annual IRA contributions up to the lesser of $3,000 

(for 2003) or 100 percent of compensation if the individual's adjusted gross 

income (AGI) does not exceed certain limits. 

 The maximum deduction for IRA contributions for an individual who has 

attained age 50 before the end of the year is increased by a certain dollar amount 

($500 for 2003). (The maximum dollar limit on IRA contributions applies to 

aggregate IRA contributions of an individual, including contributions to a Roth 

IRA.) 

 If an individual (or the individual’s spouse) is an active participant in an 

employer-sponsored retirement plan, the deduction is phased out for taxpayers 

with adjusted gross income over certain levels for the taxable year. The adjusted 

gross income phase-out limits for taxpayers who are active participants in 

employer-sponsored plans are as follows: 

Single Taxpayers 

Taxable years beginning in: Phase-out range 

2003 40,000-50,000 

2004 45,000-55,000 

2005 and thereafter 50,000-60,000 

Joint Returns 

Taxable years beginning in: Phase-out range

2003 60,000-70,000 

2004 65,000-75,000 

2005 70,000-80,000 

2006 75,000-85,000 

2007 and thereafter 80,000-100,000 

 The adjusted gross income phase-out range for married taxpayers filing a 

separate return is $0 to $10,000. 

 An individual who is not an active participant, but whose spouse is, may 

make a full deductible IRA contribution if the AGI for the couple does not 

exceed $150,000. The deduction limit in such cases is phased out for AGI 

between $150,000 and $160,000. An individual who is not an active participant 

 

2

 The provisions of EGTTRA generally do not apply for years beginning after December 31, 2010. 
13-16 

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 

includible in income. A 10-percent additional income tax applies unless the 

withdrawal: (1) is made after the IRA owner attains age 591⁄2 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); (4) is made to pay medical expenses in excess of 7.5 percent of 

AGI or for health insurance premiums for unemployed individuals; or (5) is 

made for first-time home buyer expenses (subject to a $10,000 lifetime cap) or 

for qualified higher education expenses. 

Nondeductible IRAs 

 An individual may make nondeductible contributions to a traditional 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 includible in income when 

withdrawn. The 10-percent early withdrawal tax applies to such earnings, 

subject to the exceptions for IRAs as described above. 

Roth IRAs

 Individuals with adjusted gross income below certain levels may make 

nondeductible contributions to a Roth IRA. The maximum annual contribution 

that may be made to a Roth IRA is the lesser of a certain dollar amount ($3,000 

for 2003) or the individual’s compensation for the year. An individual who has 

attained age 50 before the end of the taxable year also may make catch-up 

contributions to a Roth IRA up to a certain dollar amount ($500 for 2003). The 

contribution limit is reduced to the extent an individual makes contributions to 

any other IRA for the same taxable year. The maximum annual contribution 

that can be made to a Roth IRA is phased out for single individuals with 

adjusted gross income between $95,000 and $110,000 and for joint filers with 

adjusted gross income between $150,000 and $160,000. The adjusted gross 

income phase-out range for married taxpayers filing a separate return is $0 to 

$10,000. 

 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 591⁄2, 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 includible in income, to the extent earnings are included in the distribution, 
13-17 

and are subject to the 10-percent tax on early withdrawal, unless an exception 

applies, as described above for traditional IRAs. 

 Taxpayers with AGI of less than $100,000 may convert an IRA to a Roth 

IRA at any time. If the conversion was made before January 1, 1999, the 

amounts that would have been includible in income had the amounts converted 

been withdrawn are includible in income ratably over four years. The 10-percent 

tax on early withdrawals does not apply to conversions of IRAs to Roth IRAs. 

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 

peaked at 16.2 million in 1985. In 1987, only 7.3 million taxpayers reported 

deductible contributions. Since then, the number generally has continued to fall 

(Table 13-8). 

 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. 

 Before EGTRRA, eligibility percentages and the real value of the IRA 

contribution limits declined over time because prior law did not index the 

contribution limits or the income eligibility limits for inflation. For example, the 

real value of a $2,000 contribution declined more than 38 percent between 1986 

and 2001 because of inflation. Under EGTRRA, the IRA contribution limit 

increases to $5,000 in 2008 and is indexed for inflation (subject to the general 

EGTRRA sunset for years beginning after December 31, 2010). 

 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). 
13-18 

TABLE 13-8 -- USE OF DEDUCTIBLE IRAs, 1980-2000 

Year Number of tax returns deducting IRA 

contributions (millions) Total IRA deductions (billions) 

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 

1996 4.4 8.6 

1997 4.1 8.7 

1998 3.9 8.2 

1999 3.7 7.9 

2000 3.5 7.5 

Source: Internal Revenue Service, Statistics of Income, various years. 

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 1941.32

 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 employerprovided retirement benefits. The Consolidated Omnibus Budget Reconciliation 

 

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. 
13-19 

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 AGI exceeds certain limits, a portion of 

Social Security and tier 1 railroad retirement benefits is included in taxable 

income. Modified AGI is AGI 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 AGI 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 AGI 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, 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 

 Approximately one-third 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 CONTRIBUTIONS 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 
13-20 

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 
13-21 

dollar's worth of health insurance for the employee.43 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. 

 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. According to a special analysis of data from the 

Current Population Survey conducted by the Congressional Budget Office, 

nearly 75 percent of all workers under age 65 were covered by employmentbased health insurance. Slightly over 4 percent of the workers under age 65 

purchased insurance privately and nearly 3 percent received public insurance 

either through Medicare, Medicaid, or the Department of Veterans Affairs. The 

analysis reveals that slightly more than 18 percent of the workers under age 65 

had no health insurance, up from 15 percent in 1996 (Committee, 1998, pp. 853-

54). 

 Health coverage through employer-based plans tends to be more 

prevalent in the finance, government, manufacturing, mining, professional 

service, transportation, and wholesale trade sectors of the economy; among 

medium and large firms; for more highly paid workers; and among those over 

age 30 (Table 13-9). 

TAX CREDIT FOR HEALTH INSURANCE OF ELIGIBLE 

INDIVIDUALS 

 The Trade Act of 2002 created a refundable tax credit equal to 65 percent 

of an eligible taxpayer’s expenses for qualified health insurance of the taxpayer 

and qualifying family members for certain periods. Eligible individuals include 

eligible TAA recipients, eligible alternative TAA recipients, and eligible PBGC 

pension recipients. The credit is payable on an advanced basis. 

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. MSAs were renamed Archer MSAs by the 

Community Renewal Tax Relief Act of 2000 (P.L. 106-554). Within limits, 

contributions to an Archer 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 

 

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). 
13-22 

an Archer MSA are not currently taxable. Distributions from an Archer MSA for 

medical expenses are not includible in gross income. Distributions from an 

Archer MSA that are not for medical expenses are includible in gross income 

and are subject to an additional tax of 15 percent, unless the distribution is made 

after death, disability, or age 65. 

TABLE 13-9--PRIMARY SOURCE OF HEALTH INSURANCE FOR 

WORKERS UNDER AGE 65, BY DEMOGRAPHIC CATEGORY, 

MARCH 2003 

Percentage distribution by source of insurance 

Category 

Number of 

Workers 

(millions) 

Own or 

Other 

Employer

Individual 

Policy 

Public 

Insurance1

No 

Insurance 

Industry: 

 Agriculture 1.8 49.9 12.9 6.1 31.0 

 Mining 0.6 83.8 2.6 1.2 12.5 

 Construction 10.2 59.8 5.6 2.1 32.6 

 Manufacturing 16.7 83.1 2.0 1.6 13.3 

 Wholesale & Retail Trade 18.4 73.4 4.2 3.1 19.3 

 Transportation & Utilities 6.9 78.3 2.7 1.7 17.3 

 Information 3.5 84.5 3.0 1.5.0 11.0 

 Financial Activities 9.4 82.7 5.8 1.1 10.4 

 Professional & Business Services 14.0 73.2 5.3 2.5 19.0 

 Education & Health Services 27.2 83.4 3.2 2.7 10.7 

 Leisure & Hospitality 9.9 53.7 5.0 5.5 35.8 

 Other Services 6.1 59.7 8.2 3.8 28.2 

 Public Administration 5.8 92.6 1.3.0 1.0 5.1 

Family Income (as a percentage of poverty): 

 Under 100 8.5 28 5.6 18.9 47.5 

 100--199 18.7 49.7 4.5 7.2 38.6 

 200--299 22.8 69.9 4.3 2.6 23.2 

 300 or more 87.8 85.7 4.0 0.6 9.7 

Firm Size (number of employees): 

 Fewer than 10 27.5 51.1 12.2 4.4 32.3 

 10 - 24 12.9 65 4.9 3.9 26.2 

 25 - 99 17.9 73.9 2.8 3.2 20.1 

 100 - 499 19.0 82.2 1.9 2.5 13.5 

 500 - 999 7.5 85.7 1.7 2.0 10.6 

 1,000 or more 52.9 85.3 1.6 2.2 10.9 

Age: 

 Under 30 31.0 61.1 3.4 5.7 29.8 

 30-39 35.4 75.3 3.4 3.0 18.2 

 40-49 37.7 79.3 4.4 2.0 14.3 

 50-64 33.7 81.3 5.6 1.5 11.7 

Region: 

 Northeast 26.0 77.2 3.4 3.5 15.9 

 Midwest 32.0 78.6 4.1 3 14.3 

 South 48.3 72.7 4.2 2.4 20.8 

 West 31.5 71.7 5.0 3.3 20.0 

All nonelderly workers 137.8 74.7 4.2 3.0 18.2 1

 Public insurance includes Medicaid, SCHIP, Medicare, and other government health care. 

