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SECTION 13. TAX PROVISIONS RELATED TO

RETIREMENT, HEALTH, POVERTY, EMPLOYMENT, DISABILITY AND OTHER SOCIAL

ISSUES

CONTENTS

Introduction

Tax Provisions

Use of Distributional Analysis

Tax Provision Estimates

Net Exclusion of Pension Contributions and Earnings

Individual Retirement Plans

Exclusion of Social Security and Railroad Retirement Benefits

Exclusion of Employer Contribution for Medical Insurance

Premiums and Medical Care

Medical Savings Accounts

Cafeteria Plans

Health Care Continuation Rules

Group Health Plan Requirements

Tax Benefits for Accelerated Death Benefits and Long-Term

Care Insurance

Deduction for Health Insurance Expenses of Self-Employed

Individuals

Exclusion of Medicare Benefits

Deductibility of Medical Expenses

Earned Income Credit

Exclusion of Public Assistance and SSI Benefits

Dependent Care Tax Credit

HOPE Credit and Lifetime Learning Credit

Qualified State Tuition Programs and Education IRAs

Student Loan Interest Deduction

Exclusion for Employer-Provided Dependent Care

Work Opportunity Tax Credit

Welfare-to-Work Tax Credit

Exclusion of Workers’ Compensation and Special Benefits

for Disabled Coal Miners

Additional Standard Deduction for the Elderly and Blind

Tax Credit for the Elderly and Certain Disabled Individuals

Tax Provisions Related to Housing

Owner-Occupied Housing

Low-Income Housing Credit

Tax Credit and Exclusion for Adoption Expenses

Child Tax Credit

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

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Hypothetical Tax Calculations for Selected Families

Tax Treatment of the Elderly

Distribution of Family Income and Taxes

Federal Tax Treatment of Families in Poverty

References

INTRODUCTION

The preceding sections of this publication discuss direct payments to individuals for retirement, health, public assistance, employment, and disability benefits provided through entitlement programs within the jurisdiction of the Committee on Ways and

Means. The Federal Government also provides benefits to individuals through elements of the income tax set forth in the Internal

Revenue Code of 1986 (the Code). The Code is entirely within the

jurisdiction of the Committee on Ways and Means.

TAX PROVISIONS

Several different types of income tax provisions are available to

provide economic incentives. Examples include: exclusions, exemptions, deductions, preferential rates, deferrals and credits. 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) 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 meanstested 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 1999 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 1999 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 TAX LIABILITY AT 1999 RATES AND 1999 LAW AND 1999 INCOME LEVELS 1

Income class (thousands) 2 All returns 3 Taxable returns Itemized

returns Tax liability

Below $10 ......................... 22,371 1,463 460 ¥$8,300

$10–$20 ............................ 26,314 8,634 1,236 ¥8,519

$20–$30 ............................ 20,301 13,052 2,356 18,989

$30–$40 ............................ 15,902 13,532 3,710 34,291

$40–$50 ............................ 13,082 12,232 4,342 46,655

$50–$75 ............................ 19,829 19,533 10,219 116,354

$75–$100 .......................... 10,042 9,993 7,268 102,779

$100–$200 ........................ 8,461 8,449 7,222 173,919

$200 and over ................... 2,527 2,524 2,309 319,360

Total ......................... 138,829 89,410 39,121 795,530

1 Tax law as in effect on January 1, 1999, is applied to the 1999 level and sources of income and

their distribution among taxpayers. 2 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. 3 Includes filing and nonfiling units. Filing units include all taxable and nontaxable returns. Nonfiling

units include individuals with income that is exempt from Federal income taxation (e.g., transfer payments, interest from tax-exempt bonds, etc.). Excludes individuals who are dependents of other taxpayers

and taxpayers with negative income.

Note.—Money amounts in millions of dollars, returns in thousands. Detail may not add to total due to

rounding.

Source: Joint Committee on Taxation.

TAX PROVISION ESTIMATES

Table 13–2 provides various estimates for 36 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.

TABLE 13–2.—ESTIMATED TAX BASE EXCEPTIONS AND CREDITS UNDER THE PRESENT INCOME TAX FOR VARIOUS ITEMS,1 CALENDAR YEARS 2

[In billions of dollars]

Item

Year 

2

2001 2002 2003 2004 2005

I. Tax base exceptions related to:

Retirement:

Net exclusion of pension contributions and earnings ........... $372.9 $361.5 $344.9 $341.3 $344.3 $Keogh plans ............................................................................ 20.1 20.4 20.6 21.9 23.7 Individual retirement plans .................................................... 55.5 62.9 67.6 73.3 76.7 Exclusion of Social Security and railroad retirement benefits

in excess of employee share of payroll tax 2 ..................... 269.7 279.3 288.4 298.8 307.1 

Health:

Exclusions of employer contributions for medical care,

health insurance premiums and long-term care insurance premiums 3 ................................................................ 359.5 384.5 407.1 431.9 458.9 

Exclusion of Medicare benefits:

Medicare part A ............................................................. 131.7 138.3 145.4 153.8 164.8 Medicare part B ............................................................. 81.7 88.0 96.3 103.2 111.9 

Deductibility of medical expenses 4 ....................................... 29.5 32.3 33.9 35.5 36.5 Deductibility of health insurance expenses of the selfemployed 5 .......................................................................... 7.2 9.0 14.1 14.9 15.8 

Exclusion of accelerated death benefits ................................ 2.1 2.5 2.9 3.5 3.9 

Poverty:

Exclusion of public assistance and SSI cash benefits ......... 54.7 57.4 60.4 63.4 69.8 

Employment:

Exclusion of employer-provided dependent care 6 ................. 0.7 0.7 0.7 0.8 0.8 Employee stock ownership plans ........................................... 13.5 14.0 14.6 15.2 15.8 Exclusion for benefits provided under cafeteria plans 7 ....... 45.7 48.9 51.8 55.0 58.5 

Elderly and disabled:

Exclusion of workers’ compensation and special benefits for

disabled coal miners:

Workers’ compensation .................................................. 32.1 33.7 34.6 35.3 37.2 Special benefits for disabled coal miners .................... 0.3 0.3 0.3 0.3 0.3 

Additional standard deduction for elderly and blind ............ 12.1 12.5 13.0 13.5 14.4 

Housing:

Deductibility of mortgage interest ......................................... 239.4 250.9 261.7 273.4 285.8 Deductibility of property tax on owner-occupied housing ..... 85.4 89.5 93.8 98.2 102.6 Exclusion of interest on State and local government bonds

for owner-occupied housing ............................................... 3.3 3.3 3.3 3.4 3.4 

Depreciation of rental housing in excess of alternative depreciation system ............................................................... 6.7 7.6 8.2 9.3 10.6 Exclusion of interest on State and local government bonds

for rental housing .............................................................. 0.7 0.7 0.7 0.8 0.8 

Families:

Qualified State tuition programs and education IRAs .......... 0.1 0.2 0.2 0.2 0.2 Student loan interest deduction ............................................. 0.4 0.4 0.4 0.5 0.5 Employer-provided adoption expenses .................................. (8) (8) (8) (8) (8) 

II. Tax credits related to:

Poverty:

Earned income credit:

Nonrefundable portion ................................................... 4.3 4.3 4.4 4.5 4.6 Refundable portion 9 ...................................................... 26.4 26.7 27.2 27.8 28.4 

Employment:

Dependent care credit ............................................................ 2.4 2.3 2.3 2.3 2.1 Work opportunity tax credit .................................................... 0.3 0.3 0.2 0.1 (8) 

Welfare-to-work tax credit .................................................... 0.1 0.1 (8) (8) (8) 

Elderly and disabled:

Tax credit for elderly and disabled ........................................ (8) (8) (8) (8) (8) 

TABLE 13–2.—ESTIMATED TAX BASE EXCEPTIONS AND CREDITS UNDER THE PRESENT INCOME TAX FOR VARIOUS ITEMS,1 CALENDAR YEARS 

5—Continued

[In billions of dollars]

Item

Year 

2

2001 2002 2003 2004 2005

Housing:

Low-income housing tax credit .............................................. 3.7 3.9 4.0 4.1 4.2 

Families:

Child tax credit:

Nonrefundable portion .................................................. 19.1 18.5 18.3 17.8 17.2 Refundable portion ....................................................... 0.8 0.8 0.8 0.8 0.8 

HOPE credit and lifetime learning credit ............................. 4.6 4.2 4.3 4.3 4.3 Adoption credit ...................................................................... 0.3 0.1 0.1 0.1 0.1 

1 Estimates of exclusions and deductions represent changes in the tax base; they do not measure changes in tax liability. Tax effects of provisions are not comparable2 In addition to OASDI benefits for retired workers, these figures also include disability insurance benefits and benefits for dependents and survivors. 3 Estimate includes employer-provided health insurance purchased through cafeteria plans and health care spending through flexible spending accounts. 4 Amounts reported on tax returns in excess of the medical deductions floor (7.5 percent of adjusted gross income).5 Amounts deductible from gross income (60 percent of health insurance expenses in 2001, 70 percent in 2002, and 100 percent in 2003–5). 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 c

ble spending accounts. These amounts are also included in other line items in this table. 8 Less than $50 million.

9 Estimate provided by the Congressional Budget Office.

Note.—Details may not add to totals due to rounding.Source: Joint Committee on Taxation.

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The rules relating to qualified plans were substantially revised

by the Employee Retirement Income Security Act of 1974 (ERISA),

which added overall limitations on contributions and benefits and

other requirements on minimum participation, coverage, vesting,

benefit accrual, and funding. Further revisions of these rules have

been made in every major tax bill enacted after 1974.

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 is subject

to a 10-percent excise tax on such excess (sec. 4972).

The qualification rules limit the amount of benefits that can be

provided through a qualified plan and require that benefits be provided on a basis that does not discriminate in favor of highly compensated employees. In addition, qualified plans are required to

meet minimum standards relating to participation (the restrictions

that may be imposed on participation in the plan), coverage (the

number of employees participating in the plan), vesting (the time

at which an employee’s benefit becomes nonforfeitable), and benefit

accrual (the rate at which an employee earns a benefit). Also, minimum funding standards apply to the rate at which employer contributions are required to be made to certain plans to ensure the

solvency of pension plans.

If a defined benefit pension plan is terminated, any assets remaining after satisfaction of the plan’s liabilities may revert to the

employer. Such reversions are included in the gross income of the

employer and are subject to income tax plus an additional excise

tax (sec. 4980). The excise tax is 20 percent if the employer establishes a qualified replacement plan or provides certain benefit increases. Otherwise, the excise tax is 50 percent. Transfers of excess

assets can be made from an ongoing defined benefit plan to pay

certain retiree health benefits if certain requirements are satisfied

(sec. 420). The assets transferred are not includable in the income

of the employer or subject to the tax on reversions.

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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

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).

Benefit accrual rules

The protection afforded employees under the minimum vesting

rules depends not only on the minimum vesting schedules, but also

on the accrued benefits to which these schedules are applied. In the

case of a defined contribution plan, the accrued benefit is the participant’s account balance. In the case of a defined benefit plan, a

participant’s accrued benefit is determined under the plan benefit

formula, subject to certain restrictions. In general, the accrued benefit is defined in terms of the benefit payable at normal retirement

age and does not include certain ancillary nonretirement benefits.

Each defined benefit plan is required to satisfy one of three accrued benefit tests. The primary purpose of these tests is to prevent undue backloading of benefit accruals (i.e., by providing low

rates of benefit accrual in the employee’s early years of service

when the employee is most likely to leave and by concentrating the

accrual of benefits in the employee’s later years of service when he

is most likely to remain with the employer until retirement) (sec.

412).

Coverage rules

A plan is not qualified unless the plan satisfies at least one of

the following coverage requirements: (1) the plan benefits at least

70 percent of all nonhighly compensated employees, (2) the plan

benefits a percentage of nonhighly compensated employees that is

at least 70 percent of the percentage of highly compensated employees benefiting under the plan, or (3) the plan meets an average

benefits test (sec. 410(b)). In addition, a defined benefit plan is not

a qualified plan unless it benefits at least the lesser of: (1) 50 employees, or (2) the greater of 40 percent of the employees of the employer or 2 employees (or if there is only 1 employee, such employee; 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)).

Limitations on contributions and benefits

The maximum annual benefit that may be provided by a defined

benefit pension plan (payable at the Social Security retirement age)

is the lesser of 100 percent of average compensation, or $135,000

for 2000 (sec. 415(b)). The dollar limit is adjusted annually for inflation. The dollar limit is reduced if payments of benefits begin beVerDate 20-JUL-2000 13:14 Sep 29, 2000 Jkt 061710 PO 00000 Frm 00784 Fmt 6601 Sfmt 6601 J:\SKAYNE\GB96\61710.013 WAYS3 PsN: WAYS3
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fore the Social Security retirement age and increased if benefits

begin after the Social Security retirement age.

Funding rules

Pension plans are required to meet a minimum funding standard

for each plan year (sec. 412). In the case of a defined benefit pension plan, an employer must contribute an annual amount sufficient to fund a portion of participants’ projected benefits determined in accordance with one of several prescribed funding methods, using reasonable actuarial assumptions. Plans with asset values of less than 100 percent of current liabilities are subject to additional, faster funding rules.

Taxation of distributions

An employee who participates in a qualified plan is taxed when

the employee receives a distribution from the plan to the extent the

distribution is not attributable to employee contributions (sec. 402).

With certain exceptions, a 10-percent additional income tax is imposed on early distributions from a qualified plan (sec. 72(t)).

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 employersponsored retirement plan. A SIMPLE plan can be either an individual retirement account (IRA) for each employee or part of a

qualified cash or deferred arrangement (401(k) plan). If established

in IRA form, a SIMPLE plan is not subject to the nondiscrimination rules generally applicable to qualified plans and simplified reporting requirements apply. If adopted as part of a 401(k) plan, the

plan does not have to satisfy the special nondiscrimination tests

applicable to 401(k) plans and is not subject to the top-heavy rules.

The other qualified plan rules continue to apply. SIMPLE plans are

subject to special rules regarding eligibility of employees to participate and special contribution limits.

EFFECT OF PROVISION

The tax treatment of pension contributions and earnings has encouraged employers to establish qualified retirement plans and to

compensate employees in the form of pension contributions to such

plans. There are two potential tax advantages of being compensated through pension contributions. One advantage is the ability to earn tax-free returns to savings. When saving is done

through a pension plan, the employee earns a higher rate of return

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1This 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.

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

1999 Current Population Survey. The data referred to below come

from that survey unless otherwise noted.

As of March 1998, 63 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

(table 13–3). Half 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.

TABLE 13–3.—EMPLOYER SPONSORSHIP AND EMPLOYEE COVERAGE UNDER PENSION

OR RETIREMENT PLAN, PRIVATE WAGE AND SALARY WORKERS, 1998

Percent covered

Total Full time Part time

Employer sponsorship:

Employer sponsors plan .................... 57 63 34

Employer does not sponsor ............... 43 37 66

Employee coverage:

Employee covered under plan ........... 43 50 12

Employee is not covered ................... 57 50 88

Number of private wage and salary workers (in thousands) ...... 108,930 86,709 22,221

Source: Congressional Research Service estimates based on the U.S. Census Bureau’s Current Population Survey of March 1999.

Younger workers are much less likely to be covered by a pension

than middle aged and older workers. Coverage rates rise steadily

from 20 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).

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Higher paying jobs are more likely to offer pensions. Just 11 percent of full-time private wage and salary workers earning less than

$10,000 per year in 1998 were covered compared to 77 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.

TABLE 13–4.—COVERAGE UNDER EMPLOYER-SPONSORED PENSION OR RETIREMENT

PLANS FOR FULL-TIME PRIVATE WAGE AND SALARY WORKERS BY WORKERS’ AGE, 1998

Age

Percent covered

Total Men Women

Under 25 .................................................... 20 21 19

25–29 ......................................................... 41 39 43

30–34 ......................................................... 50 52 46

35–39 ......................................................... 55 57 52

40–44 ......................................................... 59 62 56

45–49 ......................................................... 62 66 58

50–54 ......................................................... 63 67 58

55–59 ......................................................... 61 64 56

60–64 ......................................................... 59 61 55

65 or older ................................................. 41 42 38

Total .............................................. 50 52 47

Source: Congressional Research Service estimates based on the U.S. Census Bureau’s Current Population Survey of March 1999.

TABLE 13–5.—COVERAGE UNDER EMPLOYER-SPONSORED PENSION OR RETIREMENT

PLANS FOR FULL-TIME PRIVATE WAGE AND SALARY WORKERS BY WORKERS’ WAGES,

1998

Annual earnings

Percent covered

Total Men Women

Under $10,000 ........................................... 11 10 12

$10,000–$14,999 ....................................... 22 17 26

$15,000–$19,999 ....................................... 35 30 40

$20,000–$24,999 ....................................... 45 38 52

$25,000–$29,999 ....................................... 56 53 60

$30,000–$34,999 ....................................... 63 61 66

$35,000–$39,999 ....................................... 65 63 69

$40,000–$49,999 ....................................... 71 71 72

$50,000–$74,999 ....................................... 77 77 76

$75,000 or over ......................................... 79 80 73

Total 1 ........................................... 50 52 47

1 Total includes workers not responding on wages.

Source: Congressional Research Service estimates based on the U.S. Census Bureau’s Current Population Survey of March 1999.

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Coverage is much lower for smaller firms (table 13–6). Smaller

firms are less likely to offer comprehensive fringe benefit packages

as part of total compensation. Only 17 percent of full-time private

wage and salary workers in firms with fewer than 10 employees

are covered. The rate rises with employer size but does not reach

50 percent (the average across all firm sizes) until firms have 100

or more employees (table 13–6).

Significant differences in coverage also are apparent between

full-time private wage and salary workers and other wage and salary workers. Coverage is much lower among part-time workers and

much higher among public employees. Among part-time, private

wage and salary workers, 12 percent are covered. Seventy-four percent of public sector wage and salary workers are covered including

82 percent of those who are full-time workers (table 13–7).

TABLE 13–6.—COVERAGE UNDER EMPLOYER-SPONSORED PENSION OR RETIREMENT

PLANS FOR FULL-TIME PRIVATE WAGE AND SALARY WORKERS BY SIZE OF FIRM, 1998

Firm size (number of workers)

Percent covered

Total Men Women

Fewer than 10 ............................................ 17 17 17

10–24 ......................................................... 28 28 28

25–99 ......................................................... 41 43 37

100–499 ..................................................... 54 57 51

500–999 ..................................................... 61 63 59

1,000 or more ............................................ 66 70 61

Total .................................................. 50 52 47

Source: Congressional Research Service estimates based on the U.S. Census Bureau’s Current Population Survey of March 1999.

TABLE 13–7.—COVERAGE OF WAGE AND SALARY WORKERS UNDER EMPLOYERSPONSORED PENSION OR RETIREMENT PLAN, BY PRIVATE OR PUBLIC SECTOR, 1998

Sector of employment

Percent covered

Total Full time Part time

All wage and salary workers ..................... 48 56 15

Men ................................................... 51 57 10

Women ............................................... 44 54 17

Private sector ............................................. 43 50 12

Men ................................................... 47 52 9

Women ............................................... 38 47 14

Public sector .............................................. 74 82 30

Men ................................................... 76 82 19

Women ............................................... 72 82 34

Source: Congressional Research Service estimates based on the U.S. Census Bureau’s Current Population Survey of March 1999.

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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 most recent survey in 1998 showed a drop in coverage to 43

percent (table 13–7).

The decline in coverage in the 1980s was concentrated among

younger men. The coverage rate among older men has fallen less

dramatically, and among women it has risen at some ages and fallen at others.

The decline in pension coverage has occurred at the same time

that employers have been shifting from defined benefit plans. Of

the private wage and salary workers covered by a pension plan in

1975, 87 percent were covered by a defined benefits 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. Employee stock ownership plans and 401(k) plans have been among

the most rapidly growing defined contribution plans.

INDIVIDUAL RETIREMENT PLANS

LEGISLATIVE HISTORY

ERISA added section 219 to the Internal Revenue Code, providing a tax deduction for certain contributions to 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 retireVerDate 20-JUL-2000 13:14 Sep 29, 2000 Jkt 061710 PO 00000 Frm 00789 Fmt 6601 Sfmt 6601 J:\SKAYNE\GB96\61710.013 WAYS3 PsN: WAYS3
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ment 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 taxfree nondeductible IRA, the Roth IRA, was added; and (4) the 10-

percent early withdrawal tax was waived for distributions from

IRAs for education and first-time home buyer expenses.

EXPLANATION OF PROVISION

Deductible IRAs

An individual who is an active participant in an employersponsored retirement plan may deduct annual IRA contributions

up to the lesser of $2,000 or 100 percent of compensation if the individual’s adjusted gross income (AGI) does not exceed certain limits.

The full $2,000 IRA deduction limit is phased out for married individuals over the following levels of AGI: for 2000, $52,000–

$62,000; for 2001, $53,000–$63,000; for 2002, $54,000–$64,000; for

2003, $60,000–$70,000; for 2004, $65,000–$75,000; for 2005,

$70,000–$80,000; for 2006, $75,000–$85,000; and for 2007 and

thereafter, $80,000–$100,000. The phase-out range for married individuals filing separate returns is $0–$10,000. A couple is not

treated as married if the spouses file separate returns and do not

live together at any time during the year. The phase-out range for

single individuals is: for 2000, $32,000–$42,000; for 2001, $33,000–

$43,000; for 2002, $34,000–$44,000; for 2003, $40,000–$50,000; for

2004, $45,000–$55,000; for 2005 and thereafter, $50,000–$60,000.

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

is, may make a full $2,000 deductible IRA contribution if the AGI

for the couple does not exceed $150,000. The deduction limit is

phased out for AGI between $150,000 and $160,000. An individual

who is not an active participant in an employer-sponsored retirement plan may deduct IRA contributions up to the limits described

above without limitation based on income.

The investment income of IRA accounts is not taxed until withdrawn. Withdrawn amounts attributable to deductible contributions and all earnings are includable in income. A 10-percent additional income tax is levied unless the withdrawal: (1) is made after

the IRA owner attains age 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); or (4) is made to pay medical expenses in excess of 7.5 percent of AGI or for insurance premiums

for unemployed individuals; or (5) is made for first-time home

buyer expenses (subject to a $10,000 lifetime cap) or for qualified

higher education expenses.

Roth IRAs

An individual may make nondeductible contributions up to the

lesser of $2,000 or 100 percent of compensation to a Roth IRA if

the individual’s AGI does not exceed $95,000 for an unmarried individual, or $150,000 for a married couple filing a joint return. The

maximum contribution is phased out between AGI ranges of

791

$95,000–$110,000 for unmarried individuals and of $150,000–

$160,000 for married individuals filing a joint return. No more

than $2,000 of contributions can be made to all an individual’s

IRAs for a taxable year.

Qualified distributions from a Roth IRA are not includable in income. Qualified distributions are distributions: (1) made after the

5-year taxable period beginning with the first taxable year for

which a contribution is made, and (2) which are made on or after

the date the individual attains age 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 includable in income,

to the extent earnings are included in the distribution, and are

subject to the 10-percent tax on early withdrawal, unless an exception applies, as described above for deductible IRAs. Taxpayers with AGI of less than $100,000 may convert an IRA

to a Roth IRA at any time. If the conversion was made before January 1, 1999, the amounts that would have been includable in income had the amounts converted been withdrawn are includable in

income ratably over 4 years. The 10-percent tax on early withdrawals does not apply to conversions of IRAs to Roth IRAs.

Nondeductible IRAs

An individual may make nondeductible contributions to an IRA

to the extent the individual does not or cannot make deductible

contributions to an IRA or contributions to a Roth IRA. Earnings

on contributions to a nondeductible IRA accumulate tax free, and

are includable in income when withdrawn. The 10-percent early

withdrawal tax applies to such earnings, subject to the exceptions

for deductible and Roth IRAs as described above.

EFFECT OF PROVISION

Use of IRAs expanded significantly when eligibility was expanded in 1982 to all persons with earnings and contracted correspondingly in 1987 when deductibility was restricted for higher

income taxpayers who were covered by an employer-provided pension. The number of taxpayers claiming a deductible IRA contribution jumped from 3.4 million in 1981 to 12.0 million in 1982 and

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

reported deductible contributions. Since then, the number 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 deVerDate 20-JUL-2000 13:14 Sep 29, 2000 Jkt 061710 PO 00000 Frm 00791 Fmt 6601 Sfmt 6601 J:\SKAYNE\GB96\61710.013 WAYS3 PsN: WAYS3
792

ductible contributions apply only to a small fraction of taxpayers

with AGI below $30,000.

TABLE 13–8.—USE OF DEDUCTIBLE INDIVIDUAL RETIREMENT ACCOUNTS, 1980–97

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 ........................................................................ 4.1 8.3

1996 ........................................................................ 4.4 8.6

1997 ........................................................................ 4.1 8.7

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

Eligibility percentages and the real value of the IRA contribution

limits decline over time because present law does not index the

contribution limits or the income eligibility limits for inflation. For

example, the real value of a $2,000 contribution has declined more

than 30 percent since 1986 because of inflation.

Congress established IRAs to allow workers not covered by employer pension plans to have tax-advantaged retirement saving.

Nonetheless, since 1981 IRA participation rates have been higher

among those covered by an employer-provided pension plan than

those without one, and many of those who are not covered by a

pension plan do not contribute to an IRA. In 1987, 10 percent of

full-time private-sector earners without pension coverage contributed to an IRA, while 15 percent of those with coverage contributed

(Woods, 1989, p. 9).

EXCLUSION OF SOCIAL SECURITY AND RAILROAD

RETIREMENT BENEFITS

LEGISLATIVE HISTORY

The exclusion from gross income for Social Security benefits was

not initially established by statute. Prior to the Social Security

Amendments of 1983, the exclusion was based on a series of adVerDate 20-JUL-2000 13:14 Sep 29, 2000 Jkt 061710 PO 00000 Frm 00792 Fmt 6601 Sfmt 6601 J:\SKAYNE\GB96\61710.013 WAYS3 PsN: WAYS3
793

2See 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.

ministrative rulings issued by the Internal Revenue Service in

1938 and 1941.2

Under the Social Security Amendments of 1983, a portion of the

Social Security benefits paid to higher income taxpayers is included

in gross income. In 1993, the Omnibus Budget Reconciliation Act

increased the amount of benefits subject to tax and increased the

rate of tax for some benefit recipients.

The exclusion from gross income of benefits paid under the Railroad Retirement System was enacted in the Railroad Retirement

Act of 1935. A portion of the benefits payable under the Railroad

Retirement System (generally, tier 1 benefits) is equivalent to Social Security benefits. The tax treatment of tier 1 railroad retirement benefits was modified in the Social Security Amendments of

1983 to conform to the tax treatment of Social Security benefits.

Other railroad retirement benefits are taxable in the same manner

as employer-provided retirement benefits. The Consolidated Omnibus Budget Reconciliation Act of 1985 provided that tier 1 benefits

are taxable in the same manner as Social Security benefits only to

the extent that Social Security benefits otherwise would be payable. Other tier 1 benefits are taxable in the same manner as all

other railroad retirement benefits (for further details, see section

5).

EXPLANATION OF PROVISION

For taxpayers whose modified 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 taxexempt 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 of 1986, all other

benefits payable under the Railroad Retirement System are includable in income when received to the extent they exceed employee

contributions.

794

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 CONTRIBUTION FOR

MEDICAL INSURANCE PREMIUMS AND MEDICAL CARE

LEGISLATIVE HISTORY

In 1943, the Internal Revenue Service (IRS) ruled that employer

contributions to group health insurance policies were not taxable to

the employee. Employer contributions to individual health insurance policies, however, were declared to be taxable income in an

IRS revenue ruling in 1953.

Section 106 of the Internal Revenue Code, enacted in 1954, reversed the 1953 IRS ruling. As a result, employer contributions to

all accident or health plans generally are excluded from gross income and therefore are not subject to tax. Under section 105 of the

Internal Revenue Code, benefits received under an employer’s accident or health plan generally are not included in the employee’s income.

In the Revenue Act of 1978, Congress added section 105(h) to tax

the benefits payable to highly compensated employees under a selfinsured 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 selfinsured 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 taxfavored 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.

795

3To 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).

EFFECT OF PROVISION

The exclusion for employer-provided health coverage provides an

incentive for compensation to be furnished to the employee in the

form of health coverage, rather than in cash subject to current taxation. For example, an employer designing a compensation package

for an employee would be indifferent between paying the employee

one dollar in cash and purchasing one dollar’s worth of health insurance for the employee.3 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).

MEDICAL SAVINGS ACCOUNTS

The Health Insurance Portability and Accountability Act of 1996

included provisions for medical savings accounts (MSAs), effective

for years beginning after December 31, 1996. Within limits, contributions to an MSA are deductible if made by an eligible individual and are excludable from income and employment taxes if made

by the employer (other than contributions made through a cafeteria

plan). Earnings on amounts in an MSA are not currently taxable.

Distributions from an MSA for medical expenses are not includable

in gross income. Distributions from an MSA that are not for medical expenses are includable in gross income and are subject to an

additional tax of 15 percent, unless the distribution is made after

death, disability, or age 65.