Source: Congressional Budget Office estimates based on the March 2003 Current Population Survey. 
13-23 

 Archer MSAs are available to employees covered under an employersponsored 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 Archer 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 adjusted annual deductible amounts for tax years beginning in 

2003 are between $1,700 and $2,500 for individual coverage and between 

$3,350 and $5,050 for 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 Archer 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 pilot period 1997-2003, 

only those individuals who (1) made an MSA contribution or had an employer 

Archer MSA contribution for the year or a preceding year (i.e., are active Archer 

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, Archer MSAs of previously uninsured individuals are 

not taken into account. 

 After December 31, 2003, no new contributions may be made to Archer 

MSAs except by or on behalf of an individual who previously had Archer MSA 

contributions and employees who are employed by a participating employer. 

Self-employed individuals who made contributions to an Archer MSA during 

the period 1997-2003 also may continue to make contributions after 2003. 

HEALTH SAVINGS ACCOUNTS 

 The Medicare Prescription Drug, Improvement, and Modernization Act 

of 2003 (P.L. 108-173) added provisions for health savings accounts (HSAs), 

effective for taxable years beginning after December 31, 2003. Within limits, 

contributions to an HSA made by or on behalf of an eligible individual are 

deductible by the individual. Contributions to an HSA are excludable from 

income and employment taxes if made by the employer. Earnings on amounts 

in HSAs are not taxable. Distributions from an HSA for qualified medical 

expenses are not includible in gross income. Distributions from an HSA that are 

not used for qualified medical expenses are includible in gross income and are 

subject to an additional tax of 10 percent, unless the distribution is made after 
13-24 

death, disability, or the individual attains the age of Medicare eligibility (i.e., 

age 65). 

 Eligible individuals for HSAs are individuals who are covered by a high 

deductible health plan and no other health plan that is not a high deductible 

health plan. A high deductible health plan is a health plan that has a deductible 

that is at least $1,000 for self-only coverage or $2,000 for family coverage 

(indexed for inflation) and that has an out-of-pocket expense limit that is no 

more than $5,000 in the case of self-only coverage and $10,000 in the case of 

family coverage. 

 The maximum aggregate annual contribution that can be made to an HSA 

is the lesser of (1) 100 percent of the annual deductible under the high 

deductible health plan, or (2) the maximum deductible permitted under an 

Archer MSA high deductible health plan under present law, as adjusted for 

inflation. For 2004, the amount of the maximum deductible under an Archer 

MSA high deductible health plan is $2,600 in the case of self-only coverage and 

$5,150 in the case of family coverage. The annual contribution limits are 

increased for individuals who have attained age 55 by the end of the taxable 

year. In the case of policyholders and covered spouses who are age 55 or older, 

the HSA annual contribution limit is greater than the otherwise applicable limit 

by $500 in 2004, $600 in 2005, $700 in 2006, $800 in 2007, $900 in 2008, and 

$1,000 in 2009 and thereafter. 

 

CAFETERIA PLANS 

LEGISLATIVE HISTORY 

 Under present law, compensation generally is includible 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 (P.L. 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. 
13-25 

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 to such individuals. 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 after-tax benefit to the employee at minimum after-tax 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 Federal Unemployment Tax Act (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 after-tax 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 
13-26 

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 1997, 

52 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 1996, only 23 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, 1996). 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 
13-27 

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 
13-28 

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). 
13-29 

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 
13-30 

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 $220 per day for calendar year 2003 ($80,520 annually) as 

indexed,4

 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 includible 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. 
13-31 

 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 AGI). 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 longterm care insurance contract. In addition, certain consumer protection provisions 

apply to issuers of long-term care insurance contracts. 

DEDUCTION FOR HEALTH INSURANCE EXPENSES OF SELFEMPLOYED INDIVIDUALS 

 Self-employed individuals may currently deduct 100 percent of their 

health insurance expenses for themselves and their spouses and dependents. The 
13-32 

deduction also applies to certain long-term care premiums treated as medical 

expenses. 

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 includible 

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. 
13-33 

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 

after-tax 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 AGIs above a certain limit ($139,500 

for 2003, 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. 

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 13-11). 
13-34 

TABLE 13-10 -- TAX RETURNS CLAIMING DEDUCTIBLE MEDICAL 

AND DENTAL EXPENSES, 1980-2000 

Returns claiming medical and dental expenses 

in excess of the AGI floor 

Year Number of returns filed 

(in millions) Number of returns

(in millions) 

Expenses in excess of the 

AGI floor 

(in billions) 

Average 

amount 

over floor 

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 2,741 

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 

1996 120.4 5.4 27.0 5,003 

1997 122.4 5.3 29.3 5,571 

1998 124.8 5.6 32.0 5,753 

1999 127.1 5.9 35.4 6,012 

2000 129.4 6.5 39.3 6,027 

Source: Internal Revenue Service. 

 TABLE 13-11 -- DISTRIBUTION OF ITEMIZED DEDUCTIONS 

FOR MEDICAL EXPENSES, 2003 

Income class1 Average 

deduction 

Returns 

(thousands) 

Total amount 

(billions)2

Below $10,000 $6,064 256 $1.5 

$10,000-$20,000 4,702 378 1.8 

$20,000-$30,000 7,785 749 5.8 

$30,000-$40,000 6,629 908 6.0 

$40,000-$50,000 7,072 852 6.0 

$50,000-$75,000 7,532 1554 11.7 

$75,000-$100,000 7,770 807 6.3 

$100,000-$200,000 13,545 477 6.5 

$200,000 and over 26,544 56 1.5 

 Total 7.805 6,035 47.1 

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: Joint Committee on Taxation. 
13-35 

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 certain income range. The income ranges and percentages have been 

revised several times since original enactment, expanding the credit (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. They 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 modified 

AGI phase-out 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. 

 EGTRRA made several changes to the EIC to provide marriage penalty 

relief and promote simplification, including: (1) increasing the beginning and 

ending amounts of the phase out ranges by $1,000 (for 2002-2004), $2,000 (for 

2005-2007), and $3,000 (in 2007, indexed thereafter) for married taxpayers who 

file a joint return; (2) excluding nontaxable employee compensation from the 

definition of earned income; (3) repealing the reduction of the EIC by the 

amount of an individual’s alternative minimum tax; (4) eliminating the need to 

calculate modified adjusted gross income for EIC purposes; (5) expanding the 

relationship test for purposes of qualifying child, and eliminating the 

requirement that certain individuals have the same principal place of abode as 

the taxpayer for the entire year; (6) simplifying the tie-breaker rule that applies 

if multiple taxpayers claim the same qualifiying child; and 

(7) effective January 1, 2004, with respect to noncustodial parents, expanding 

the math error authority of the Internal Revenue Service based on the Federal 

Case Registry of Child Support Orders. 
13-36 

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 2003 of 

34 percent of their earnings up to $7,490, resulting in a maximum credit of 

$2,547. The maximum credit is available for those with earnings between 

$7,490 and $13,730 ($14,730 if married filing jointly). The credit begins to 

phase down at a rate of 15.98 percent of earnings above $13,730 ($14,730 if 

married filing jointly). The credit is phased down to $0 at $33,692 of earnings 

($34,692 if married filing jointly). 