796

TABLE 13–9.—PRIMARY SOURCE OF HEALTH INSURANCE FOR WORKERS UNDER AGE 65

BY DEMOGRAPHIC CATEGORY, MARCH 1999

Category

Number

of

workers

(millions)

Percentage distribution by source of

insurance

Own or

other

employer

Individual policyPublic

insurance 1

No insurance

Industry:

Agriculture ......................................... 2.8 45.4 14.5 3.9 36.1

Mining ................................................ 0.6 85.0 3.3 0.1 11.6

Construction ...................................... 8.8 59.9 5.9 1.5 32.7

Manufacturing ................................... 20.1 84.5 1.7 1.4 12.3

Transportation ................................... 9.1 81.7 2.4 1.4 14.5

Wholesale trade ................................. 5.0 81.0 4.2 1.3 13.5

Retail trade ....................................... 18.8 62.3 4.9 5.0 27.8

Finance .............................................. 8.4 83.2 4.5 0.9 11.4

Professional services ......................... 30.4 82.9 3.7 2.2 11.1

Other services .................................... 14.5 63.3 6.1 4.1 26.5

Government ........................................ 5.9 91.3 1.4 1.3 6.1

Family income (as a percentage of poverty):

under 100 .......................................... 8.6 28.0 5.3 20.2 46.5

100–199 ............................................ 17.7 50.4 5.1 6.4 38.1

200–299 ............................................ 21.9 71.6 3.9 2.2 22.3

300 or more ....................................... 83.2 85.7 3.9 0.5 9.9

Firm size (number of employees):

Fewer than 10 ................................... 25.2 53.1 12.1 3.8 31.1

10–24 ................................................ 11.6 64.0 5.4 3.5 27.0

25–99 ................................................ 16.6 73.8 2.5 3.3 20.5

100–499 ............................................ 18.8 79.9 2.1 2.9 15.1

500–999 ............................................ 7.6 84.8 1.7 2.0 11.5

1,000 or more .................................... 51.6 84.9 1.6 2.3 11.2

Age:

Under 30 ............................................ 31.2 61.6 3.6 5.4 29.3

30–39 ................................................ 36.5 76.1 3.3 3.1 17.5

40–49 ................................................ 35.6 80.6 4.2 1.7 13.6

50–64 ................................................ 28.1 80.6 5.8 1.2 12.4

Region:

Northeast ........................................... 24.7 76.7 4.0 2.8 16.5

Midwest ............................................. 31.2 79.3 4.1 2.7 13.9

South ................................................. 45.5 73.4 4.0 2.6 20.0

West ................................................... 30.0 70.8 4.5 3.6 21.1

All nonelderly workers 131.4 74.8 4.1 2.9 18.2

1 Public insurance includes Medicaid, Medicare, and coverage provided by the Department of Veterans

Affairs.

Source: Congressional Budget Office estimates based on the March 1999 Current Population Survey.

797

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 MSA contribution, an otherwise eligible individual must be covered under a high deductible health

plan and no other health plan. A high deductible health plan is a

plan with an annual deductible of at least $1,500 and no more than

$2,250 in the case of individual coverage (and at least $3,000 and

no more than $4,500 in the case of family coverage). The dollar limits are indexed for inflation. High deductible plans must also meet

certain limits on out-of-pocket expenses.

The number of taxpayers benefiting annually from an MSA contribution is limited to a threshold level (generally, 750,000 taxpayers). If it is determined in a year that the threshold level has

been exceeded (called a cutoff year), then, in general, for succeeding

years during the 4-year pilot period 1997–2000, only those individuals who (1) made an MSA contribution or had an employer MSA

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

participants) or (2) are employed by a participating employer,

would be eligible for an MSA contribution. In determining whether

the threshold for any year has been exceeded, MSAs of previously

uninsured individuals are not taken into account.

After December 31, 2000, no new contributions may be made to

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

MSA contributions and employees who are employed by a participating employer. Self-employed individuals who made contributions

to an MSA during the period 1997–2000 also may continue to make

contributions after 2000.

CAFETERIA PLANS

LEGISLATIVE HISTORY

Under present law, compensation generally is includable in gross

income when received. An exception applies if an employee may

choose between cash and certain employer-provided nontaxable

benefits under a cafeteria plan.

Prior to 1978, ERISA provided that an employer contribution

made before January 1, 1977 to a cafeteria plan in existence on

June 27, 1974, had to be included in an employee’s gross income

only to the extent that the employee actually elected taxable benefits. If a plan did not exist on June 27, 1974, the employer contribution was to be included in income to the extent the employee

could have elected taxable benefits. The Revenue Act of 1978 set

up permanent rules for plans that offer an election between taxable

and nontaxable benefits.

The Deficit Reduction Act of 1984 (Public Law 98–369) clarified

the types of employer-provided benefits that could be provided

through a cafeteria plan, added a 25-percent concentration test,

and required annual reporting to the IRS by employers.

The Tax Reform Act of 1986 also modified the rules relating to

cafeteria plans in several respects.

798

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 aftertax benefit to the

employee at minimum aftertax cost to the employer (see Scholes &

Wolfson, 1992, chapter 10). Both the potential taxation of compensation provided to employees and the deductibility of compensation provided by the employer would be considered. If only income

taxes were considered, employers would be indifferent between the

payment of $1 in salary or wages and the payment of $1 in fringe

benefits to an employee, because both types of compensation are

fully deductible. When the employer payments for FICA and 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 aftertax value. An additional dollar

of salary or wage paid to the employee will be subject to tax. If a

fringe benefit is excludable from the employee’s income, the employee pays no tax on receipt of the benefit. Consequently, the employee receives greater compensation via the fringe benefit. This

differential treatment of salary or wage payments and excludable

fringe benefits implies that compensation packages designed to

799

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 mediumsized 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 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 deVerDate 20-JUL-2000 13:14 Sep 29, 2000 Jkt 061710 PO 00000 Frm 00799 Fmt 6601 Sfmt 6601 J:\SKAYNE\GB96\61710.013 WAYS3 PsN: WAYS3
800

ductions and the exclusion. The Health Insurance Portability and

Accountability Act of 1996 made some changes to the health care

continuation rules in cases of disability.

EXPLANATION OF PROVISION

The health care continuation rules in section 4980B require that

an employer provide qualified beneficiaries with the opportunity to

participate for a specified period in the employer’s health plan after

that participation otherwise would have terminated. If the employee elects such continuation coverage, the employee may be required to pay for the coverage. The amount the employee can be

required to pay is subject to certain limits.

The qualifying events that may trigger rights to continuation

coverage are: (1) the death of the employee; (2) the voluntary or involuntary termination of the employee’s employment (other than by

reason of gross misconduct); (3) a reduction of the employee’s

hours; (4) the divorce or legal separation of the employee; (5) the

employee becoming entitled to benefits under Medicare; and (6) a

dependent child of the employee ceasing to be a dependent under

the employer’s plan. The maximum period of continuation coverage

is 36 months, except in the case of termination of employment or

reduction of hours for which the maximum period is 18 months.

The 18-month period is extended to 29 months in certain cases involving the disability of the qualified beneficiary. Certain events,

such as the failure by the qualified beneficiary to pay the required

premium, may trigger an earlier cessation of the continuation coverage.

A beneficiary has a prescribed period of time during which to

elect continuation coverage after the employee receives notice from

the plan administrator of the right to continuation coverage.

GROUP HEALTH PLAN REQUIREMENTS

The Health Insurance Portability and Accountability Act of 1996

imposes certain requirements regarding health coverage portability

through limitations on preexisting condition exclusions, prohibitions on excluding individuals from coverage based on health status, and guaranteed renewability of health insurance coverage. An

excise tax is imposed with respect to failures of a group health plan

to comply with the requirements. The tax is usually imposed on the

employer sponsoring the plan. The amount of the tax is generally

equal to $100 per day for each day during which the failure occurs

until the failure is corrected. The maximum tax that can be imposed is the lesser of 10 percent of the employer’s payments during

the taxable year in which the failure occurred under group health

plans or $500,000. The Secretary of the Treasury may waive all or

part of the tax to the extent that payment of the tax would be excessive relative to the failure involved (see discussion of health care

continuation rules).

801

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 longterm care services. Thus, the treatment of long-term care contracts

and services was unclear. Prior and present law provide rules relating to medical expenses and accident or health insurance.

Amounts received by a taxpayer under accident or health insurance for personal injuries or sickness generally are excluded from

gross income to the extent that the amounts received are not attributable to medical expenses that were allowed as a deduction for

a prior taxable year (sec. 104).

EXPLANATION OF PROVISION

Accelerated death benefits

The Health Insurance Portability and Accountability Act of 1996

provides an exclusion from gross income as an amount paid by reason of the death of an insured for amounts received under a life

insurance contract and for amounts received for the sale or assignment of a life insurance contract to a qualified viatical settlement

802

4 Internal Revenue Service (1999).

provider, provided that the insured under the life insurance contract is either terminally ill or chronically ill.

The exclusion does not apply in the case of an amount paid to

any taxpayer other than the insured, if such taxpayer has an insurable interest by reason of the insured being a director, officer, or

employee of the taxpayer, or by reason of the insured being financially interested in any trade or business carried on by the taxpayer.

A terminally ill individual is defined as one who has been certified by a physician as having an illness or physical condition that

reasonably can be expected to result in death within 24 months of

the date of certification.

A chronically ill individual has the same meaning as provided

under the long-term care rules (see below). In the case of a chronically ill individual, the exclusion with respect to amounts paid

under a life insurance contract and amounts paid in a sale or assignment to a viatical settlement provider applies if the payment

received is for costs incurred by the payee (not compensated by insurance or otherwise) for qualified long-term care services for the

insured person for the period, and two other requirements (similar

to requirements applicable to long-term care insurance contracts)

are met.

The first requirement is that under the terms of the contract giving rise to the payment, the payment is not a payment or reimbursement of expenses reimbursable under Medicare (except where

Medicare is a secondary payor under the arrangement, or the arrangement provides for per diem or other periodic payments without regard to expenses for qualified long-term care services). No

provision of law shall be construed or applied so as to prohibit the

offering of such a contract giving rise to such a payment on the

basis that the contract coordinates its payments with those provided under Medicare. The second requirement is that the arrangement complies with the consumer protection provisions applicable

to long-term care insurance contracts and issuers that are specified

in Treasury regulations.

Long-term care insurance

Exclusion of long-term care insurance proceeds.—The Health Insurance Portability and Accountability Act of 1996 provides that a

long-term care insurance contract generally is treated as an accident and health insurance contract. Amounts (other than policyholder dividends or premium refunds) received under a long-term

care insurance contract generally are excludable as amounts received for personal injuries and sickness, subject to a dollar cap on

aggregate payments under per diem contracts. A reporting requirement applies to payors of excludable amounts.

The amount of the dollar cap on aggregate payments under per

diem contracts with respect to any one chronically ill individual

(who is not also terminally ill) is $190 per day for calendar year

2000 ($69,540 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.

803

If more than one payee receives payments with respect to any one

chronically ill individual, then everyone receiving periodic payments with respect to the same insured is treated as one person

for purposes of the dollar cap. The amount of the dollar cap is used

first by the chronically ill person, and any remaining amount is to

be allocated in accordance with Treasury regulations. If payments

under such contracts exceed the dollar cap, then the excess is excludable only to the extent of actual costs (in excess of the dollar

cap) incurred for long-term care services. Amounts in excess of the

dollar cap, with respect to which no actual costs were incurred for

long-term care services, are fully includable in income without regard to rules relating to return of basis under section 72. A grandfather rule applies to any per diem-type contract issued to a policyholder on or before July 31, 1996.

Exclusion for employer-provided long-term care coverage.—A plan

of an employer providing coverage under a long-term care insurance contract generally is treated as an accident and health plan.

Thus, employer-provided long-term care coverage is generally excludable from income and wages and deductible by the employer.

Employer-provided coverage under a long-term care insurance contract is not, however, excludable by an employee if provided

through a cafeteria plan; similarly, expenses for long-term care

services cannot be reimbursed under a flexible spending arrangement.

Definition of long-term care insurance contract.—A long-term

care insurance contract is defined as any insurance contract that

provides only coverage of qualified long-term care services and that

meets other requirements. The other requirements are that: (1) the

contract is guaranteed renewable; (2) the contract does not provide

for a cash surrender value or other money that can be paid, assigned, pledged or borrowed; (3) refunds (other than refunds on the

death of the insured or complete surrender or cancellation of the

contract) and dividends under the contract may be used only to reduce future premiums or increase future benefits; and (4) the contract generally does not pay or reimburse expenses reimbursable

under Medicare (except where Medicare is a secondary payor, or

the contract makes per diem or other periodic payments without

regard to expenses).

A contract does not fail to be treated as a long-term care insurance contract solely because it provides for payments on a per diem

or other periodic basis without regard to expenses incurred during

the period.

Medicare duplication rules.—No provision of law may be applied

to prohibit the offering of a long-term care insurance contract on

the basis that the contract coordinates its benefits with those provided under Medicare.

Definition of qualified long-term care services.—Qualified longterm 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

804

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 long-term care insurance contract. In addition, certain consumer protection provisions apply to issuers of long-term

care insurance contracts.

DEDUCTION FOR HEALTH INSURANCE EXPENSES OF

SELF-EMPLOYED INDIVIDUALS

Self-employed individuals may currently deduct 60 percent of

their health insurance expenses for themselves and their spouses

and dependents. The deduction also applies to certain long-term

care premiums treated as medical expenses. Under the Tax and

Trade Relief Extension Act of 1998, the deduction for health insurance of self-employed individuals will increase as follows: the deduction will be 60 percent in 2000 and 2001; 70 percent in 2002;

and 100 percent in 2003 and thereafter.

805

EXCLUSION OF MEDICARE BENEFITS

LEGISLATIVE HISTORY

The exclusion from income of Medicare benefits has never been

expressly established by statute. A 1970 IRS ruling, Rev. Rul. 70–

341, 1970–2 C.B. 31, provided that the benefits under part A of

Medicare are not includable in gross income because they are disbursements made to further the social welfare objectives of the

Federal Government. The Internal Revenue Service relied on a

similar ruling, Rev. Rul. 70–217, 1970–1 C.B. 13, with respect to

the excludability of Social Security disability insurance benefits in

reaching this conclusion. (For background on the exclusion of Social

Security benefits, see above section on pension contributions.) Rev.

Rul. 70–341 also held that benefits under part B of Medicare are

excludable as amounts received through accident and health insurance (though the subsidized portion of part B also may be excluded

under the same theory applicable to the exclusion of part A benefits).

EXPLANATION OF PROVISION

Benefits under part A and part B of Medicare are excludable

from the gross income of the recipient. In general, part A pays for

certain inpatient hospital care, skilled nursing facility care, home

health care, and hospice care for eligible individuals (generally the

elderly and the disabled). Part B covers certain services of a physician and other medical services for elderly or disabled individuals

who elect to pay the required premium.

DEDUCTIBILITY OF MEDICAL EXPENSES

LEGISLATIVE HISTORY

An itemized deduction for unreimbursed medical expenses above

a specified floor has been allowed since 1942. From 1954 through

1982, the floor under the medical expense deduction was 3 percent

of the taxpayer’s adjusted gross income (AGI); a separate floor of

1 percent of AGI applied to expenditures for medicine and drugs.