 Taxpayers with more than one qualifying child may claim a credit in 

2003 of 40 percent of earnings up to $10,510, resulting in a maximum credit of 

$4,204. The maximum credit is available for those with earnings between 

$10,510 and $13,730 ($14,720 if married filing jointly). The credit begins to 

phase down at a rate of 21.06 percent of earnings above $13,730 ($14,730 if 

married filing jointly). The credit is phased down to $0 at $33,692 of earnings 

($34,692 if married filing jointly). 

 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 $4,990, 

resulting in a maximum credit of $382. The maximum credit is available for 

those with incomes between $4,990 and $6,240 ($7,240 if married filing 

jointly). The credit begins to phase down at a rate of 7.65 percent of earnings 

above $6,240 ($7,240 if married filing jointly) resulting in a $0 credit at $11,230 

of earnings ($12,230 if married filing jointly). 

 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 (1) a child, 

stepchild, or descendant of a child or of a sibling or stepsibling. The residency 

test requires that the individual have the same place of abode as the taxpayer for 

more than half the taxable year. The households 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. 
TABLE 13-12 -- EARNED INCOME CREDIT PARAMETERS, 1975-2003 

Phaseout range 

Non joint filers Joint filers Calendar year Credit rate (percent) 

Minimum 

income for 

maximum 

credit 

Maximum 

credit 

Phaseout 

rate 

(percent) Beginning income Ending income Beginning income Ending income 

1975-1978 10.00 $4,000 $400 10.00 $4,000 $8,000 NA NA 1979-1984 10.00 5,000 500 12.50 6,000 10,000 NA NA 1985-1986 14.00 5,000 550 12.22 6,500 11,000 NA NA 1987 14.00 6,080 851 10.00 6,920 15,432 NA NA 1988 14.00 6,240 874 10.00 9,840 18,576 NA NA 1989 14.00 6,500 910 10.00 10,240 19,340 NA NA 1990 14.00 6,810 953 10.00 10,730 20,264 NA NA 1991: 

One child 16.70 7,140 1,192 11.93 11,250 21,250 NA NA 

Two children 17.30 7,140 1,235 12.36 11,250 21,250 NA NA 

1992: 

One child 17.60 7,520 1,324 12.57 11,840 22,370 NA NA Two children 18.40 7,520 1,384 13.14 11,840 22,370 NA NA 

1993: 

One child 18.50 7,750 1,434 13.21 12,200 23,050 NA NA Two children 19.50 7,750 1,511 13.93 12,200 23,050 NA NA 

1994: 

No children 7.65 4,000 306 7.65 5,000 9,000 NA NA One child 26.30 7,750 2,038 15.98 11,000 23,755 NA NA 

Two children 30.00 8,425 2,528 17.68 11,000 25,296 NA NA 

1995: 

No children 7.65 4,100 314 7.65 5,130 9,230 NA NA One child 34.00 6,160 2,094 15.98 11,290 24,396 NA NA Two children 36.00 8,640 3,110 20.22 11,290 26,673 NA NA 

1996: 

No children 7.65 4,220 323 7.65 5,280 9,500 NA NA One child 34.00 6,330 2,152 15.98 11,610 25,078 NA NA Two children 40.00 8,890 3,556 21.06 11,610 28,495 NA NA 
TABLE 13-12 -- EARNED INCOME CREDIT PARAMETERS, 1975-2003- continued 

Phaseout range 

Non joint filers Joint filers Calendar year Credit rate (percent) 

Minimum 

income for 

maximum 

credit 

Maximum 

credit 

Phaseout 

rate 

(percent) Beginning income Ending income Beginning income Ending income 

1997: 

No children 7.65 4,340 332 7.65 5,430 9,770 NA NA 

One child 34.00 6,500 2,210 15.98 11,930 25,750 NA NA 

Two children 40.00 9,140 3,656 21.06 11,930 29,290 NA NA 

1998: 

No children 7.65 4,460 341 7.65 5,570 10,030 NA NA One child 34.00 6,680 2,271 15.98 12,260 26,473 NA NA Two children 40.00 9,390 3,756 21.06 12,260 30,095 NA NA 

1999: 

No children 7.65 4,530 347 7.65 5,670 10,200 NA NA One child 34.00 6,800 2,312 15.98 12,460 26,928 NA NA Two children 40.00 9,540 3,816 21.06 12,460 30,580 NA NA 

2000 

No children 7.65 4,610 353 7.65 5,770 10,380 NA NA One child 34 6,920 2,353 15.98 12,690 27,415 NA NA 

Two children 40 9,720 3,888 21.06 12,690 31,152 NA NA 

2001  No children 7.65 4,760 364 7.65 5,950 10,710 NA NA 

One child 34 7,140 2,428 15.98 13,090 28,281 NA NA Two children 40 10,020 4,008 21.06 13,090 32,121 NA NA 

2002 

No children 7.65 4,910 376 7.65 6,150 11,060 7,150 12,060 One child 34 7,370 2,506 15.98 13,520 29,201 14,520 30,201 

Two children 40 10,350 4,140 21.06 13,520 33,178 14,520 34,178 

2003 

No children 7.65 4,990 382 7.65 6,240 11,230 7,240 12,230 One child 34 7,490 2,547 15.98 13,730 29,666 14,730 30,666 Two children 40 10,510 4,204 21.06 13,730 33,692 14,730 34,692 

Source: Joint Committee on Taxation. 
13-39 

 

 An individual is not eligible for the EIC if the aggregate amount of 

disqualified income of the taxpayer for the taxable year exceeds $2,600 (for 

2003). 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 AGI, if greater) in excess of the 

beginning of the phaseout range, the maximum EIC amount is reduced by the 

phaseout rate multiplied by the amount of earned income (or AGI, if greater) in 

excess of the beginning of the phaseout range. For taxpayers with earned income 

(or AGI, if greater) in excess of the end of the phaseout range, no credit is 

allowed. 

 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 selfemployment 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. 
13-40 

INTERACTION WITH MEANS-TESTED PROGRAMS 

 The treatment of the EIC for purposes of Aid to Families with Dependent 

Children (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 19.2 million taxpayers are expected to take advantage of the 

EIC for 2003 (Table 13-13). Their claims are expected to total $34 billion, 

approximately 90 percent of which will be refunded as direct payments to these 

families (Table 13-14). As Table 13-13 also shows, approximately 75 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 EIC 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. 
13-41 

TABLE 13-13 -- DISTRIBUTION OF EARNED INCOME CREDIT, 2003 

Joint returns Head of household 

and single returns All returns Income class 

Number Amount Number Amount Number Amount 

Below $10,000 510 $816 5,062 $6,129 5,572 $6,945 

$10,000-$20,000 1,033 2,851 4,505 10,901 5,538 13,752 

$20,000-$30,000 1,327 3,007 3,207 6,758 4,534 9,766 

$30,000-$40,000 1,229 1,543 1,765 1,976 2,994 3,519 

$40,000-$50,000 397 262 210 130 608 392 

$50,000-$75,000 36 37 2 2 38 39 

$75,000 and over 0 0 0 0 0 0 

Total 4,533 8,516 14,752 25,896 19,284 34,412 

Percent distribution by 

type of return 23.5 24.8 76.5 75.3 100.0 100.0 

Note- Numbers in thousands; amount in millions of dollars. Detail may not add due to rounding. 

Source: Joint Committee on Taxation. 

 

TABLE 13-14 -- EARNED INCOME CREDIT: NUMBER OF RECIPIENTS 

AND AMOUNT OF CREDIT, 1975-2003 

Year 

Number of 

recipient families 

(thousands) 

Total amount 

of credit 

(millions) 

Refunded 

portion of credit 

(millions) 

Average credit 

per 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 19,017 21,105 16,598 1,110 

1995 19,334 25,956 20,829 1,342 

1996 19,464 28,825 23,157 1,481 

1997 19,391 30,389 24,396 1,567 

1998 20,273 32,340 27,175 1,595 

1999 19,259 31,901 27,604 1,656 

2000 19,277 32,296 27,803 1,675 

2001 19,593 33,376 29,043 1,704 

20021

 19,795 35,784 31,769 1,808 

20031

 19,284 34,412 30,869 1,784 1

 Preliminary 

Source: For 1975-2001, Internal Revenue; for 2002-2003, Joint Committee on Taxation. 
13-42 

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 

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. 

 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. 
13-43 

 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 five to two 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 Job Protection Act of 1996 required a TIN for all 

children for whom a dependent care credit may be claimed. 

 EGTRRA increased the credit rate for lower-income taxpayers, as well as 

the maximum eligible expense amount for the credit for all taxpayers. 

EXPLANATION OF PROVISION 

 A taxpayer may claim a nonrefundable credit against income tax liability 

for up to 35 percent of a limited amount of employment-related dependent care 

expenses. Eligible employment-related expenses are limited to $3,000 if there is 

one qualifying dependent or $6,000 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 35-percent credit rate is reduced, but not below 20 percent, by 1 

percentage point for each $2,000 (or fraction thereof) of AGI above $15,000. 
13-44 

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 2001, the number of families that claimed the dependent 

care credit increased from 2.7 to a projected 6.3 million, the aggregate amount 

of credits claimed increased from $0.5 to $2.7 billion, and the average amount of 

credit claimed per family increased from $206 to $440 (table 13-15). 

 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 1997 from the Internal Revenue Service show that about 10 

percent of the benefit from the credit accrues to families with AGI of less than 

$20,000; about 42 percent to families with AGI between $20,000 and $50,000; 

and about 48 percent to families with AGI above $50,000. 

TABLE 13-15 -- DEPENDENT CARE TAX CREDIT: NUMBER OF 

FAMILIES AND AMOUNT OF CREDIT, 1976-2001 

Year 

Number of returns 

claiming credit 

 (thousands) 

Aggregate amount 

of credit claimed 

(millions) 

Average credit 

claimed per return 

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 5,796 2,464 425 

1998 6,128 2,661 434 

1999 6,182 2,677 432 

2000 6,368 2,794 439 

20011

 6,335 2,741 440 1

 Preliminary. 

Source: Joint Committee on Taxation. 
13-45 

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 two 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 $1,500 maximum HOPE credit amount is indexed for inflation. 

 The lifetime learning credit rate is 20 percent of up to $10,000 in 

qualified tuition and fees 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 halftime 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 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 adjusted gross income (AGI) between 

$41,000 and $51,000 ($83,000 and $103,000 for joint returns). These phaseouts are indexed for inflation. For a taxable year, a taxpayer may elect with 

respect to an eligible student either the HOPE credit, the lifetime learning credit, 

or the deduction for qualified tuition and related expenses. 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. 
13-46 

QUALIFIED TUITION PROGRAMS AND COVERDELL EDUCATION 

SAVINGS ACCOUNTS 

 The Taxpayer Relief Act of 1997 and EGTRRA modified section 529 of 

the Tax Code, which governs the tax treatment of qualified tuition programs. 

Section 529 was enacted as part of the Small Business Job Protection Act of 

1996, and provided tax-exempt status and deferral of tax on earnings of 

qualified State tuition programs. The Taxpayer Relief Act of 1997 also provided 

that taxpayers may establish education IRAs. (Renamed Coverdell Education 

Savings Accounts by P.L. 107-22). EGTRRA extended the provisions to 

programs established by eligible education institutions. 

 Qualified State tuition programs are programs established and maintained 

by a State or agency or instrumentality thereof or by one or more eligible 

educational institutions under which persons may: (1) purchase tuition credits or 

certificates 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) in the case of a program established by a State agency or instrumentality 

thereof make contributions to an account that is established for the purpose of 

meeting qualified higher education expenses 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 qualified tuition programs are not deductible. 

EGTRRA provided that earnings on qualified tuition programs are not includible 

in income if used for qualified expenses. Distributions from a qualified 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 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. Withdrawals of earnings that are not used for qualified expenses 

are includible in income and also are subject to an additional 10 percent tax. 

 A Coverdell Education Savings Account is a trust or custodial account 

created exclusively for the purpose of paying qualified higher education 

expenses of a named beneficiary. Contributions to a Coverdell Education 

Savings Account are not deductible; earnings on contributions are not currently 

includable in income. Contributions to a Coverdell education savings account 

are limited to $2,000 per year per beneficiary. The contribution limit is phased 

out ratably for contributions with modified AGI between $95,000 and $110,000 

($190,000 and $220,000 for joint returns). With respect to post-secondary 

education, qualified expenses are the same as those for qualified tuition 

programs. Qualified expenses also include elementary and secondary education 

expenses. Qualified elementary and secondary education expenses include 
13-47 

tuition, fees, academic tutoring, special needs services, books, supplies, room 

and board, and education-related computer equipment and software. 

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. 

STUDENT LOAN INTEREST DEDUCTION 

 The Taxpayer Relief Act of 1997 provided for the above-the-line 

deductibility of interest on qualified education loans. 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 a Coverdell education savings account or qualified 

tuition program 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 $2,500 and is not indexed for inflation. This 

deduction is phased out ratably for individuals with modified AGI of $50,000-

$65,000 ($100,000 and $130,000 for joint returns). These income ranges are 

indexed for inflation and rounded down to the closest multiple of $5,000. 

QUALIFIED TUITION DEDUCTION 

The Economic Growth and Tax Relief Reconciliation Act of 2001 added 

an above-the-line deduction for qualified tuition and related expenses paid by 

the taxpayer during a taxable year. Qualified expenses are defined in the same 

manner as for the purposes of the HOPE credit. 

In 2002 and 2003, taxpayers with adjusted gross income that does not 

exceed $65,000 ($130,000 in the case of married couples filing joint returns) are 

entitled to a maximum deduction of $3,000 per year. Taxpayers with adjusted 

gross income above these thresholds would not be entitled to a deduction. In 

2004 and 2005, taxpayers with adjusted gross income that does not exceed 
13-48 

$65,000 ($130,000 in the case of married taxpayers filing joint returns) are 

entitled to a maximum deduction of $4,000 and taxpayers with adjusted gross 

income that does not exceed $80,000 ($160,000 in the case of married taxpayers 

filing joint returns) are entitled to a maximum deduction of $2,000. The 

deduction is not available in 2006 and thereafter. 

Taxpayers are not eligible to claim the deduction and a HOPE or Lifetime 

Learning Credit in the same year with respect to the same student. A taxpayer 

may not claim a deduction for amounts taken into account in determining the 

amount excludable due to a distribution (i.e., the earnings and contribution 

portion of a distribution) from a Coverdell education savings account or the 

amount of interest excludable with respect to education savings bonds. A 

taxpayer may not claim a deduction for the amount of a distribution from a 

qualified tuition program that is excludable from income; however, a taxpayer 

may claim a deduction for the amount of a distribution from a qualified tuition 

program that is not attributable to earnings. 

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 
13-49 

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 

AFDC); (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. 
13-50 

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 January 

1, 2004. 

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 two 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 two 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 
13-51 

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 January 1, 2004. 

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. 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 
13-52 

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 

$950 in 2003 for an elderly or a blind individual who is married (whether filing 

jointly or separately) or is a surviving spouse, and $1,900 for such an individual 

who is both elderly and blind. The additional amount is $1,150 for a head of 

household who is elderly or blind ($2,300, 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 

 In 2000, approximately 11.3 million taxpayers claimed the extra standard 

deduction. About 76 percent of the 11.3 million beneficiaries had incomes of 

less than $40,000. 

 
13-53 

TAX CREDIT FOR THE ELDERLY AND CERTAIN DISABLED 

INDIVIDUALS 

LEGISLATIVE HISTORY 

 The present tax credit for individuals who are age 65 or older, 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). 
13-54 

EFFECT OF PROVISION 

 

 In 2000, $33 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 

1976-2000 

Year Number of families that 

received credit (thousands) 

Total amount of credit 

(millions) 

Average credit 

per return 

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 252 48 191 

1996 168 32 189 

1997 190 41 217 

1998 180 36 198 

1999 182 34 185 

2000 156 33 209 

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. 
13-55 

 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 five out 

of the last eight 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 by repealing the age 55 requirements and one-time 

applicability, and increasing the maximum excludible amount. 

Explanation of Provision

 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 two years. 

 To be eligible for the exclusion, a taxpayer must have owned the 

residence and occupied it as a principal residence for at least two of the five 
13-56 

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 two years that 

these requirements are met. 

Effects of Provision

 Preliminary tax return information for 2000 indicates that 35 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—66 percent of all American 

households own the homes they live in (U.S. Census Bureau, 1999, p. 729, table 

1212). 

 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 owneroccupied 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. The Community 

Renewal Tax Relief Act of 2000 increased and indexed the annual amount of 

allocable credits. 

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 lowincome 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 
13-57 

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 for 2003 is $1.75 per 

resident or $2.03 million in total, if larger. 