In the Tax Equity and Fiscal Responsibility Act of 1982

(TEFRA), the floor was increased to 5 percent of AGI (effective for

1983 and thereafter) and was applied to the total of all eligible

medical expenses, including prescription drugs and insulin. TEFRA

made nonprescription drugs ineligible for the deduction and eliminated the separate floor for drug costs.

The Tax Reform Act of 1986 increased the floor under the medical expense deduction to 7.5 percent of AGI, beginning in 1987.

EXPLANATION OF PROVISION

Individuals who itemize deductions may deduct amounts they

pay during the taxable year, if not reimbursed by insurance or otherwise, for medical care of the taxpayer and of the taxpayer’s

spouse and dependents, to the extent that the total of such expenses exceeds 7.5 percent of AGI (sec. 213).

Medical care expenses eligible include: (1) health insurance (including aftertax employee contributions to employer health plans);

806

(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 ($128,950 for 2000 and adjusted annually for inflation;

Joint Committee on Taxation staff projections).

EFFECT OF PROVISION

The Tax Code allows taxpayers to claim an itemized deduction

if unreimbursed medical expenses absorb a substantial portion of

income and thus adversely affect the taxpayer’s ability to pay

taxes. In order to limit the deduction to extraordinary expenses,

medical expenses are deductible only to the extent that they exceed

7.5 percent of the taxpayer’s AGI.

Table 13–10 shows the effect on medical expense deductions of

the increases in the floor on medical deductions. In the absence of

those increases, one would have expected the number of taxpayers

claiming the deduction to have increased because of inflation of

medical costs. However, increasing the floor should reduce the

number of taxpayers claiming the deduction because many taxpayers with relatively modest expenses no longer qualify. The average deduction in excess of the 7.5 percent of AGI floor has increased substantially, from $769 in 1980 to $5,571 in 1997. Both

increases in the floor (to 5 percent in 1983 and to 7.5 percent in

1987) substantially reduced the number of taxpayers claiming deductions.

Taxpayers in higher tax rate brackets receive more of a benefit

from each dollar of deductible medical expense than do taxpayers

in lower tax rate brackets. However, because the floor automatically rises with a taxpayer’s income, higher income taxpayers are

able to deduct a smaller amount (if any) of medical expenses above

their floor than are low-income taxpayers incurring the same aggregate amount of medical expenses.

In 2000 it is estimated that approximately 5.4 million taxpayers

will claim itemized medical expenses in excess of the medical deductions floor (7.5 percent of AGI; Joint Committee on Taxation

staff projections). It is also estimated by the staff of the Joint Committee that 81 percent will have incomes of less than $50,000 (table

13–11). However, taxpayers with incomes over $50,000 will receive

far more than half of the total tax savings attributable to medical

expense deductions.

807

TABLE 13–10.—TAX RETURNS CLAIMING DEDUCTIBLE MEDICAL AND DENTAL EXPENSES,

1980–97

Year

Total number

of returns filed

(in millions)

Returns claiming medical and dental expenses in

excess of the AGI floor

Number of

returns

(in millions)

Expenses in excess of the AGI

floor

(in billions)

Average

amount over

the 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 3,741

1989 .................................. 112.1 5.1 20.9 4,079

1990 .................................. 113.7 5.1 21.5 4,215

1991 .................................. 114.7 5.3 23.7 4,444

1992 .................................. 113.6 5.5 25.7 4,675

1993 .................................. 114.6 5.5 26.5 4,829

1994 .................................. 115.9 5.2 26.4 5,044

1995 .................................. 118.2 5.4 27.0 5,039

1996 .................................. 120.4 5.4 27.0 5,003

1997 .................................. 122.4 5.3 29.3 5,571

Source: Internal Revenue Service.

TABLE 13–11.—DISTRIBUTION OF ITEMIZED DEDUCTIONS FOR MEDICAL EXPENSES,

2000

Income class (thousands) 1 Average deduction

Returns

(thousands)

Total amount

(billions) 2

0–$10 ......................................................... $4,135 185 $0.8

$10–$20 ..................................................... 4,352 318 1.4

$20–$30 ..................................................... 4,882 603 2.9

$30–$40 ..................................................... 5,522 880 4.9

$40–$50 ..................................................... 4,386 907 4.0

$50–$75 ..................................................... 4,871 1,493 7.3

$75–$100 ................................................... 4,805 627 3.0

$100–$200 ................................................. 10,360 372 3.9

$200 and over ........................................... 31,109 46 1.4

Total ................................................. 5,431 5,432 29.5

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.

808

EARNED INCOME CREDIT

LEGISLATIVE HISTORY

The earned income credit (EIC Code sec. 32), enacted in 1975,

generally equals a specified percentage of wages up to a maximum

dollar amount. The maximum amount applies over a certain income range and then diminishes to zero over a specified phaseout

range. The income ranges and percentages have been revised several times since original enactment, expanding the credit (table 13–

12).

In 1987, the credit was indexed for inflation. In 1990 and again

in 1993, Congress enacted substantial expansions of the credit.

Auxiliary credits were added for very young children and for health

insurance premiums paid on behalf of a qualifying child in 1990.

These were repealed in 1993. Also in 1993, eligibility for the credit

was expanded to include childless workers. The Personal Responsibility and Work Opportunity Reconciliation Act of 1996 incorporated new rules relating to taxpayer identification numbers and

the modified AGI phaseout of the credit in addition to amending

the credit’s unearned income test (described below). The Taxpayer

Relief Act of 1997 also included provisions to improve compliance.

The provisions: (1) deny the EIC for 10 years to taxpayers who

fraudulently claimed the EIC, 2 years for EIC claims which are a

result of reckless or intentional disregard of rules or regulations);

(2) require EIC recertification for a taxpayer who is denied the

EIC; (3) imposes due diligence requirements on paid preparers of

returns involving the EIC; (4) requires information sharing between the Treasury Department and State and local governments

regarding child support orders; and (5) allows expanded use of Social Security Administration records to enforce the tax laws, including the EIC. The Balanced Budget Act of 1997 also increased the

IRS authorization to improve enforcement of the EIC.

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 1999

of 34 percent of their earnings up to $6,800, resulting in a maximum credit of $2,312. The maximum credit is available for those

with earnings between $6,800 and $12,460. At $12,460 of earnings

the credit begins to phase down at a rate of 15.98 percent of earnings above $12,460. The credit is phased down to 0 at $26,928 of

earnings.

Taxpayers with more than one qualifying child may claim a credit in 1999 of 40 percent of earnings up to $9,540, resulting in a

maximum credit of $3,816. The maximum credit is available for

those with earnings between $9,540 and $12,460. At $12,460 of

earnings the credit begins to phase down at a rate of 21.06 percent

of earnings above $12,460. The credit is phased down to $0 at

$30,580 of earnings.

809

TABLE 13–12.—EARNED INCOME CREDIT PARAMETERS, 1975–99

[Dollar amounts unadjusted for inflation]

Calendar year

Credit

rate

(percent)

Mininum

income

for maximum

credit

Maximum

credit

Phaseout

rate

(percent)

Phaseout range

Beginning

income

Ending

income

1975–78 .......................... 10.00 $4,000 $400 10.00 $4,000 $8,000

1979–84 .......................... 10.00 5,000 500 12.50 6,000 10,000

1985–86 .......................... 14.00 5,000 550 12.22 6,500 11,000

1987 ................................. 14.00 6,080 851 10.00 6,920 15,432

1988 ................................. 14.00 6,240 874 10.00 9,840 18,576

1989 ................................. 14.00 6,500 910 10.00 10,240 19,340

1990 ................................. 14.00 6,810 953 10.00 10,730 20,264

1991:

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

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

1992:

One child ..................... 17.60 7,520 1,324 12.57 11,840 22,370

Two children ................ 18.40 7,520 1,384 13.14 11,840 22,370

1993:

One child ..................... 18.50 7,750 1,434 13.21 12,200 23,050

Two children ................ 19.50 7,750 1,511 13.93 12,200 23,050

1994:

No children .................. 7.65 4,000 306 7.65 5,000 9,000

One child ..................... 26.30 7,750 2,038 15.98 11,000 23,755

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

1995:

No children .................. 7.65 4,100 314 7.65 5,130 9,230

One child ..................... 34.00 6,160 2,094 15.98 11,290 24,396

Two children ................ 36.00 8,640 3,110 20.22 11,290 26,673

1996:

No children .................. 7.65 4,220 323 7.65 5,280 9,500

One child ..................... 34.00 6,330 2,152 15.98 11,610 25,078

Two children ................ 40.00 8,890 3,556 21.06 11,610 28,495

1997:

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

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

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

1998:

No children .................. 7.65 4,460 341 7.65 5,570 10,030

One child ..................... 34.00 6,680 2,271 15.98 12,260 26,473

Two children ................ 40.00 9,390 3,756 21.06 12,260 30,095

1999:

No children .................. 7.65 4,530 347 7.65 5,670 10,200

One child ..................... 34.00 6,800 2,312 15.98 12,460 26,928

Two children ................ 40.00 9,540 3,816 21.06 12,460 30,580

Source: Joint Committee on Taxation.

810

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 $4,530, resulting in a maximum credit of $347. The

maximum is available for those with incomes between $4,530 and

$5,670. At $5,670 of earnings, the credit begins to phase down at

a rate of 7.65 percent of earnings above that amount, resulting in

a $0 credit at $10,200.

All income thresholds are indexed for inflation annually. In order

to be a qualifying child, an individual must satisfy a relationship

test, a residency test, and an age test. The relationship test requires that the individual be a child, stepchild, a descendant of a

child, or a foster or adopted child of the taxpayer. The residency

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

the taxpayer for more than half the taxable year. The household

must be located in the United States. The age test requires that

the individual be under 19 (24 for a full-time student) or be permanently and totally disabled.

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

of disqualified income of the taxpayer for the taxable year exceeds

$2,350. 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 selfemployment income.

For taxpayers with earned income (or modified 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 modified AGI, if greater) in excess of

the beginning of the phaseout range. For taxpayers with earned income (or modified AGI, if greater) in excess of the end of the phaseout range, no credit is allowed.

The definition of modified AGI used for phasing out the EIC disregards certain losses. The losses disregarded are:

1. Net capital losses (if greater than zero),

2. Net losses from trusts and estates,

3. Net losses from nonbusiness rents and royalties, and

4. Seventy-five percent of the net losses from businesses, computed separately with respect to sole proprietorships (other

than in farming), sole proprietorships in farming, and other

businesses.

The definition of modified AGI also includes tax-exempt interest

and nontaxable distributions from pensions, annuities, and individual retirement accounts (IRAs; but only if not called over into similar vehicles during the applicable rollover period).

Individuals are ineligible for the credit if they do not include

their taxpayer identification number and their qualifying child’s

number (and, if married, their spouse’s taxpayer identification

number) on their tax return. Solely for these purposes and for purposes of the present-law identification test for a qualifying child, a

taxpayer identification number is defined as a Social Security number issued to an individual by the Social Security Administration

811

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 selfemployment fails to pay the proper amount of self-employment tax

on such net earnings, the failure will be treated as a mathematical

or clerical error for purposes of the amount of credit allowed.

The EIC is relatively unique because it is a refundable tax credit;

i.e., if the amount of the credit exceeds the taxpayer’s Federal income tax liability, the excess is payable to the taxpayer as a direct

transfer payment. In this sense, the EIC is like other Federal programs that provide poor and low-income families with public benefits. However, the EIC differs from other Federal programs in that

its benefits require earnings.

Under an advance payment system, available since 1979, eligible

taxpayers may elect to receive the credit in their paychecks, rather

than waiting to claim a refund on their tax return filed by April

15 of the following year. In 1993, Congress required that the IRS

begin to notify eligible taxpayers of the advance payment option.

INTERACTION WITH MEANS-TESTED PROGRAMS

The treatment of the EIC for purposes of 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.

812

EFFECT OF PROVISION

More than 18.4 million taxpayers are expected to take advantage

of the EIC in 2000 (table 13–13). Their claims are expected to total

$30 billion, 87 percent of which will be refunded as direct payments

to these families. As table 13–13 also shows, approximately 72 percent of the tax relief or direct spending from the EIC accrues to

taxpayers who file as singles or heads of households.

TABLE 13–13.—DISTRIBUTION OF TAX PROVISIONS: EARNED INCOME CREDIT, 2000

Income class

Joint returns Head of household

and single returns

All returns

Number Amount Number Amount Number Amount

$0–$10,000 ....................... 592 $1,041 4,490 $4,575 5,082 $5,616

$10,000–$20,000 .............. 1,187 2,993 4,724 10,056 5,910 13,049

$20,000–$30,000 .............. 1,747 3,196 3,312 5,989 5,059 9,185

$30,000–$40,000 .............. 1,026 996 1,143 970 2,169 1,966

$40,000–$50,000 .............. 172 130 17 12 189 141

$50,000–$75,000 .............. 29 43 0 0 29 43

$75,000 and over .............. 000000

Total ..................... 4,754 8,398 13,685 21,602 18,459 30,000

Percent distribution by type

of return ........................ 25.8 28.0 74.2 72.0 100.0 100.0

Note.—Number of returns in thousands; amount of credit in millions.

Source: Joint Committee on Taxation.

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.

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, MedicVerDate 20-JUL-2000 13:14 Sep 29, 2000 Jkt 061710 PO 00000 Frm 00812 Fmt 6601 Sfmt 6601 J:\SKAYNE\GB96\61710.013 WAYS3 PsN: WAYS3
813

aid, and housing assistance. None of these payments is subject to

income tax.

TABLE 13–14.—EARNED INCOME CREDIT: NUMBER OF RECIPIENTS AND AMOUNT OF

CREDIT, 1975–2000

Year

Number of recipient families

(thousands)

Total amount

of credit

(millions)

Refunded

portions 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 1 ................................ 20,273 32,340 27,175 1,595

1999 2 ................................ 19,440 29,965 25,800 1,541

2000 2 ................................ 18,439 30,002 26,148 1,625

2001 2 ................................ 18,502 30,662 26,763 1,657

2002 2 ................................ 18,233 31,010 26,916 1,701

1 Preliminary.

2 Projected.

Source: For 1975–98, Internal Revenue Service; for 1999–2002, Joint Committee on Taxation.

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.

814

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.

The Tax Reform Act of 1976 replaced the deduction with a nonrefundable credit. This change broadened eligibility to those who do

not itemize deductions and provided relatively greater benefit to

low-income taxpayers. In addition, the act eased the rules related

to family status and simplified the computation.

In the Economic Recovery Tax Act of 1981, Congress provided a

higher ceiling on creditable expenses, a larger credit for low-income

individuals, and modified rules relating to care provided outside

the home.

The Family Support Act of 1988 reduced to 13 the age of a child

for whom the dependent care credit may be claimed, reduced the

amount of eligible expenses by the amount of expenses excludable

from that taxpayer’s income under the dependent care exclusion,

lowered from 5 to 2 the age at which a taxpayer identification number had to be submitted for children for whom the credit was

claimed, and disallowed the credit unless the taxpayer reports on

her tax return the correct name, address, and taxpayer identification number (generally, an employer identification number or a Social Security number) of the dependent care provider.