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 90 percent or greater since 1994. Year-toyear 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. 

 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 
13-58 

made available for allocation by other States. Thus, the amount allocated in any 

one year could be less than the States' authority, but such authority may 

ultimately be allocated. 

TABLE 13-17 -- ALLOCATION OF THE LOW-INCOME HOUSING 

CREDIT, 1987-2000 

Years Authority 

(millions) 

Allocated 

(millions) 

Allocated 

(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 

19911

 497.3 400.6 80.6 

19921

 476.4 332.7 70.0 

19931

 564.4 424.7 77.7 

19941

 523.7 495.5 94.7 

19951

 432.6 410.9 95.0 

19961

 391.6 379.9 97.0 

1997 387.3 382.9 98.9 

1998 376.8 373.8 99.0 

1999 373.6 370.0 99.0 

2000 382.3 378.7 99.0 

1

 Increased authority includes credits unallocated from prior years carried over to the current 

year. 

Source: Survey of the State allocating agencies conducted by the National Council of State 

Housing Agencies. 

TAX CREDIT AND EXCLUSION FOR ADOPTION EXPENSES 

 The Small Business Job Protection Act of 1996 (Public Law 104-188) 

enacted 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) was created to help defray onetime adoption expenses (Code section 23). The credit was phased out for 

families with incomes above $75,000, and was unavailable to families with 

incomes above $115,000. Second, employees could 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 (Code section 137). Under 

the Act, the credit (other than for foreign special-needs adoptions) and the 

exclusion were not available after December 31, 2001. 

 EGTRRA and the Job Creation and Worker’s Assistance Act of 2002 

(“JCWAA”) made several changes to these provisions. EGTRRA, as clarified 

by JCWWA: (1) made permanent the adoption credit and exclusion for 

employer-provided assistance; (2) increased the maximum credit and exclusion 

amounts to $10,000; (3) provided that the maximum credit and exclusion 

amounts for special-needs adoption expenses are available regardless of whether 

the taxpayer has qualified adoption expenses (effective after 2002); and (4) 

increased the beginning and end points of the income phase out ranges to 

$150,000 and $190,000, respectively, for both the credit and the exclusion. 
13-59 

EGTTRA also provided that the dollar limits and the income limitations of the 

credit and the exclusion are adjusted for inflation in taxable years beginning 

after December 31, 2002. For 2003, the maximum credit and exclusion amounts 

are $10,160 and the beginning and end points of the income phase out ranges are 

$152,390 and $192,390, respectively. 

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 AGI in excess of certain thresholds, 

the allowable child credit is phased out. 

 EGTRRA increased the child credit on a phased in basis, reaching 

$1,000 in 2011, and provided for limited refundability of the credit. JCWAA 

accelerated this increase in the credit to $1,000, effective for 2003 and 2004, and 

expanded the refundability of the credit. 

 The child credit is refundable to the extent of 10 percent of the taxpayer’s 

earned income in excess of $10,500 (indexed for inflation) in 2003. This 

percentage is increased to 15 percent for calendar year 2005 and thereafter. 

Families with three or more children are allowed a refundable credit for the 

amount by which the taxpayer’s Social Security taxes exceed the taxpayer’s 

earned income credit, if that amount is greater than the refundable credit based 

on the taxpayer’s earned income in excess of $10,500. 

 For taxpayers with modified AGI in excess of certain thresholds, the child 

credit is phased out. The phase out 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. 

EFFECT OF TAX PROVISIONS ON THE INCOME AND TAXES OF 

THE ELDERLY AND THE POOR 

 Tables 13-18 and 13-19 present actual and projected values of the 

personal exemptions, standard deductions, additional standard deductions for the 

elderly and the blind, and taxable income brackets for 1996-2013. The figures 

for 2004-13 are based on Congressional Budget Office projections. The value to 
13-60 

taxpayers of personal exemptions, standard deductions, and additional standard 

deductions for the elderly and the blind (with the exception of joint filers after 

2010) will grow 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 2003 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 EIC, 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 

2002, a single elderly individual with $5,000 in Social Security benefits can 

have up to $8,850 in other income without incurring tax liability (or total income 

of $13,850). An elderly married couple filing jointly with $5,000 in excluded 

Social Security benefits has a tax threshold of $15,650 (or total income of 

$20,650). By comparison, the poverty thresholds in 2002 for a single elderly 

person and an elderly couple were $8,628 and $10,874, respectively. Table 13-

21 displays similar information for other years and for varying amounts of 

Social Security benefits. 

 The combination of these tax provisions means that an estimated 50 

percent of elderly individuals will have no tax liability, applying 2003 tax law to 

2000 population and income data (Table 13-22). 
TABLE 13-18 -- ACTUAL PERSONAL EXEMPTIONS, STANDARD DEDUCTIONS, AND TAXABLE 

INCOME LEVELS, 1996-2003 

Exemption, deduction, or income level 1996 1997 1998 1999 2000 2001 2002 2003 

Personal exemptions 2,550 2,650 2,700 2,750 2,800 2,900 3,000 3,050 Standard deductions:  Joint 6,700 6,900 7,100 7,200 7,350 7,600 7,850 9,500  Single 4,000 4,150 4,250 4,300 4,400 4,550 4,700 4,750  Head of household 5,900 6,050 6,250 6,350 6,450 6,650 6,900 7,000 Additional standard deductions for elderly/blind: 

 Joint (each individual) 800 800 850 850 850 900 900 950  Single/head of household 1,000 1,000 1,050 1,050 1,100 1,100 1,150 1,150 

Taxable brackets: 

 First rate 0.0% 0.0% 0.0% 0.0% 0.0% 10.0% 10.0% 10.0%  Second rate 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 

 Third rate 28.0% 28.0% 28.0% 28.0% 28.0% 28.0% 28.0% 25.0% 

 Fourth rate 31.0% 31.0% 31.0% 31.0% 31.0% 31.0% 30.0% 28.0%  Fifth rate 36.0% 36.0% 36.0% 36.0% 36.0% 36.0% 35.0% 33.0% 

 Sixth rate 39.6% 39.6% 39.6% 39.6% 39.6% 39.1% 38.6% 35.0% 

Tax income levels:  Single 

 First rate 0 0 0 0 0 6,000 6,000 7,000 

 Second rate 24,000 24,650 25,350 25,750 26,250 27,050 27,950 28,350  Third rate 58,150 59,750 61,400 62,450 63,550 65,550 67,700 68,700 

 Fourth rate 121,300 124,650 128,100 130,250 132,600 136,750 141,250 143,350 

 Fifth rate 263,750 271,050 278,450 283,150 288,350 297,350 307,050 311,650 

 Joint 

 First rate 0 0 0 0 0 12,000 12,000 14,000 

 Second rate 40,100 41,200 42,350 43,050 43,850 45,200 46,700 56,700  Third rate 96,900 99,600 102,300 104,050 105,950 109,250 112,850 114,500 

 Fourth rate 147,700 151,750 155,950 158,550 161,450 166,500 171,950 174,500  Fifth rate 263,750 271,050 278,450 283,150 288,350 297,350 307,050 311,650 

 Head of household 

 First rate 0 0 0 0 0 10,000 10,000 10,000  Second rate 32,150 33,050 33,950 34,550 35,150 36,250 37,450 38,000 
TABLE 13-18 -- ACTUAL PERSONAL EXEMPTIONS, STANDARD DEDUCTIONS, AND TAXABLE 

INCOME LEVELS, 1996-2003-continued

Exemption, deduction, or income level 1996 1997 1998 1999 2000 2001 2002 2003 

 Third rate 83,050 85,350 87,700 89,150 90,800 93,650 96,700 98,150 

 Fourth rate 134,500 138,200 142,000 144,400 147,050 151,650 156,600 158,950 

 Fifth rate 263,750 271,050 278,450 283,150 288,350 297,350 307,050 311,650 

Source: Congressional Budget Office. 

TABLE 13-19 -- PROJECTED PERSONAL EXEMPTIONS, STANDARD DEDUCTIONS, AND TAXABLE 

INCOME LEVELS, 2004-2013 

Exemption, deduction, or 

income level 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 

Personal exemptions 3,100 3,200 3,250 3,350 3,400 3,500 3,600 3,700 3,750 3,850 Standard deductions:  Joint 9,700 8,600 9,350 9,700 10,150 11,000 11,200 9,600 9,850 10,100  Single 4,850 4,950 5,100 5,200 5,350 5,500 5,600 5,750 5,900 6,050  Head of household 7,150 7,300 7,500 7,650 7,850 8,050 8,250 8,450 8,650 8,900 Additional standard deductions for elderly/blind:  Joint (each individual) 950 950 1,000 1,000 1,050 1,100 1,100 1,150 1,150 1,200  Single/head of household 1,200 1,200 1,250 1,300 1,300 1,350 1,400 1,400 1,450 1,500 Taxable brackets 

 First rate 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 10.0% 0.0% 0.0% 0.0%

 Second rate 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0%  Third rate 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 28.0% 28.0% 28.0% 

 Fourth rate 28.0% 28.0% 28.0% 28.0% 28.0% 28.0% 28.0% 31.0% 31.0% 31.0%

 Fifth rate 33.0% 33.0% 33.0% 33.0% 33.0% 33.0% 33.0% 36.0% 36.0% 36.0%  Sixth rate 35.0% 35.0% 35.0% 35.0% 35.0% 35.0% 35.0% 39.6% 39.6% 39.6%

Tax income levels:  Single 

 First rate 7,000 6,000 6,000 6,000 7,000 7,175 7350 0 0 0  Second rate 29,050 29,650 30,350 31,100 31,900 32,700 33500 34350 35200 36050 

 Third rate 70,350 71,850 73,500 75,350 77,200 79,150 81,100 83,150 85,250 87,350 
 Fourth rate 146,700 149,850 153,350 157,150 161,100 165,100 169,250 173,450 177,800 182,250 

 Fifth rate 318,950 325,800 333,400 341,650 350,200 358,950 367,900 377,100 386,550 396,200 

 Joint 

 First rate 14,000 12,000 12,000 12,000 14,000 14,350 14,700 0 0 0  Second rate 58,100 53,350 56,750 60,000 63,800 65,400 67,000 57,350 58,800 60,250 

 Third rate 117,200 119,700 122,500 125,550 128,700 131,900 135,200 138,600 142,050 145,600  Fourth rate 178,600 182,450 186,700 191,300 196,100 201,000 206,050 211,200 216,450 221,850 

 Fifth rate 318,950 325,800 333,400 341,650 350,200 358,950 367900 377100 386550 396200 

 Head of household 

 First rate 10,000 10,000 10,000 10,000 10,000 10,250 10,500 0 0 0  Second rate 38,900 39,750 40,650 41,650 42,700 43,800 44,850 46,000 47,150 48,350 

 Third rate 100,450 102,600 105,000 107,600 110,300 113,050 115,850 118,750 121,750 124,750  Fourth rate 162,650 166,150 170,000 174,250 178,600 183,050 187650 192300 197150 202050 

 Fifth rate 318,950 325,800 333,400 341,650 350,200 358,950 367,900 377,100 386,550 396,200 

Note: Tax law for future years are those in effect as of July 2003. 

Source: Congressional Budget Office. 
13-64 

TABLE 13-20 -- EXAMPLES OF FEDERAL INCOME AND PAYROLL 

TAX LIABILITIES OF HYPOTHETICAL TAXPAYERS, 2003 

Type of filing unit and income Income tax 

liability 

FICA tax 

liability 

Total tax 

liability 

Overall 

average

 tax rate 

(percent)1

Overall 

marginal tax 

rate (percent)1

Joint filer- 3 exemptions:2 

$10,000 -2,547 1,530 -1,017 -9.4 14.2 

$30,000 29 4,590 4,619 14.3 38.3 

$50,0003

 2,928 7,650 10,578 19.7 28.1 

$100,0004

 10,333 13,688 24,021 22.5 27.5 

Head of household- 2 exemptions:2 

$10,000 -2,547 1,530 -1,017 -9.4 14.2 

$30,000 1,035 4,590 5,625 17.4 28.1 

$50,0003

 3,585 7,650 11,235 20.9 28.1 

$100,0004

 14,710 13,688 27,858 26.1 27.5 

Elderly couple filing joint return: 

$10,0005

 0 0 0 0.0 0.06

$30,0007

 50 0 50 0.2 10.08

$50,0009

 3,275 1,530 4,805 9.5 40.0 

Elderly single filer: 

$10,00010 0 0 0 0.0 0.06

$30,00011 1,870 0 1,870 6.2 22.512

$50,00013 6,791 3,060 9,851 19.1 37.4 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 the itemized deductions. 

2

 Assumes one child who is eligible for the child credit, 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 

23.5 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 the adjusted gross income) and the 

FICA tax liability on this income. 

13 Same as above plus $20,000 of wages. 

Source: Joint Committee on Taxation. 
13-65 

TABLE 13-21 -- INCOME TAX THRESHOLDS FOR ELDERLY 

INDIVIDUALS, 1996-2003 (ACTUAL) AND 2004-2013 (PROJECTED) 

Amount of Social Security Income Year and filing status None $2,500 $5,000 $7,500 

 Single 10,867 11,700 12,550 15,050 1996: 

 Joint 17,267 18,100 18,933 20,900 

 Single 11,033 11,867 12,800 15,300 1997: 

 Joint 17,533 18,367 19,200 21,300 

 Single 11,167 12,000 13,000 15,500 1998: 

 Joint 17,800 18,633 19,467 21,700 

 Single 11,233 12,067 13,100 15,600 1999: 

 Joint 17,933 18,767 19,600 21,900 

 Single 11,367 12,200 13,300 15,800 2000: 

 Joint 18,100 18,933 19,767 22,150 

 Single 12,386 13,457 13,550 16,050 2001: 

 Joint 19,400 20,471 20,200 22,700 

 Single 12,557 13,629 13,850 16,350 2002: 

 Joint 19,657 20,729 20,650 23,150 

 Single 12,614 13,686 13,950 16,450 2003: 

 Joint 20,714 21,786 22,500 25,000 

 Single 12,729 13,800 14,150 16,650 2004: 

 Joint 20,886 21,957 22,800 25,300 

 Single 12,843 13,914 14,350 16,850 2005: 

 Joint 20,371 21,443 21,900 24,400 

 Single 12,986 14,057 14,600 17,100 2006: 

 Joint 20,914 21,986 22,850 25,350 

 Single 13,129 14,200 14,850 17,350 2007: 

 Joint 21,229 22,300 23,400 25,900 

 Single 13,243 14,314 15,050 17,550 2008: 

 Joint 21,600 21,550 24,050 26,550 

 Single 13,414 14,486 15,350 17,850 2009: 

 Joint 22,257 22,700 25,200 27,700 

 Single 13,557 14,629 15,600 18,100 2010: 

 Joint 22,486 23,100 25,600 28,100 

 Single 13,700 14,771 15,850 18,350 2011: 

 Joint 21,743 21,800 24,300 26,800 

 Single 13,843 14,914 16,100 18,600 2012: 

 Joint 21,943 22,150 24,650 27,150 

 Single 14,014 15,086 16,400 18,900 2013: 

 Joint 22,257 22,700 25,200 27,700 

Note- Tax law for future years are those in effect as of July 2003. 

Source: Congressional Budget Office. 
13-66 

TABLE 13-22 -- TAX FILING UNITS CLASSIFIED BY MARGINAL 

FEDERAL INCOME TAX RATE,1 2003 TAX LAW 

 (2000 POPULATION AND INCOME) 

[Thousands of units]

Family type and marginal tax rate (percent) Returns Percent 

With children: 

 0 21,388 45.8 

10 1,500 3.2 

15 14,311 30.6 

25 6,389 13.7 

28 740 1.6 

33 247 0.5 

35 312 0.7 

AMT 1,830 3.9 

Total 46,717 100.0 

Elderly: 

 0 11,070 49.6 

10 3,216 14.4 

15 4,922 22.1 

25 2,225 10.0 

28 361 1.6 

33 79 0.4 

35 67 0.3 

AMT 373 1.7 

Total 22,313 100.0 

Other: 

 0 21,378 28.6 

10 12,691 17.0 

15 24,704 33.0 

25 12,697 17.0 

28 1,827 2.4 

33 339 0.5 

35 238 0.3 

AMT 902 1.2 

Total 74,776 100.0 

All tax units: 

 0 53,836 37.4 

10 17,406 12.1 

15 43,937 30.6 

25 21,311 14.8 

28 2,928 2.0 

33 665 0.5 

35 617 0.4 

AMT 3,105 2.2 

Total 143,805 100.0 1

 The rate used is the ordinary rate bracket for taxable income without capital gains. Some tax 

payers classified with a marginal rate greater than 0 may owe no income tax because of their 

ability to claim tax credits. 