The Small Business Protection Act of 1996 required a TIN for all

children for whom a dependent care credit may be claimed.

EXPLANATION OF PROVISION

A taxpayer may claim a nonrefundable credit against income tax

liability for up to 30 percent of a limited amount of employmentrelated dependent care expenses. Eligible employment-related expenses are limited to $2,400 if there is one qualifying dependent or

$4,800 if there are two or more qualifying dependents. Generally,

a qualifying individual is a dependent under the age of 13 or a

physically or mentally incapacitated dependent or spouse.

Employment-related dependent care expenses are expenses for

the care of a qualifying individual incurred to enable the taxpayer

to be gainfully employed, other than expenses incurred for an overnight camp. For example, amounts paid for the services of a housekeeper generally qualify if such services are performed at least

partly for the benefit of a qualifying individual; amounts paid for

a chauffeur or gardener do not qualify.

Expenses that may be taken into account in computing the credit

generally may not exceed an individual’s earned income or, in the

case of married taxpayers, the earned income of the spouse with

815

the lesser earnings. Thus, if one spouse is not working, no credit

generally is allowed. Also, the amount of expenses eligible for the

dependent care credit is reduced, dollar for dollar, by the amount

of expenses excludable from that taxpayer’s income under the dependent care exclusion (discussed below).

The 30-percent credit rate is reduced, but not below 20 percent,

by 1 percentage point for each $2,000 (or fraction thereof) of AGI

above $10,000. Because married couples are required to file a joint

return to claim the credit, a married couple’s combined AGI is used

for purposes of this computation.

EFFECT OF PROVISION

From 1976 to 1997, the number of families that claimed the dependent care credit increased from 2.7 to 5.8 million, the aggregate

amount of credits claimed increased from $0.5 to $2.5 billion, and

the average amount of credit claimed per family increased from

$206 to $425 (table 13–15). In 1998, 6.1 million families are expected to claim an average credit of $433, for a total of $2.6 billion.

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.

HOPE CREDIT AND LIFETIME LEARNING CREDIT

The Taxpayer Relief Act of 1997 established the HOPE credit

and the lifetime learning credit as nonrefundable credits against

Federal income tax liability for qualified tuition and fees required

for the attendance of an eligible student at an eligible educational

institution.

The HOPE credit rate is 100 percent of the first $1,000 of qualified tuition and fees per eligible student per year, and 50 percent

of the next $1,000 of qualified tuition and fees per eligible student

per year. The HOPE credit is available only for the first 2 years

of postsecondary education. The qualified tuition and fees must be

incurred on behalf of the taxpayer, the taxpayer’s spouse, or a dependent. Charges and fees associated with meals, lodging, books,

student activities, athletics, insurance, transportation, and similar

personal, living, or family expenses are not eligible for the credit.

An eligible student for purposes of the HOPE credit is a student

enrolled in a degree, certificate, or other program on at least a halftime 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 deVerDate 20-JUL-2000 13:14 Sep 29, 2000 Jkt 061710 PO 00000 Frm 00815 Fmt 6601 Sfmt 6601 J:\SKAYNE\GB96\61710.013 WAYS3 PsN: WAYS3
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TABLE 13–15.—DEPENDENT CARE TAX CREDIT: NUMBER OF FAMILIES AND AMOUNT OF

CREDIT, 1976–98

Year

Number of returns claiming

dependent

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 1 ......................................................... 6,120 2,649 433

1 Preliminary.

Source: Joint Committee on Taxation.

gree, or another recognized postsecondary credential. Certain proprietary institutions and postsecondary vocational institutions are

also eligible educational institutions. The HOPE credit is effective

for expenses paid after December 31, 1997, for education furnished

in academic periods beginning after such date. For taxable years

beginning after 2001, the $1,500 maximum HOPE credit amount

will be indexed for inflation.

The lifetime learning credit rate is 20 percent of up to $5,000 in

qualified tuition and fees for a maximum credit of $1,000. For expenses paid after December 31, 2002, up to $10,000 in qualified

tuition and fees will be eligible for the 20-percent credit, for a maximum credit of $2,000. In contrast to the HOPE credit, the lifetime

learning credit is available for an unlimited number of years of

education. Also in contrast to the HOPE credit, which requires a

half-time or greater enrollment status, the lifetime learning credit

is available with respect to any course of instruction at an eligible

educational institution to acquire or improve job skills, regardless

of enrollment status. Qualified tuition and fees are defined in the

same manner as under the HOPE credit provisions. As with the

HOPE credit, eligible students are the taxpayer, the taxpayer’s

817

spouse, or a dependent. In contrast to the HOPE credit, the maximum amount of the lifetime learning credit that may be claimed

on a taxpayer’s return will not vary with the number of students

in the taxpayer’s family. The lifetime learning credit is effective for

expenses paid after June 30, 1998, for education furnished in academic periods beginning after such date. The maximum lifetime

learning credit amount is not indexed for inflation.

Eligibility for the HOPE credit and the lifetime learning credit

is phased out ratably for taxpayers with modified adjusted gross income (AGI) between $40,000 and $50,000 ($80,000 and $100,000

for joint returns). These phaseout ranges are indexed for inflation

for taxable years beginning after 2001. For a taxable year, a taxpayer may elect with respect to an eligible student either the

HOPE credit, the lifetime learning credit, or the exclusion from

gross income for certain distributions from an education IRA. For

purposes of both the HOPE credit and the lifetime learning credit,

if a parent claims a child as a dependent, then only the parent may

claim the credit.

QUALIFIED STATE TUITION PROGRAMS AND

EDUCATION IRAs

The Taxpayer Relief Act of 1997 modified section 529 of the Tax

Code, which governs the tax treatment of qualified State tuition

programs. Section 529 was enacted as part of the Small Business

Job Protection Act of 1996, and provides tax-exempt status and deferral of tax on earnings of qualified State tuition programs. The

Taxpayer Relief Act of 1997 also provides that taxpayers may establish education IRAs.

Qualified State tuition programs are programs established and

maintained by a State under which persons may: (1) purchase tuition credits on behalf of a designated beneficiary that entitle the

beneficiary to a waiver or payment of qualified higher education expenses of the beneficiary; or (2) make contributions to an account

that is established for the purpose of meeting qualified higher education expense of a designated beneficiary. Qualified higher education expenses are defined as tuition, fees, books, supplies, and

equipment required for the enrollment of or attendance at a college

or university (or certain vocational schools). The Taxpayer Relief

Act of 1997 expanded the definition of qualified expenses to include

room and board expenses. Contributions to State tuition programs

are not deductible. Earnings on qualified State tuition programs

are includable in income only when ultimately distributed. Distributions from a qualified State tuition program also entitle the

distributee to claim either the HOPE or the lifetime learning credit

with respect to education expenses paid with such distributions, assuming the other requirements for claiming the HOPE credit or the

lifetime learning credit are satisfied. There are no income limits for

participation in qualified State tuition programs, though contributions must be limited by the program to amounts no greater than

an amount necessary to provide for the education of the beneficiary. The program must also impose a more than de minimis

penalty on earnings not used for qualified expenses.

An education IRA is a trust or custodial account created exclusively for the purpose of paying qualified higher education expenses

818

of a named beneficiary. Contributions to an education IRA are not

deductible; earnings on contributions are not currently includable

in income. Contributions to education IRAs are limited to $500 per

year per beneficiary. However, no contribution may be made by any

person to an education IRA established on behalf of a beneficiary

during any taxable year in which any contributions are made by

anyone to a qualified State tuition program on behalf of the same

beneficiary. The contribution limit is phased out ratably for contributors with modified AGI between $95,000 and $110,000

($150,000 and $160,000 for joint returns). Qualified expenses are

the same as those for the qualified State tuition programs, with the

exception that room and board expenses are qualified expenses

only if the student is enrolled on at least a half-time basis. Withdrawals of earnings from education IRAs are excludable from income provided that such withdrawals are used to pay for qualified

higher education expenses. If the earnings are not used for qualified expenses, they are includable in income and are also subject

to an additional 10-percent penalty tax. A taxpayer may not simultaneously claim an exclusion from income for distributions from an

education IRA and claim either the HOPE credit or the lifetime

learning credit.

STUDENT LOAN INTEREST DEDUCTION

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

deductibility of interest on qualified education loans. The deduction

is allowed only with respect to interest paid during the first 60

months in which interest payments are required. A qualified education loan is generally defined as any indebtedness incurred to

pay for the qualified higher education expenses of the taxpayer, the

taxpayer’s spouse, or any dependent of the taxpayer as of the time

the indebtedness was incurred in attending either postsecondary

educational institutions and certain vocational schools defined by

reference to section 481 of the Higher Education Act of 1965, or institutions conducting internship or residency programs leading to

a degree or certificate from an institution of higher education, a

hospital, or a health care facility conducting postgraduate training.

Qualified higher education expenses are defined as the student’s

cost of attendance as defined in section 472 of the Higher Education Act of 1965 (generally, tuition, fees, room and board, and related expenses), reduced by: (1) any amount excluded under section

135 (i.e., U.S. saving bonds used to pay higher education tuition

and fees); (2) any amount distributed from an education IRA and

excluded from gross income; and (3) the amount of any scholarship

or fellowship grants excludable from gross income under section

117, as well as any other tax-free education benefits, such as

employer-provided educational assistance that is excludable from

the employee’s gross income under section 127.

The maximum deduction is phased in gradually, with a $2,000

maximum in 2000, and $2,500 in 2001. The maximum deduction is

not indexed for inflation, and the deduction is phased out ratably

for individual taxpayers with modified AGI of $40,000–$55,000

($60,000–$75,000 for joint returns). These income ranges will be indexed for inflation occurring after the year 2002, and rounded

down to the closest multiple of $5,000. This provision is effective

819

for interest payments due and paid after December 31, 1997, on

any qualified education loan.

EXCLUSION FOR EMPLOYER-PROVIDED DEPENDENT

CARE

LEGISLATIVE HISTORY

The value of certain employer-provided dependent care is excluded from the employee’s gross income. The Economic Recovery

Tax Act of 1981 added this exclusion (sec. 129) and amended Code

sections 3121(a)(18) and 3306(b)(13) to exclude such employerprovided 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 employerprovided dependent care excluded from the taxpayer’s income to reduce, dollar for dollar, the amount of expenses eligible for the dependent care tax credit.

EXPLANATION OF PROVISION

Amounts paid or incurred by an employer for dependent care assistance provided to an employee generally are excluded from the

employee’s gross income if the assistance is furnished under a program meeting certain requirements. These requirements include

that the program be described in writing, satisfy certain nondiscrimination rules, and provide for notification to all eligible employees. The type of dependent care eligible for the exclusion is the

same as the type eligible for the dependent care credit.

The dependent care exclusion is limited to $5,000 per year except

that a married taxpayer filing a separate return may exclude only

$2,500. Amounts excluded from gross income generally are excludable from wages for employment tax purposes. Dependent care expenses excluded from income are not eligible for the dependent care

tax credit.

EFFECT OF PROVISION

The exclusion provides an incentive to taxpayers with expenses

for dependent care to seek compensation in the form of dependent

care assistance rather than in cash subject to taxation. This incentive is of greater value to employees in higher tax brackets.

Many employees covered by the exclusion for employer-provided

dependent care also are eligible to use the dependent care tax credit. While the limitations on the exclusion and the credit differ, the

credit generally is less valuable than the exclusion for taxpayers

who are above the 15-percent tax bracket.

According to a survey of private firms with 100 or more workers

conducted by the U.S. Bureau of Labor Statistics (1993), nearly

one-tenth of full-time workers at these firms were eligible for child

care benefits provided by the employer in the form of on-site or

near-site child care facilities or through direct reimbursement of

employee expenses. A more prevalent form of providing dependent

820

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 exfelons; (3) vocational rehabilitation referrals; (4) qualified summer

youth employees; (5) qualified veterans; (6) youths who reside in an

empowerment zone or enterprise community; (7) families receiving

food stamps; and (8) persons receiving certain Supplemental Security Income (SSI) benefits.

The credit generally is equal to 40 percent (25 percent for employment of 400 hours or less) of qualified wages. Qualified wages

consist of wages attributable to service rendered by a member of

a targeted group during the 1-year period beginning with the day

the individual begins work for the employer. For a vocational rehabilitation referral, however, the period will begin on the day the individual begins work for the employer on or after the beginning of

the individual’s vocational rehabilitation plan as under prior law. Generally, no more than $6,000 of wages during the first year of

employment is permitted to be taken into account with respect to

any individual. Thus, the maximum credit per individual is $2,400.

With respect to qualified summer youth employees, the maximum

credit is 40 percent of up to $3,000 of qualified first-year wages, for

a maximum credit of $1,200.

In general, an individual is not to be treated as a member of a

targeted group unless: (1) on or before the day the individual begins work for the employer, the employer received in writing a certification from the designated local agency that the individual is a

member of a specific targeted group; or (2) on or before the day the

individual is offered work with the employer, a prescreening notice

is completed with respect to that individual by the employer and

within 21 days after the individual begins work for the employer,

the employer submits such notice, signed by the employer and the

individual under penalties of perjury, to the designated local agency as part of a written request for certification. The prescreening

notice will contain the information provided to the employer by the

individual that forms the basis of the employer’s belief that the individual is a member of a targeted group.

No credit is allowed for wages paid unless the eligible individual

is employed by the employer for at least 120 hours. The credit percentage is 25 percent for employment of 400 hours or less, assuming that the minimum employment period is satisfied with respect

to that employee. For employment of more than 400 hours, the

credit percentage is 40 percent.

The credit is effective for wages paid or incurred to a qualified

individual who begins work for an employer after September 30,

1996, and before January 1, 2002.

821

WELFARE-TO-WORK TAX CREDIT

The Code provides to employers a tax credit on the first $20,000

of eligible wages paid to qualified long-term family assistance

(TANF) recipients during the first 2 years of employment. The

credit is 35 percent of the first $10,000 of eligible wages in the first

year of employment and 50 percent of the first $10,000 of eligible

wages in the second year of employment. The maximum credit is

$8,500 per qualified employee.

Qualified long-term family assistance recipients are: (1) members

of a family that has received TANF benefits for at least 18 consecutive months ending on the hiring date; (2) members of a family that

has received TANF benefits for a total of at least 18 months

(whether or not consecutive) after the date of enactment of this

credit if they are hired within 2 years after the date that the 18-

month total is reached; and (3) members of a family who are no

longer eligible for TANF because of either Federal or State time

limits, if they are hired within 2 years after the Federal or State

time limits made the family ineligible for family assistance.

Eligible wages include cash wages paid to an employee plus

amounts paid by the employer for the following: (1) educational assistance excludable under a section 127 program (or that would be

excludable but for the expiration of sec. 127); (2) health plan coverage for the employee, but not more than the applicable premium

defined under section 4980B(f)(4); and (3) dependent care assistance excludable under section 129.

The welfare to work credit is effective for wages paid or incurred

to a qualified individual who begins work for an employer on or

after January 1, 1998 and before January 1, 2002.