Source: Congressional Budget Office tax simulation model. 
13-67 

 Table 13-23 is a more comprehensive 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. 

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 

earned income credit (EIC), a 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 13-23 -- DISTRIBUTION OF EARNERS BY INCOME AND MARGINAL TAX RATES ON WAGES, 

2003 TAX LAW (2000 POPULATIONS AND INCOMES) 

[In thousands of 2000 dollars]

Income in thousands of 2000 dollars Family type and marginal tax rate 

(percent) Less than $10 $10-$20 $20-$30 $30-$40 $40-$50 $50-$75 $75-$100 $100- $200 $200 and over A

inc

All earners ages 21-64 without Social Security earnings: 

Less than 0 3,150 1,538 103 41 24 19 0 1 0 4,

0-4.9 1,912 271 220 174 53 15 5 12 9 2,5.0-9.9 3,586 1,598 360 274 102 81 12 11 6 6,10.0-14.9 543 1,190 137 74 37 37 20 3 1 2,15.0-19.9 2,354 6,657 4,460 2,012 351 218 179 12 7 1620.0-24.9 426 5,109 8,957 9,511 9,509 17,877 1,921 65 29 53

25.0-29.9 782 366 235 337 64 316 1,739 1,820 278 5,30.0-34.9 1 1,292 1,099 2,591 3,091 5,372 9,109 6,140 428 29

35.0-39.9 0 253 2,038 148 33 273 263 3,909 1,899 8,40.0-44.9 0 7 572 26 0 11 30 558 1,344 2,45.0-49.9 0 0 36 0 1 0 17 177 193 4

Total 12,754 18,281 18,216 15,188 13,265 24,219 13,293 12,708 4,193 132

Mean marginal tax rate 2.1 17.5 23.9 23.4 24.7 25.0 30.4 33.7 38.1 2Mean marginal income tax rate -5.6 9.9 16.3 15.8 17.1 17.4 23.7 28.3 34.0 1

Mean marginal Social Security tax rate 7.6 7.6 7.6 7.6 7.6 7.6 6.7 5.4 4.0 7

Single earners: 

Less than 0 2,313 864 13 1 2 0 0 0 0 3,0-4.9 1,539 151 26 8 3 6 4 2 1 1,

5.0-9.9 2,748 646 77 47 13 2 0 1 0 3,10.0-14.9 477 679 35 6 1 2 0 0 0 1,
15.0-19.9 2,066 4,622 667 87 12 5 2 1 1 

20.0-24.9 418 4,910 8,465 4,424 1,129 254 2 3 2 25.0-29.9 777 168 120 327 64 84 590 297 45 30.0-34.9 1 1,110 404 2,578 3,091 3,739 429 366 29 35.0-39.9 0 244 1,218 23 33 264 184 180 176 40.0-44.9 0 7 564 26 0 8 12 39 30 45.0-49.9 0 0 36 0 1 0 2 11 2 

Total 10,339 13,401 11,624 7,528 4,349 4,364 1,225 900 287 

Mean marginal tax rate 3.3 19.1 25.4 26.3 29.9 32.3 31.1 32.4 35.7 Mean marginal income tax rate -4.3 11.5 17.7 18.6 22.3 24.7 27.3 29.8 33.2 

Mean marginal Social Security tax rate 7.6 7.6 7.6 7.6 7.6 7.5 3.8 2.6 2.5 

Married earners: 

Less than 0 837 674 91 40 22 19 0 1 0 0-4.9 373 120 194 165 49 9 1 10 8 5.0-9.9 838 952 282 226 89 79 12 11 6 10.0-14.9 67 511 102 68 36 35 19 3 1 15.0-19.9 288 2,035 3,793 1,925 339 212 177 11 6 20.0-24.9 8 199 492 5,087 8,380 17,623 1,919 62 26 25.0-29.9 5 197 115 10 0 232 1,149 1,522 233 30.0-34.9 0 182 694 12 0 1,633 8,680 5,775 398 35.0-39.9 0 9 820 125 0 9 79 3,729 1,723 40.0-44.9 0 0 8 0 0 3 17 519 1,314 45.0-49.9 0 0 0 0 0 0 14 166 191 

Total 2,415 4,880 6,591 7,660 8,916 19,855 12,068 11,808 3,906 

Mean marginal tax rate -3.2 13.2 21.4 20.6 22.2 23.5 30.4 33.8 38.2 

Mean marginal income tax rate -10.8 5.6 13.8 12.9 14.5 15.8 23.3 28.2 34.1 

Mean marginal Social Security tax rate 7.6 7.6 7.6 7.6 7.6 7.6 7.0 5.6 4.1 
TABLE 13-23 -- DISTRIBUTION OF EARNERS BY INCOME AND MARGINAL TAX RATES ON WAGES, 

2003 TAX LAW (2000 POPULATIONS AND INCOMES)-continued 

[In thousands of 2000 dollars]

Income in thousands of 2000 dollars Family type and marginal tax rate 

(percent) Less than $10 $10-$20 $20-$30 $30-$40 $40-$50 $50-$75 $75- $100 $100- $200 $200 and over All incomes

Earners with children: 

Less than 0 2,912 1,467 102 41 24 19 0 1 0 4,566 

0-4.9 349 260 212 172 49 9 2 6 7 1,067 5.0-9.9 1,026 616 229 235 82 72 11 6 4 2,282 10.0-14.9 27 895 68 54 15 18 12 2 0 1,091 15.0-19.9 96 2,742 2,440 1,769 299 160 151 6 4 7,668 20.0-24.9 10 364 852 4,367 6,108 12,041 1,638 39 15 25,436 

25.0-29.9 6 345 230 36 27 147 825 886 160 2,662 30.0-34.9 0 1,195 1,054 69 213 1,183 5,306 3,319 270 12,609 35.0-39.9 0 223 1,962 139 7 112 97 2,983 1,098 6,620 40.0-44.9 0 1 535 26 0 7 21 414 898 1,902 45.0-49.9 0 0 36 0 0 0 13 114 135 298 

Total 4,426 8,108 7,720 6,909 6,825 13,770 8,075 7,776 2,591 66,200 

Mean marginal tax rate -14.1 15.8 27.0 20.7 22.4 23.6 29.9 34.3 38.3 22.7 Mean marginal income tax rate -21.7 8.1 19.4 13.0 14.8 16.0 23.0 28.9 34.2 15.5 

Mean marginal Social Security  tax rate 7.6 7.6 7.6 7.6 7.6 7.6 6.9 5.4 4.1 7.2 

Source: Congressional Budget Office tax simulation model. 
13-71 

 

TABLE 13-24 -- RELATIONSHIP BETWEEN INCOME TAX 

THRESHOLD AND POVERTY LEVEL FOR A FAMILY OF FOUR, 

SELECTED YEARS 1959-2013 

Year Income tax threshold Poverty level Tax threshold as a 

percent of poverty level 

1959 $2,667 $2,978 89.6% 

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 $15,141 139.3% 

1995 $22,362 $15,570 143.6% 

1996 $23,671 $15,911 148.8% 

1997 $24,385 $16,276 149.8% 

1998 $27,795 $16,530 168.1% 

1999 $28,203 $16,895 166.9% 

2000 $28,682 $17,463 164.2% 

2001 $31,738 $17,960 176.7% 

2002 $33,209 $18,250 182.0% 

2003 $39,700 $18,667 212.7% 

2004 $40,100 $19,074 210.2% 

2005 $36,170 $19,527 185.2% 

2006 $37,047 $20,014 185.1% 

2007 $37,874 $20,515 184.6% 

2008 $39,544 $21,027 188.1% 

2009 $41,257 $21,553 191.4% 

2010 $43,833 $22,092 198.4% 

2011 $36,716 $22,644 162.1% 

2012 $37,498 $23,210 161.6% 

2013 $38,374 $23,791 161.3% 

Note- Tax law for future years are those in effect as of July 2003. 

Source: Congressional Budget Office. 
13-72 

TABLE 13-25 -- TAX THRESHOLDS, POVERTY LEVELS, AND 

FEDERAL TAX AMOUNTS FOR DIFFERENT FAMILY SIZES WITH 

EARNINGS EQUAL TO THE POVERTY LEVEL, 1995-2012 

Measure Family size 

and year 1 2 3 4 5 6 

1996 8,163 10,564 12,629 15,911 18,725 20,965 

1997 8,350 10,805 12,919 16,276 19,154 21,446 

1998 8,480 10,972 13,120 16,530 19,453 21,780 

1999 8,667 11,214 13,410 16,895 19,882 22,261 

2000 8,959 11,590 13,861 17,463 20,550 23,009 

2001 9,214 11,920 14,255 17,960 21,135 23,664 

2002 9,363 12,113 14,485 18,250 21,477 24,047 

2003 9,577 12,389 14,816 18,667 21,967 24,595 

2004 9,786 12,659 15,139 19,074 22,446 25,132 

2005 10,018 12,960 15,499 19,527 22,979 25,729 

2006 10,268 13,283 15,885 20,014 23,552 26,371 

2007 10,525 13,615 16,283 20,515 24,141 27,030 

2008 10,788 13,956 16,690 21,027 24,745 27,706 

2009 11,057 14,305 17,107 21,553 25,363 28,398 

2010 11,334 14,662 17,535 22,092 25,997 29,108 

2011 11,617 15,029 17,973 22,644 26,647 29,836 

2012 11,908 15,405 18,422 23,210 27,314 30,582 

2013 12,205 15,790 18,883 23,791 27,996 31,346 

Income tax threshold: 

1996 7,546 11,800 19,883 23,671 24,732 25,793 

1997 7,803 12,200 20,477 24,385 25,487 26,590 

1998 7,990 12,500 22,628 27,795 30,600 36,633 

1999 8,113 12,700 22,984 28,203 30,950 37,033 

2000 8,274 12,950 23,380 28,682 31,350 37,483 

2001 8,862 13,400 25,979 31,738 38,100 45,000 

2002 9,156 13,850 27,371 33,209 38,850 45,850 

2003 9,286 15,600 29,870 39,700 49,416 59,133 

2004 9,480 15,900 30,424 40,100 49,866 59,633 

2005 9,701 15,000 29,984 36,170 42,599 50,466 

2006 9,932 15,850 30,769 37,047 43,600 51,516 

2007 10,179 16,400 31,508 37,874 44,450 52,466 

2008 10,423 16,950 32,844 39,544 45,816 53,883 

2009 10,703 18,000 34,217 41,257 49,283 58,116 

2010 10,955 18,400 35,768 43,833 54,100 64,366 

2011 10,844 17,000 30,131 36,716 39,642 45,133 

2012 11,092 17,350 30,788 37,498 40,444 45,683 

2013 11,375 17,800 31,529 38,374 41,362 46,533 

Tax at poverty threshold: 

1996 140 0 -1,989 -2,650 -2,058 -1,586 

1997 124 0 -2,052 -2,741 -2,135 -1,652 

1998 111 0 -2,134 -2,857 -2,241 -1,751 

1999 125 0 -2,160 -2,882 -2,253 -1,752 

2000 155 0 -2,166 -2,883 -2,233 -1,760 

2001 62 0 -2,667 -3,778 -3,427 -3,148 

2002 36 0 -2,919 -4,144 -3,788 -3,503 

2003 51 0 -2,959 -4,185 -3,820 -3,530 

2004 54 0 -3,024 -4,283 -3,910 -3,613 

2005 56 -59 -3,341 -5,007 -4,798 -4,632 

2006 59 -55 -3,420 -5,114 -4,899 -4,729 

2007 61 -53 -3,488 -5,224 -5,005 -4,830 
13-73 

TABLE 13-25 -- TAX THRESHOLDS, POVERTY LEVELS, AND 

FEDERAL TAX AMOUNTS FOR DIFFERENT FAMILY SIZES WITH 

EARNINGS EQUAL TO THE POVERTY LEVEL, 1995-2012-continued

Measure Family size 

and year 1 2 3 4 5 6 

2008 64 -127 -3,556 -5,553 -5,328 -5,148 

2009 62 -128 -3,686 -5,696 -5,465 -5,281 

2010 67 -133 -3,780 -5,842 -5,605 -5,417 

2011 175 0 -2,858 -3,811 -2,968 -2,297 

2012 185 0 -2,930 -3,906 -3,042 -2,354 

2013 188 0 -3,003 -4,003 -3,117 -2,411 

Payroll tax at poverty threshold: 

1996 624 808 966 1,217 1,432 1,604 

1997 639 827 988 1,245 1,465 1,641 

1998 649 839 1,004 1,265 1,488 1,666 

1999 663 858 1,026 1,292 1,521 1,703 

2000 685 887 1,060 1,336 1,572 1,760 

2001 705 912 1,091 1,374 1,617 1,810 

2002 716 927 1,108 1,396 1,643 1,840 

2003 733 948 1,133 1,428 1,680 1,882 

2004 749 968 1,158 1,459 1,717 1,923 

2005 766 991 1,186 1,494 1,758 1,968 

2006 785 1,016 1,215 1,531 1,802 2,017 

2007 805 1,042 1,246 1,569 1,847 2,068 

2008 825 1,068 1,277 1,609 1,893 2,119 

2009 846 1,094 1,309 1,649 1,940 2,172 

2010 867 1,122 1,341 1,690 1,989 2,227 

2011 889 1,150 1,375 1,732 2,039 2,282 

2012 911 1,178 1,409 1,776 2,089 2,340 

2013 934 1,208 1,445 1,820 2,142 2,398 

Combined tax at poverty threshold: 

1996 764 808 -1,023 -1,433 -625 18 

1997 763 827 -1,064 -1,496 -669 -11 

1998 760 839 -1,130 -1,592 -753 -85 

1999 788 858 -1,134 -1,590 -732 -49 

2000 841 887 -1,105 -1,547 -661 0 

2001 767 912 -1,576 -2,404 -1,810 -1,337 

2002 753 927 -1,811 -2,748 -2,145 -1,664 

2003 784 948 -1,826 -2,757 -2,140 -1,648 

2004 803 968 -1,866 -2,824 -2,193 -1,690 

2005 822 933 -2,155 -3,514 -3,040 -2,663 

2006 845 961 -2,205 -3,583 -3,098 -2,711 

2007 866 988 -2,242 -3,655 -3,158 -2,762 

2008 890 941 -2,279 -3,944 -3,435 -3,029 

2009 908 966 -2,377 -4,047 -3,525 -3,109 

2010 934 989 -2,438 -4,152 -3,616 -3,190 

2011 1,064 1,150 -1,483 -2,079 -930 -14 

2012 1,096 1,178 -1,520 -2,131 -953 -14 

2013 1,122 1,208 -1,558 -2,183 -975 -13 

Combined tax at poverty level as a percent of poverty level: 

1996 9.4 7.7 -8.1 -9.0 -3.3 0.1 

1997 9.1 7.7 -8.2 -9.2 -3.5 -0.1 

1998 9.0 7.7 -8.6 -9.6 -3.9 -0.4 

1999 9.1 7.7 -8.5 -9.4 -3.7 -0.2 

2000 9.4 7.7 -8.0 -8.9 -3.2 0.0 
13-74 

 

TABLE 13-25 -- TAX THRESHOLDS, POVERTY LEVELS, AND 

FEDERAL TAX AMOUNTS FOR DIFFERENT FAMILY SIZES WITH 

EARNINGS EQUAL TO THE POVERTY LEVEL, 1995-2012- continued 

Measure Family size 

and year 1 2 3 4 5 6 

2001 8.3 7.7 -11.1 -13.4 -8.6 -5.7 

2002 8.0 7.7 -12.5 -15.1 -10.0 -6.9 

2003 8.2 7.7 -12.3 -14.8 -9.7 -6.7 

2004 8.2 7.7 -12.3 -14.8 -9.8 -6.7 

2005 8.2 7.2 -13.9 -18.0 -13.2 -10.4 

2006 8.2 7.2 -13.9 -17.9 -13.2 -10.3 

2007 8.2 7.3 -13.8 -17.8 -13.1 -10.2 

2008 8.2 6.7 -13.7 -18.8 -13.9 -10.9 

2009 8.2 6.8 -13.9 -18.8 -13.9 -10.9 

2010 8.2 6.7 -13.9 -18.8 -13.9 -11.0 

2011 9.2 7.7 -8.2 -9.2 -3.5 0.0 

2012 9.2 7.7 -8.3 -9.2 -3.5 0.0 

2013 9.2 7.7 -8.3 -9.2 -3.5 0.0 

Note- Tax law for future years are those in effect as of July 2003. 

Source: Congressional Budget Office 

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