EXCLUSION OF WORKERS’ COMPENSATION AND

SPECIAL BENEFITS FOR DISABLED COAL MINERS

LEGISLATIVE HISTORY

Workers’ compensation benefits generally are not taxable under

section 104(a)(1) of the Internal Revenue Code of 1986. Workers’

compensation benefits are treated as Social Security benefits to the

extent that they reduce Social Security benefits received (see

above). This exclusion from gross income was first codified in the

Revenue Act of 1918. The Ways and Means Committee report for

that act suggests that such payments were not subject to tax even

prior to the 1918 act.

Payments made to coal miners or their survivors for death or disability resulting from pneumoconiosis (black lung disease) under

the Federal Coal Mine Health and Safety Act of 1969 (as amended)

are excluded from gross income. Payments made as a result of

claims filed before December 31, 1972 originally were excluded

from Federal income tax by the Federal Coal Mine Health and

Safety Act of 1969. Later payments are excluded from gross income

because they are considered to be in the nature of workers’ compensation (Rev. Rul. 72–400, 1972–2 C.B. 75).

822

EXPLANATION OF PROVISION

Gross income does not include amounts received as workers’ compensation for personal injuries or sickness. This exclusion also applies to benefits paid under a workers’ compensation act to a survivor of a deceased employee.

Benefits for disabled coal miners (black lung benefits) are not includable in gross income.

There are two types of black lung programs. The first involves

Federal payments to coal miners and their survivors due to death

or disability, payable for claims filed before July 1, 1973 (December

31, 1973, in the case of survivors). This program provided total annual payments of around $672 million to approximately 143,000

beneficiaries in December 1995 (Social Security Administration,

1996).

The second program requires coal mine operators to ensure payment of black lung benefits for claims filed on or after July 1, 1973

(December 31, 1973, in the case of survivors) in a federally mandated workers’ compensation program. Benefits include medical

treatment as well as cash payments. These benefits are paid from

a trust fund financed by an excise tax on coal production if there

is no responsible operator (an operator for whom the miner worked

for at least 1 year) or if the responsible operator is in default. This

program provided total annual payments of around $610 million to

approximately 156,550 claimants in 1986 (U.S. Department of

Labor, 1989, tables 3 & 6).

ADDITIONAL STANDARD DEDUCTION FOR THE

ELDERLY AND BLIND

LEGISLATIVE HISTORY

From 1954 through 1986, an additional personal exemption was

allowed for a taxpayer or a spouse who was 65 years or older at

the close of the year. An additional personal exemption also was allowed for a taxpayer or a spouse who was blind.

The Tax Reform Act of 1986 repealed the additional personal exemption for the elderly and blind and replaced it with an additional

standard deduction amount. These additional standard deduction

amounts are adjusted for inflation.

EXPLANATION OF PROVISION

The additional standard deduction amount for the elderly or the

blind is $850 in 2000 for an elderly or a blind individual who is

married (whether filing jointly or separately) or is a surviving

spouse, and $1,700 for such an individual who is both elderly and

blind. The additional amount is $1,100 for a head of household who

is elderly or blind ($2,200, 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

823

than 20/200 in the better eye with correcting lenses, or if visual

acuity is better than 20/200 but is accompanied by a limitation in

the fields of vision such that the widest diameter of the visual field

subtends an angle no greater than 20 degrees.

EFFECT OF PROVISION

The additional standard deduction increases the tax threshold for

elderly and blind taxpayers. For example, the additional amount is

$1,700 for two elderly individuals filing a joint return, raising the

tax threshold in 2000 from $12,950 to $14,650.

In 1997, about 11.1 million taxpayers claimed the extra standard

deduction. About 81 percent of the 11.1 million beneficiaries had

incomes of less than $40,000.

TAX CREDIT FOR THE ELDERLY AND CERTAIN

DISABLED INDIVIDUALS

LEGISLATIVE HISTORY

The present tax credit for individuals who are age 65 or 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

824

of certain limits: $7,500 for a single individual, $10,000 for married

taxpayers filing a joint return, or $5,000 for married taxpayers filing separate returns. These computational rules reflect that the

credit is designed to provide tax benefits to individuals who receive

only taxable retirement or disability income, or who receive a combination of taxable retirement or disability income plus Social Security benefits that generally are comparable to the tax benefits

provided to individuals who receive only Social Security benefits

(including Social Security disability benefits).

EFFECT OF PROVISION

In 1997, $41 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, 1976–97

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

Source: Joint Committee on Taxation.

825

TAX PROVISIONS RELATED TO HOUSING

OWNER-OCCUPIED HOUSING

Legislative history

Deductibility of mortgage interest.—Prior to the Tax Reform Act

of 1986, all interest payments on indebtedness incurred for personal use (e.g., to purchase consumption goods) were deductible in

computing taxable income. The 1986 act amended section 163(h) of

the Internal Revenue Code to disallow deductions for all personal

interest except for interest on indebtedness secured by a first or

second home.

In the Omnibus Budget Reconciliation Act of 1987, Congress further restricted the deductibility of mortgage interest. Only two

classes of interest were distinguished as deductible: interest on acquisition indebtedness and interest on home equity indebtedness.

Acquisition indebtedness, defined as indebtedness secured by a residence and used to acquire or improve the residence by which it is

secured, was limited to $1,000,000 ($500,000 in the case of a married individual filing a separate return). Home equity indebtedness,

defined as any nonacquisition indebtedness secured by a residence

(for example, a home equity loan), was limited to the lesser of

$100,000 ($50,000 for married taxpayers filing separately) or the

excess of the fair market value of the residence over the acquisition

indebtedness.

Exclusion of capital gains for certain taxpayers.—In the Revenue

Act of 1964, Congress introduced section 121 of the Internal Revenue Code of 1954, which permitted a one-time exclusion of all or

part of the gain on the sale of a principal residence by older individuals. This exclusion was limited to homeowners who had lived

in the property as a principal residence for 5 out of the last 8 years

before the property’s sale or exchange. Furthermore, full exclusion

was permitted only for houses that sold for $20,000 or less.

The parameters of this exclusion have been modified and expanded a number of times. Most recently, the Taxpayer Relief Act

of 1997 significantly expanded the exclusion (e.g., the age 55 requirement was repealed).

Explanation of 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

826

loans is generally not deductible in computing the alternative minimum tax.

Under present law, a taxpayer generally is able to exclude up to

$250,000 ($500,000 if married filing a joint return) of gain realized

on the sale or exchange of a principal residence. The exclusion is

allowed each time a taxpayer selling or exchanging a principal residence meets the eligibility requirements, but generally no more frequently than once every 2 years.

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

residence and occupied it as a principal residence for at least 2 of

the 5 years prior to the sale or exchange. A taxpayer who fails to

meet these requirements by reason of a change of place of employment, health, or other unforeseen circumstances is able to exclude

the fraction of the $250,000 ($500,000 if married filing a joint return) equal to the fraction of 2 years that these requirements are

met.

Effects of provision

Preliminary tax return information for 1997 indicates that 30

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 owner-occupied housing, so even a modest shift of investment

to other assets could have sizable effects.

LOW-INCOME HOUSING CREDIT

Legislative history

The low-income rental housing tax credit was first enacted in the

Tax Reform Act of 1986. The Omnibus Budget Reconciliation Act

of 1989 substantially modified the credit. The Omnibus Budget

Reconciliation Act of 1993 modified the credit again and made it

permanent.

Explanation of provision

A tax credit may be claimed by owners of residential rental property used for low-income rental housing. The credit is claimed annually, generally for a period of 10 years. New construction and rehabilitation expenditures for low-income housing projects are eligiVerDate 20-JUL-2000 13:14 Sep 29, 2000 Jkt 061710 PO 00000 Frm 00826 Fmt 6601 Sfmt 6601 J:\SKAYNE\GB96\61710.013 WAYS3 PsN: WAYS3
827

ble for a maximum 70-percent present value credit, claimed annually for 10 years. The acquisition cost of existing projects that meet

the substantial rehabilitation requirements and the cost of newly

constructed projects receiving other Federal subsidies are eligible

for a maximum 30-percent present value credit, also claimed annually for 10 years. These credit percentages are adjusted monthly

based on an Applicable Federal Rate.

The credit amount is based on the qualified basis of the housing

units serving the low-income tenants. A residential rental project

will qualify for the credit only if: (1) 20 percent or more of the aggregate residential rental units in the project are occupied by individuals with 50 percent or less of area median income; or (2) 40

percent or more of the aggregate residential rental units in the

project are occupied by individuals with 60 percent or less of area

median income. These income figures are adjusted for family size.

Maximum rents that may be charged families in units on which a

credit is claimed depend on the number of bedrooms in the unit.

The rent limitation is 30 percent of the qualifying income of a family deemed to have a size of 1.5 persons per bedroom (e.g., a twobedroom unit has a rent limitation based on the qualifying income

for a family of three).

Credit eligibility also depends on the existence of a 30-year extended low-income use agreement for the property. If property on

which a low-income housing credit is claimed ceases to qualify as

low-income rental housing or is disposed of before the end of a 15-

year credit compliance period, a portion of the credit may be recaptured. The 30-year extended use agreement creates a State law

right to enforce low-income use for an additional 15 years after the

initial 15-year recapture period.

In order for a building to be a qualified low-income building, the

building owner generally must receive a credit allocation from the

appropriate credit authority. An exception is provided for property

that is substantially financed with the proceeds of tax-exempt

bonds subject to the State’s private-activity bond volume limitation.

The low-income housing credit is allocated by State or local government authorities subject to an annual limitation for each State

based on State population. The annual credit allocation per State

is $1.25 per resident.

Effect of provision

Comprehensive data from tax returns concerning the low-income

housing tax credit are unavailable. Table 13–17 presents data from

a survey of State credit allocating agencies. These data indicate

that annual allocation of available credit authority generally has

been 67 percent or greater. Year-to-year variations in credit allocation probably reflect changes in Federal law affecting the credit

and changing economic conditions affecting the construction and

housing markets. For example, 1990 was the first year following

substantial modification to the credit and included a temporary period during which State credit allocating agencies were limited to

allocating authority of $0.9375 per capita rather than the $1.25 per

capita of present and prior law.

828

TABLE 13–17.—ALLOCATION OF THE LOW-INCOME HOUSING CREDIT, 1987–98

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

1991 1 ......................................................... 497.3 400.6 80.6

1992 1 ......................................................... 476.8 332.7 70.0

1993 1 ......................................................... 546.4 424.7 77.7

1994 1 ......................................................... 523.7 495.5 94.7

1995 1 ......................................................... 432.6 410.9 95.0

1996 1 ......................................................... 391.6 379.9 97.0

1997 ........................................................... 387.3 382.9 98.9

1998 ........................................................... 376.8 373.8 99.0

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

Source: Survey of State allocating agencies conducted by the National Council of State Housing Agencies (1996).

An allocation percentage of less than 100 percent does not imply

that some credits available for allocation to low-income housing

projects go unused. Since 1990, States are permitted to carry forward unused credit subsequently made available for allocation by

other States. Thus, the amount allocated in any 1 year could be

less than the States’ authority, but such authority may ultimately

be allocated.

TAX CREDIT AND EXCLUSION FOR ADOPTION

EXPENSES

The Small Business Job Protection Act of 1996 (Public Law 104–

188), signed into law on August 20, 1996, includes two tax provisions designed to reduce economic barriers to adoption. First, a tax

credit of up to $5,000 (or $6,000 in the case of families adopting

special-needs children from the United States) is created to help

defray one-time adoption expenses. The credit is phased out for

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

with incomes above $115,000. Second, employees may receive an

income tax exclusion of up to $5,000 per child (or $6,000 in the case

of special-needs children) for employer-provided adoption assistance. The effective date for both provisions is January 1, 1997. The

credit for foreign special-needs adoptions and the exclusion are not

available after December 31, 2001.

CHILD TAX CREDIT

The Taxpayer Relief Act of 1997 provided for a $500 ($400 for

taxable year 1998) tax credit for each qualifying child under the

age of 17. A qualifying child is defined as an individual for whom

the taxpayer can claim a dependency exemption and who is a son

or daughter of the taxpayer (or a descendant of either), a stepson

or stepdaughter of the taxpayer, or an eligible foster child of the

taxpayer. For taxpayers with modified AGI in excess of certain

thresholds, the allowable child credit is phased out.

829

Generally, the maximum amount of the child credit for each taxable year cannot exceed the excess of the taxpayer’s regular tax liability over the taxpayer’s tentative minimum tax liability (determined without regard to the alternative minimum foreign tax credit). In the case of a taxpayer with three or more qualifying children, the maximum amount of the child credit for each taxable

year cannot exceed the greater of: (1) the general rule (described

above), or (2) an amount equal to the excess of the sum of the taxpayer’s regular income tax liability (net of applicable credits other

than the earned income credit (EIC)) and the employee share of

FICA (and one-half of the taxpayer’s SECA tax liability, if applicable) reduced by the EIC. In the case of a taxpayer with three or

more qualifying children, the excess of the amount allowed in (2)

over the amount computed in (1) is a refundable credit.

For taxpayers with modified AGI in excess of certain thresholds, the child credit is phased out. The phaseout rate is $50 for each

$1,000 of modified AGI (or fraction thereof) in excess of the threshold. For these purposes modified AGI is computed by increasing the

taxpayer’s AGI by the amount otherwise excluded under Code sections 911, 931, and 933 (relating to the exclusion of income of U.S.

citizens or residents living abroad; residents of Guam, American

Samoa, and the Northern Mariana Islands; and residents of Puerto

Rico, respectively). For married taxpayers filing joint returns, the

threshold is $110,000. For taxpayers filing single or head of household returns, the threshold is $75,000. For married taxpayers filing

separate returns, the threshold is $55,000. These thresholds are

not indexed for inflation.

EFFECT OF TAX PROVISIONS ON THE INCOME AND

TAXES OF THE ELDERLY AND THE POOR

Table 13–18 presents values of the personal exemptions, standard deductions, additional standard deductions for the elderly and

the blind, and taxable income brackets for 1993–2009. The figures

for 2001–9 are based on Congressional Budget Office projections.

The value to taxpayers of personal exemptions, standard deductions, and additional standard deductions for the elderly and the

blind grows steadily over the 10-year period.

HYPOTHETICAL TAX CALCULATIONS FOR SELECTED FAMILIES

Table 13–19 presents examples of tax liabilities for hypothetical

taxpayers. The table presents 1999 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

TABLE 13–18a.—ACTUAL PERSONAL EXEMPTIONS, STANDARD DEDUCTIONS, AND TAXABLE INCOME LEVELS, 1993–2000

Exemption, deduction, or income level 1993 1994 1995 1996 1997 1998 1999 

Personal exemptions $2,350 $2,450 $2,500 $2,550 $2,650 $2,700 $2,750 Standard deductions:

Joint ............................................................................... 6,200 6,350 6,550 6,700 6,900 7,100 7,200 Single ............................................................................. 3,700 3,800 3,900 4,000 4,150 4,250 4,300 Head of household ........................................................ 5,450 5,600 5,750 5,900 6,050 6,250 6,350 

Additional standard deductions for elderly/blind:

Joint (each individual) .................................................. 700 750 750 800 800 850 850 Single/head of household .............................................. 900 950 950 1,000 1,000 1,050 1,050 

Taxable income levels:

Joint returns:

15 percent rate ends at ....................................... 36,900 38,000 39,000 40,100 41,200 42,350 43,050 28 percent rate ends at ....................................... 89,150 91,850 94,250 96,900 99,600 102,300 104,050 31 percent rate ends at ....................................... 140,000 140,000 143,600 147,700 151,750 155,950 158,550 

Single returns:

15 percent rate ends at ....................................... 22,100 22,750 23,350 24,000 24,650 25,350 25,750 28 percent rate ends at ....................................... 53,500 55,100 56,550 58,150 59,750 61,400 62,450 31 percent rate ends at ....................................... 115,000 115,000 117,950 121,300 124,650 128,100 130,250 

Heads of household:

15 percent rate ends at ....................................... 29,600 30,500 31,250 32,150 33,050 33,950 34,550 28 percent rate ends at ....................................... 76,400 78,700 80,750 83,050 85,350 87,700 89,150 31 percent rate ends at ....................................... 127,500 127,500 130,800 134,500 138,200 142,000 144,400 39.6 percent rate begins at ................................. 250,000 250,000 256,500 263,750 271,050 278,450 283,150 

Source: Congressional Budget Office.

TABLE 13–18b.—PROJECTED PERSONAL EXEMPTIONS, STANDARD DEDUCTIONS, AND TAXABLE INCOME LEVELS, 2001–9

Exemption, deduction, or income level 2001 2002 2003 2004 2005 2006 2007 2008 

Personal exemptions $2,900 $2,950 $3,000 $3,100 $3,200 $3,250 $3,350 $3,400 Standard deductions:

Joint ............................................................. 7,550 7,700 7,900 8,100 8,300 8,500 8,750 8,950 Single ........................................................... 4,500 4,600 4,750 4,850 5,000 5,100 5,250 5,350 Head of household ...................................... 6,650 6,800 6,950 7,150 7,300 7,500 7,700 7,850 

Additional standard deductions for elderly/blind:

Joint (each individual) ................................ 900 900 950 950 1,000 1,000 1,050 1,050 Single/head of household ............................ 1,100 1,150 1,150 1,200 1,250 1,250 1,300 1,300 

Taxable income levels:

Joint returns:

15 percent rate ends at ..................... 44,950 46,050 47,200 48,350 49,550 50,800 52,050 53,350 28 percent rate ends at ..................... 108,650 111,250 114,050 116,850 119,800 122,750 125,800 128,950 31 percent rate ends at ..................... 165,600 169,550 173,750 178,100 182,550 187,100 191,750 196,500 

Single returns:

15 percent rate ends at ..................... 26,900 27,550 28,250 28,950 29,650 30,400 31,150 31,950 28 percent rate ends at ..................... 65,200 66,750 68,400 70,150 71,850 73,650 75,500 77,400 31 percent rate ends at ..................... 136,050 139,250 142,750 146,300 149,950 153,650 157,500 161,400 

Heads of household:

15 percent rate ends at ..................... 36,050 36,950 37,850 38,800 39,750 40,750 41,750 42,800 28 percent rate ends at ..................... 93,100 95,350 97,700 100,150 102,650 105,200 107,800 110,500 31 percent rate ends at ..................... 150,800 154,400 158,250 162,200 166,250 170,350 174,600 178,950 39.6 percent rate begins at ............... 295,750 302,800 310,350 318,050 325,950 334,100 342,400 350,950 

Source: Congressional Budget Office.

832

TABLE 13–19.—EXAMPLES OF FEDERAL INCOME AND PAYROLL TAX LIABILITIES OF

HYPOTHETICAL TAXPAYERS, 1999

Type of filing unit and income Income tax

liability

FICA tax

liability

Total tax

liability

Overall

effective

tax rate

(percent) 1

Overall

marginal

tax rate

(percent) 1

Joint filer—3 exemptions: 2

$10,000 ...................... ¥$2,312 $1,530 ¥$782 ¥7.3 14.2

$30,000 ...................... 1,683 4,590 6,273 19.4 28.1

$50,000 3 ..................... 4,263 7,650 11,913 22.1 28.1

$100,000 4 ................... 13,994 11,902 25,896 24.4 30.5

Head of household—2 exemptions: 2

$10,000 ....................... ¥2,312 1,530 ¥782 ¥7.3 14.2

$30,000 ....................... 2,223 4,590 6,813 21.1 28.1

$50,000 3 ..................... 4,675 7,650 12,325 22.9 28.1

$100,000 4 ................... 16,369 11,902 28,271 26.7 30.5

Elderly couple filing joint return:

$10,000 5 ..................... 0 0 0 0.0 6 0.0

$30,000 7 ..................... 540 0 540 1.8 8 15.0

$50,000 9 ..................... 4,440 1,530 5,970 11.8 40.0

Elderly single filer: $10,000 10 ................... 0 0 0 0.0 6 0.0

$30,000 11 ................... 2,254 0 2,254 7.5 12 22.5

$50,000 13 ................... 8,070 3,060 11,130 21.6 40.2

1 The average tax rate is total tax liability divided by income plus the employer share of FICA. The

marginal rate computations also count the employer share of FICA tax as income to the employee (for

both payroll and income tax purposes). Unless otherwise noted, all calculations assume the taxpayer

takes the standard deduction rather than itemized deductions. 2 Assumes one child 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 28.1 percent, representing both the income tax liability and the FICA tax liability on this income. 9 Same as above plus additional $10,000 of taxable interest and $10,000 of wages.

10 Of the total, $7,500 is Social Security and $7,500 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 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.

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 2000, a single elderly individual with

$5,000 in Social Security benefits can have up to $8,300 in other

833

income without incurring tax liability (or total income of $13,300).

An elderly married couple filing jointly with $5,000 in excluded Social Security benefits has a tax threshold of $14,467 (or total income of $19,467). By comparison, the poverty levels in 2000 for a

single elderly person and an elderly couple were $8,350 and

$11,250, respectively (Federal Register, 2000). Table 13–20 displays

similar information for other years and for varying amounts of Social Security benefits.

TABLE 13–20.—INCOME TAX THRESHOLDS FOR ELDERLY INDIVIDUALS WITH VARIOUS

AMOUNTS OF SOCIAL SECURITY INCOME, 1992–2009

Year and filing status

Amount of income before Social Security

None $2,500 $5,000 $7,500

1992:

Single ....................................... $10,367 $8,700 $6,800 $6,800

Joint .......................................... 16,333 14,667 13,000 12,000

1993:

Single ....................................... 10,467 8,800 6,950 6,950

Joint .......................................... 16,533 14,867 13,200 12,300

1994:

Single ....................................... 10,633 8,967 7,200 7,200

Joint .......................................... 16,833 15,167 13,500 12,750

1995:

Single ....................................... 10,733 9,067 7,350 7,350

Joint .......................................... 17,033 15,367 13,700 13,050

1996:

Single ....................................... 10,867 9,200 7,550 7,550

Joint .......................................... 17,267 15,600 13,933 13,400

1997:

Single ....................................... 11,033 9,367 7,800 7,800

Joint .......................................... 17,533 15,867 14,200 13,800

1998:

Single ....................................... 11,167 9,500 8,000 8,000

Joint .......................................... 17,800 16,133 14,467 14,200

1999:

Single ....................................... 11,233 9,567 8,100 8,100

Joint .......................................... 17,933 16,267 14,600 14,400

2000:

Single ....................................... 11,367 9,700 8,300 8,300

Joint .......................................... 18,100 16,433 14,767 14,650

2001:

Single ....................................... 11,500 9,833 8,500 8,500

Joint .......................................... 18,433 16,767 15,100 15,150

2002:

Single ....................................... 11,633 9,967 8,700 8,700

Joint .......................................... 18,600 16,933 15,267 15,400

2003:

Single ....................................... 11,767 10,100 8,900 8,900

834

TABLE 13–20.—INCOME TAX THRESHOLDS FOR ELDERLY INDIVIDUALS WITH VARIOUS

AMOUNTS OF SOCIAL SECURITY INCOME, 1992–2009—Continued

Year and filing status

Amount of income before Social Security

None $2,500 $5,000 $7,500

Joint .......................................... 18,867 17,200 15,533 15,800

2004:

Single ....................................... 11,933 10,267 9,150 9,150

Joint .......................................... 19,133 17,467 15,800 16,200

2005:

Single ....................................... 12,133 10,467 9,450 9,450

Joint .......................................... 19,467 17,800 16,133 16,700

2006:

Single ....................................... 12,233 10,567 9,600 9,600

Joint .......................................... 19,667 18,000 16,333 17,000

2007:

Single ....................................... 12,433 10,767 9,900 9,900

Joint .......................................... 20,033 18,367 16,700 17,550

2008:

Single ....................................... 12,533 10,867 10,050 10,050

Joint .......................................... 20,233 18,567 16,900 17,850

2009:

Single ....................................... 12,733 11,067 10,350 10,350

Joint .......................................... 20,567 18,900 17,233 18,350

Source: Congressional Budget Office.

The combination of these tax provisions means that an estimated

50 percent of elderly individuals will have no tax liability for 2000

(table 13–21).

DISTRIBUTION OF FAMILY INCOME AND TAXES

Table 13–21 presents estimates of the distribution of tax filing

units by the Federal individual income tax rate brackets for calendar year 2000. As shown in the bottom panel, almost 47 million

filing units pay no Federal income taxes. There are 67.5 million filing units who are in the 15-percent bracket. There are approximately 6.5 million families that face marginal income tax rates of

31 percent or above.

Table 13–22 is a more complicated version of table 13–21. 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 Tax 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 inVerDate 20-JUL-2000 13:14 Sep 29, 2000 Jkt 061710 PO 00000 Frm 00834 Fmt 6601 Sfmt 6601 J:\SKAYNE\GB96\61710.013 WAYS3 PsN: WAYS3
835

creases. Hence, effective marginal tax rates can exceed the sum of

the statutory individual income tax rate and payroll tax rate.

TABLE 13–21.—TAX FILING UNITS CLASSIFIED BY MARGINAL FEDERAL INCOME TAX

RATE, 1 PROJECTED FOR 2000

Family type and marginal tax rate (percent) Tax units

(thousands) Percent

With children:

0 ........................................................................ 12,600 27.6

15 ...................................................................... 21,300 46.6

28 ...................................................................... 9,600 21.0

31 ...................................................................... 1,100 2.4

36 ...................................................................... 500 1.1

39.6 ................................................................... 600 1.3

Total ......................................................... 45,700 100.0

Elderly:

0 ........................................................................ 11,700 50.0

15 ...................................................................... 8,500 36.3

28 ...................................................................... 2,400 10.3

31 ...................................................................... 400 1.7

36 ...................................................................... 200 3.9

39.6 ................................................................... 200 0.9

Total ......................................................... 23,400 100.0

Other:

0 ........................................................................ 22,600 28.3

15 ...................................................................... 37,700 47.2

28 ...................................................................... 16,100 20.2

31 ...................................................................... 2,400 3.0

36 ...................................................................... 600 0.8

39.6 ................................................................... 500 0.6

Total ......................................................... 79,900 100.0

All tax units:

0 ........................................................................ 46,900 31.5

15 ...................................................................... 67,500 45.3

28 ...................................................................... 28,100 18.9

31 ...................................................................... 3,900 2.6

36 ...................................................................... 1,300 0.9

39.6 ................................................................... 1,300 0.9

Total ......................................................... 149,000 100.0

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

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.

TABLE 13–22.—DISTRIBUTION OF EARNERS BY INCOME AND MARGINAL TAX RATES ON WAGES, PROJECTED FOR 2000

[In thousands]

Family type and marginal tax rate (percent)

Income in thousands of 2000 dollars

Less than 

$10 $10–$20 $20–$30 $30–$40 $40–$50 $50–$75 $75–$100 $100– $200 $200 and over

All earners ages 21–64 without Social Security

earnings:

Less than 0 ................................................... 2,987 468 57510000 0–4.9 ............................................................. 1,215 593100000 

5.0–9.9 .......................................................... 4,290 1,557 529 10263500 

10.0–14.9 ...................................................... 687 310 47 1400000 15.0–19.9 ...................................................... 549 176 107 13 0 29 39 0 0 20.0–24.9 ...................................................... 1,828 10,961 11,168 11,254 9,388 13,009 179 4 5 25.0–29.9 ...................................................... 441 1,889 1,174 293 58 429 1,430 1,007 8 30.0–34.9 ...................................................... 1,367 175 144 527 281 849 725 3,070 254 35.0–39.9 ...................................................... 0 808 1,785 2,620 3,095 11,372 10,924 6,923 972 40.0–44.9 ...................................................... 0 88 1,485 105 9 4 48 1,083 1,694 45.0–49.9 ...................................................... 0 0 22 11 0 0 33 361 654 

Total .......................................................... 13,363 16,491 16,522 14,946 12,838 25,695 13,384 12,448 3,587 Mean marginal tax rate ............................ 4.9 21.2 26.1 25.4 26.0 28.8 34.7 35.9 41.9 Mean marginal income tax rate ...............

¥2.7 13.6 18.4 17.8 18.3 21.2 27.9 30.4 38.3 

Mean marginal Social Security tax rate ... 7.6 7.6 7.6 7.6 7.6 7.6 6.7 5.4 3.5 

Single earners:

Less than 0 ................................................... 2,396 245 23200000 0–4.9 ............................................................. 1,129 331000000 

5.0–9.9 .......................................................... 3,707 784 53400500 

10.0–14.9 ...................................................... 636 183 2 0 0 0 0 0 0 15.0–19.9 ...................................................... 433 105 22 1 0 0 0 0 0 20.0–24.9 ...................................................... 1,805 9,739 8,565 3,933 695 139400 

25.0–29.9 ...................................................... 370 858 179 172 27 43 227 67 0 30.0–34.9 ...................................................... 1,367 131 32 419 62 96 586 550 10 35.0–39.9 ...................................................... 0 714 1,060 2,503 3,068 4,022 315 230 123 40.0–44.9 ...................................................... 0 65 658 7 2 4 44 25 219 

45.0–49.9 ...................................................... 0 0 0 0 0 0 0 32 10 

Total .......................................................... 11,844 12,857 10,595 7,041 3,855 4,304 1,182 904 361 Mean marginal tax rate ............................ 6.1 22.1 25.5 28.0 33.2 35.2 33.3 34.4 40.7 Mean marginal income tax rate ...............

¥1.6 14.4 17.8 20.4 25.6 27.6 29.7 32.0 38.6 

Mean marginal Social Security tax rate ... 7.6 7.6 7.6 7.6 7.6 7.6 3.5 2.4 2.0 

Married earners:

Less than 0 ................................................... 591 223 35 3 1 0 0 0 0 0–4.9 ............................................................. 86 26 3 1 0 0 0 0 0 5.0–9.9 .......................................................... 583 774 476 9863000 

10.0–14.9 ...................................................... 50 127 44 14 0 0 0 0 0 

15.0–19.9 ...................................................... 116 71 85 13 0 29 39 0 0 20.0–24.9 ...................................................... 23 1,222 2,603 7,321 8,693 12,871 175 4 5 25.0–29.9 ...................................................... 71 1,031 995 121 30 386 1,203 940 8 30.0–34.9 ...................................................... 0 43 112 108 219 753 139 2,520 244 35.0–39.9 ...................................................... 0 94 725 117 27 7,350 10,609 6,693 849 40.0–44.9 ...................................................... 0 23 827 98704 1,058 1,476 

45.0–49.9 ...................................................... 0 0 22 11 0 0 33 329 643 

Total .......................................................... 1,519 3,634 5,927 7,905 8,983 21,391 12,202 11,544 3,225 Mean marginal tax rate ............................

¥4.1 18.2 27.1 23.1 22.9 27.6 34.8 36.0 42.0 

Mean marginal income tax rate ...............

¥11.8 10.6 19.5 15.5 15.3 19.9 27.8 30.3 38.3 

TABLE 13–22.—DISTRIBUTION OF EARNERS BY INCOME AND MARGINAL TAX RATES ON WAGES, PROJECTED FOR 2000—Continued

[In thousands]

Family type and marginal tax rate (percent)

Income in thousands of 2000 dollars

Less than 

$10 $10–$20 $20–$30 $30–$40 $40–$50 $50–$75 $75–$100 $100– $200 $200 and over

Mean marginal Social Security tax rate ... 7.6 7.6 7.6 7.6 7.6 7.6 7.0 5.7 3.7 

Earners with children:

Less than 0 ................................................... 2,702 438 52300000 0–4.9 ............................................................. 53 12 3 0 0 0 0 0 0 5.0–9.9 .......................................................... 725 975 467 8623500 

10.0–14.9 ...................................................... 8 215 42 14 0 0 0 0 0 

15.0–19.9 ...................................................... 5 33 67 10 0 25 37 0 0 20.0–24.9 ...................................................... 22 678 913 5,265 5,586 8,859 158 0 0 25.0–29.9 ...................................................... 81 1,738 1,140 85 22 151 876 478 3 30.0–34.9 ...................................................... 0 89 118 39 49 323 168 1,595 136 35.0–39.9 ...................................................... 0 607 1,339 152 39 3,134 5,597 2,887 366 40.0–44.9 ...................................................... 0 63 1,384 104 7 4 35 910 753 45.0–49.9 ...................................................... 0 0 22 11 0 0 23 181 378 

Total .......................................................... 3,595 4,848 5,546 5,770 5,705 12,498 6,900 6,051 1,637 Mean marginal tax rate ............................

¥18.7 19.3 31.3 23.3 22.9 26.2 34.5 36.1 42.4 

Mean marginal income tax rate ...............

¥26.4 11.6 23.7 15.7 15.2 18.6 27.7 30.7 38.9 

Mean marginal Social Security tax rate ... 7.6 7.6 7.6 7.6 7.6 7.6 6.8 5.3 3.5 

Source: Congressional Budget Office tax simulation model.

839

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 13–23 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

TABLE 13–23.—RELATIONSHIP BETWEEN INCOME TAX THRESHOLD AND POVERTY LEVEL

FOR A FAMILY OF FOUR, SELECTED YEARS 1959–2007

Year Income tax

threshold Poverty level

Tax threshold

as a percent of

poverty level

1959 ........................................................... $2,667 $2,978 89.7

1960 ........................................................... 2,667 3,022 88.3

1965 ........................................................... 3,000 3,223 93.1

1970 ........................................................... 3,600 3,968 90.7

1975 ........................................................... 6,692 5,500 121.7

1980 ........................................................... 8,626 8,414 102.5

1984 ........................................................... 8,783 10,610 82.8

1990 ........................................................... 16,296 13,359 122.0

1991 ........................................................... 17,437 13,924 125.2

1992 ........................................................... 18,548 14,335 129.4

1993 ........................................................... 19,187 14,763 130.0

1994 ........................................................... 21,098 14,625 144.3

1995 ........................................................... 22,362 15,570 143.6

1996 ........................................................... 23,672 16,020 147.8

1997 ........................................................... 24,386 16,479 148.0

1998 ........................................................... 25,039 16,969 147.6

1999 ........................................................... 25,798 17,470 147.7

2000 ........................................................... 26,006 17,980 148.0

2001 ........................................................... 27,333 18,521 147.6

2002 ........................................................... 28,170 19,072 147.7

2003 ........................................................... 29,035 19,654 147.7

2004 ........................................................... 29,923 20,257 147.7

2005 ........................................................... 30,833 20,880 147.7

2006 ........................................................... 31,760 21,523 147.6

2007 ........................................................... 32,742 22,187 147.6

Source: Congressional Budget Office.

840

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 13–24 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 13–24.—POVERTY LEVELS, TAX THRESHOLDS, AND FEDERAL TAX AMOUNTS FOR

DIFFERENT FAMILY SIZES WITH EARNINGS EQUAL TO THE POVERTY LEVEL, 1993–2009

Poverty or tax measure and

year

Family size

12 3 4 5 6

Poverty level:

1993 ...................... $7,363 $9,414 $11,522 $14,763 $17,449 $19,718

1994 ...................... 7,547 9,661 11,821 15,141 17,900 20,235

1995 ...................... 7,759 9,924 12,150 15,570 18,022 20,786

1996 ...................... 7,982 10,211 12,501 16,020 18,542 21,386

1997 ...................... 8,211 10,504 12,859 16,479 19,074 21,999

1998 ...................... 8,480 10,915 13,120 16,530 19,453 21,780

1999 ...................... 8,667 11,156 13,410 16,895 19,882 22,261

2000 ...................... 8,887 11,439 13,750 17,323 20,386 22,825

2001 ...................... 9,103 11,717 14,084 17,744 20,882 23,380

2002 ...................... 9,329 12,009 14,435 18,186 21,401 23,962

2003 ...................... 9,561 12,307 14,794 18,639 21,934 24,558

2004 ...................... 9,799 12,614 15,162 19,103 22,480 25,170

2005 ...................... 10,043 12,928 15,540 19,578 23,040 25,796

2006 ...................... 10,294 13,250 15,927 20,066 23,614 26,439

2007 ...................... 10,550 13,580 16,324 20,566 24,202 27,098

2008 ...................... 10,813 13,919 16,731 21,079 24,805 27,774

2009 ...................... 11,083 14,266 17,148 21,604 25,424 28,466

Income tax threshold:

1993 ...................... 6,050 10,900 17,841 19,187 20,405 21,624

1994 ...................... 7,179 11,250 18,887 21,098 22,222 23,347

1995 ...................... 7,356 11,550 19,387 22,362 23,426 24,491

1996 ...................... 7,546 11,800 19,884 23,672 24,733 25,793

1997 ...................... 7,803 12,200 22,090 27,160 30,157 36,135

1998 ...................... 7,990 12,500 22,630 27,795 30,605 36,635

1999 ...................... 8,114 12,700 22,980 28,200 30,959 37,040

2000 ...................... 8,274 12,950 23,380 28,683 31,355 37,485

2001 ...................... 8,498 13,350 23,990 29,403 32,050 38,290

2002 ...................... 8,681 13,600 24,482 29,995 32,610 38,735

2003 ...................... 8,905 13,900 25,020 30,630 33,267 39,234

2004 ...................... 9,135 14,300 25,635 31,368 34,045 40,035

841

TABLE 13–24.—POVERTY LEVELS, TAX THRESHOLDS, AND FEDERAL TAX AMOUNTS FOR

DIFFERENT FAMILY SIZES WITH EARNINGS EQUAL TO THE POVERTY LEVEL, 1993–

2009—Continued

Poverty or tax measure and

year

Family size

12 3 4 5 6

2005 ...................... 9,392 14,700 26,265 32,122 34,840 40,835

2006 ...................... 9,593 15,000 26,835 32,793 35,530 41,335

2007 ...................... 9,860 15,450 27,510 33,590 36,370 42,187

2008 ...................... 10,060 15,750 28,097 34,300 37,100 42,685

2009 ...................... 10,334 16,150 28,765 35,091 37,935 43,485

Income tax at poverty

level:

1993 ...................... 197 0 ¥1,434 ¥1,154 ¥780 ¥464

1994 ...................... 83 0 ¥1,907 ¥1,795 ¥1,308 ¥895

1995 ...................... 93 0 ¥1,956 ¥2,243 ¥1,747 ¥1,187

1996 ...................... 99 0 ¥2,010 ¥2,627 ¥2,096 ¥1,497

1997 ...................... 93 0 ¥2,065 ¥2,698 ¥2,152 ¥1,535

1998 ...................... 111 ¥238 ¥2,087 ¥2,857 ¥2,241 ¥1,751

1999 ...................... 125 ¥232 ¥2,106 ¥2,882 ¥2,253 ¥1,752

2000 ...................... 139 ¥227 ¥2,130 ¥2,912 ¥2,267 ¥1,754

2001 ...................... 137 ¥245 ¥2,188 ¥2,993 ¥2,332 ¥1,806

2002 ...................... 147 ¥239 ¥2,238 ¥3,061 ¥2,384 ¥1,845

2003 ...................... 149 ¥239 ¥2,293 ¥3,136 ¥2,442 ¥1,889

2004 ...................... 150 ¥253 ¥2,348 ¥3,213 ¥2,502 ¥1,936

2005 ...................... 148 ¥266 ¥2,407 ¥3,295 ¥2,566 ¥1,985

2006 ...................... 159 ¥263 ¥2,467 ¥3,374 ¥2,627 ¥2,032

2007 ...................... 156 ¥281 ¥2,529 ¥3,459 ¥2,693 ¥2,083

2008 ...................... 171 ¥275 ¥2,592 ¥3,547 ¥2,762 ¥2,137

2009 ...................... 170 ¥283 ¥2,934 ¥3,632 ¥2,828 ¥2,187

Payroll tax at poverty

level:

1993 ...................... 563 720 881 1,129 1,335 1,508

1994 ...................... 577 739 904 1,158 1,369 1,548

1995 ...................... 594 759 929 1,191 1,379 1,590

1996 ...................... 611 781 956 1,226 1,418 1,636

1997 ...................... 628 804 984 1,261 1,459 1,683

1998 ...................... 649 835 1,004 1,265 1,488 1,666

1999 ...................... 663 853 1,026 1,292 1,521 1,703

2000 ...................... 680 875 1,052 1,325 1,560 1,746

2001 ...................... 696 896 1,077 1,357 1,597 1,789

2002 ...................... 714 919 1,104 1,391 1,637 1,833

2003 ...................... 731 942 1,132 1,426 1,678 1,879

2004 ...................... 750 965 1,160 1,461 1,720 1,925

2005 ...................... 768 989 1,189 1,498 1,763 1,973

2006 ...................... 787 1,014 1,218 1,535 1,806 2,023

2007 ...................... 807 1,039 1,249 1,573 1,851 2,073

2008 ...................... 827 1,065 1,280 1,613 1,898 2,125

842

TABLE 13–24.—POVERTY LEVELS, TAX THRESHOLDS, AND FEDERAL TAX AMOUNTS FOR

DIFFERENT FAMILY SIZES WITH EARNINGS EQUAL TO THE POVERTY LEVEL, 1993–

2009—Continued

Poverty or tax measure and

year

Family size

12 3 4 5 6

2009 ...................... 848 1,091 1,312 1,653 1,945 2,178

Combined tax at poverty

level:

1993 ...................... 760 720 ¥552 ¥25 555 1,044

1994 ...................... 661 739 ¥1,003 ¥637 62 653

1995 ...................... 686 759 ¥1,026 ¥1,052 ¥368 403

1996 ...................... 710 781 ¥1,053 ¥1,402 ¥677 139

1997 ...................... 721 804 ¥1,081 ¥1,437 ¥693 148

1998 ...................... 760 597 ¥1,084 ¥1,592 ¥753 ¥85

1999 ...................... 788 622 ¥1,080 ¥1,590 ¥732 ¥49

2000 ...................... 819 648 ¥1,078 ¥1,587 ¥708 ¥7

2001 ...................... 833 651 ¥1,110 ¥1,636 ¥735 ¥18

2002 ...................... 861 680 ¥1,134 ¥1,670 ¥747 ¥12

2003 ...................... 880 703 ¥1,161 ¥1,710 ¥764 ¥10

2004 ...................... 900 712 ¥1,188 ¥1,752 ¥782 ¥10

2005 ...................... 916 723 ¥1,218 ¥1,797 ¥803 ¥12

2006 ...................... 946 751 ¥1,249 ¥1,839 ¥820 ¥9

2007 ...................... 964 758 ¥1,281 ¥1,885 ¥841 ¥10

2008 ...................... 998 790 ¥1,312 ¥1,934 ¥864 ¥12

2009 ...................... 1,017 809 ¥1,622 ¥1,979 ¥883 ¥9

Combined tax at poverty

level as a percent of

poverty level:

1993 ...................... 10.3 7.7 ¥4.8 ¥0.2 3.2 5.3

1994 ...................... 8.8 7.7 ¥8.5 ¥4.2 0.3 3.2

1995 ...................... 8.8 7.7 ¥8.4 ¥6.8 ¥2.0 1.9

1996 ...................... 8.9 7.7 ¥8.4 ¥8.7 ¥3.7 0.7

1997 ...................... 8.8 7.7 ¥8.4 ¥8.7 ¥3.6 0.7

1998 ...................... 9.0 5.5 ¥8.3 ¥9.6 ¥3.9 ¥0.4

1999 ...................... 9.1 5.6 ¥8.1 ¥9.4 ¥3.7 ¥0.2

2000 ...................... 9.2 5.7 ¥7.8 ¥9.2 ¥3.5 0.0

2001 ...................... 9.2 5.6 ¥7.9 ¥9.2 ¥3.5 ¥0.1

2002 ...................... 9.2 5.7 ¥7.9 ¥9.2 ¥3.5 0.0

2003 ...................... 9.2 5.7 ¥7.8 ¥9.2 ¥3.5 0.0

2004 ...................... 9.2 5.6 ¥7.8 ¥9.2 ¥3.5 0.0

2005 ...................... 9.1 5.6 ¥7.8 ¥9.2 ¥3.5 0.0

2006 ...................... 9.2 5.7 ¥7.8 ¥9.2 ¥3.5 0.0

2007 ...................... 9.1 5.6 ¥7.8 ¥9.2 ¥3.5 0.0

2008 ...................... 9.2 5.7 ¥7.8 ¥9.2 ¥3.5 0.0

2009 ...................... 9.2 5.7 ¥9.5 ¥9.2 ¥3.5 0.0

Source: Congressional Budget Office.

843

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