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Income Matters, But Family Matters, Too
Who pays how much is often a matter of demographics
(RIVERWOODS, ILL., January 31, 2003) – Is the federal income tax
irrelevant? For some people, it seems to be, according to CCH
INCORPORATED (CCH), a leading provider of tax law information and
software. But while federal income tax is becoming a relatively
insignificant burden for an increasing number of low-to-moderate
income families, wealthy families and many individuals still pay a
significant percentage of their incomes as tax. Decreases in taxes
built into a 2001 law and scheduled to become effective in future
years will bring significant additional benefits to married couples,
families with children and high-income taxpayers, but the basic
pattern of who pays the most will not change.
Preliminary IRS statistics for the year 2000, the latest year for
which data is available, show that top-end taxpayers – those
reporting $200,000 or more in adjusted gross income – paid 45
percent of all federal income taxes, although they made up only 2
percent of all taxpayers that year.
Returns showing less than $15,000 in adjusted gross income were 30
percent of total returns, but accounted for less than 1 percent of tax
paid.
Many in this bottom echelon received, rather than gave, at the
federal tax payment window. The earned income tax credit provided
checks to many in the bottom tier of wage-earners.
"The earned income tax credit started out in life as the ‘negative
income tax’ in the writings of economist Milton Friedman,"
noted CCH principal federal tax analyst Mark Luscombe, JD, CPA, LLM.
"The name has changed, but the concept hasn’t."
Beginning with the introduction of the child tax credit in 1997
legislation and continuing through the major tax bill of 2001, a
series of measures have spread the benefits of greatly reduced taxes
up the income scale – especially if taxpayers fit the right
demographic. The new 10-percent bracket, increased child credits and
other provisions have already reduced the tax burden for families with
children, and may wipe out federal income tax as a serious concern for
families with modest incomes in the near future.
Here’s the 2002 income tax picture for a family of
four, with two children who both qualify for the $600 child credit and
$40,000 in total income, $500 of which is put into a deductible IRA
and which in turn qualifies for a $50 retirement savings credit:
Total Income |
$40,000 |
Deductible IRA |
$500 |
Adjusted Gross Income |
$39,500 |
Standard Deduction |
$7,850 |
Personal Exemptions |
$12,000 |
Taxable Income |
$19,650 |
Tax |
$2,351 |
Less Credits |
$1,250 |
Tax Due |
$1,101 |
The income tax due is less than 3 percent of the family’s
total income. But there are even better things to come, by and by. The
child credit is due to rise to $1,000 per child by 2010 and relief from
the so-called "marriage penalty" will gradually increase the
standard deduction for all joint filers over the years 2005-2009, while
they also will get the advantage of an expanded 15-percent bracket in
future years, as well.
If the remaining child credit, marriage penalty and rate
reductions of the 2001 tax law were to be implemented immediately, our
sample family’s income tax would practically disappear, falling to
only $69, or $119 dollars if the retirement savings credit vanished, as
it is scheduled to after 2006:
Total Income |
$40,000 |
Deductible IRA |
$500 |
Adjusted Gross Income |
$39,500 |
Standard Deduction |
$9,400 |
Personal Exemptions |
$12,000 |
Taxable Income |
$18,100 |
Tax |
$2,119 |
Credits |
$2,050 |
Tax Due |
$69 |
But although income taxes would be negligible in this
scenario, such a wage-earning couple would still be paying 7.65 percent
of their earnings as FICA tax to fund Social Security and Medicare.
For Singles, Taxes Are Different
Does anyone with a modest income feel a real bite from
the income tax? Yes – the unmarried taxpayer without children.
Here’s what the tax picture looks like for someone in
that category today, assuming a $40,000 salary with $2,000 set aside for
retirement (which doesn’t qualify for the retirement savings credit
because of income phaseouts) and no itemized deductions:
Salary |
$40,000 |
401(k) Contribution |
$2,000 |
Adjusted Gross Income |
$38,000 |
Standard Deduction |
$4,700 |
Personal Exemptions |
$3,000 |
Taxable Income |
$30,300 |
Tax |
$4,534 |
Credits |
$0 |
Tax Due |
$4,534 |
People in this situation are paying more than 11 percent
of their pre-401(k) income to the federal treasury. Future decreases in
top tax rates would help someone in this situation only very slightly,
trimming the tax bill to $4,480 – a decrease of $54.
"Both now and in the future, being married and
having children, with the associated tax credit, will make an enormous
difference for people with modest amounts of income," Luscombe
said. "While in recent years there has been a strong political
sentiment for minimizing the marriage penalty, in the future, we may see
single people and childless couples vocally upset about the share of
taxes they bear relative to families with the same income,"
Luscombe added.
One thing that would benefit both singles and married
couples would be a moratorium on payroll taxes.
A payroll tax holiday for the first $10,000 in earnings
would deliver $765 in tax relief to most single taxpayers and one-earner
married couples, and up to $1,530 to married couples who both work. This
has been proposed as an economic stimulus measure by some liberals and
some conservatives on the grounds that this kind of tax reduction leads
quickly to stimulative consumer spending.
Taxes Are Different at the Top
The top end of the income spectrum benefited from rate
decreases in the 2001 tax law but is locked out of many tax-lowering
provisions in the laws and must cope with some others that are precisely
designed to make sure that the wealthier pay more. In addition to the
progressive structure of the tax brackets, high-income taxpayers are
often shut out of benefits such as the child credit and the new
retirement savings credit by "phaseout" provisions. They often
cannot make use of the full value of their itemized deductions and
personal exemptions because of other phaseouts.
Using 2002 tax rates, here’s what the tax picture
would look like for a family of four with wage earners commanding
$250,000 in salary and contributing 10 percent of it on a pre-tax basis
to a 401(k), assuming they took $50,000 in itemized deductions:
Salary before 401(k) |
$250,000 |
401(k) Contribution |
$25,000 |
Adjusted Gross Income |
$225,000 |
Itemized Deductions |
$50,000 |
Amount Phased Out |
$2,631 |
Deductions after Phaseout |
$47,369 |
Personal Exemptions |
$12,000 |
Percentage Phased Out |
16% |
Exemptions after Phaseout |
$10,080 |
Taxable Income |
$167,551 |
Tax |
$40,676 |
Under current law, the family loses $4,551 in deductions
and exemptions due to phaseouts. They don’t qualify for the credits
that so greatly eased the tax bite for the $40,000 family. More than 16
percent of their total pre-401(k) income goes for federal income tax.
If future provisions on the marriage penalty, tax rates
and the phaseouts for itemized deductions and personal exemptions were
in place today, here’s how their financial picture would improve:
Salary before 401(k) |
$250,000 |
401(k) Contribution |
$25,000 |
Adjusted Gross Income |
$225,000 |
Itemized Deductions |
$50,000 |
Amount Phased Out |
$0 |
Deductions after Phaseout |
$50,000 |
Personal Exemptions |
$12,000 |
Percentage Phased Out |
0% |
Exemptions after Phaseout |
$12,000 |
Taxable Income |
$163,000 |
Tax |
$36,065 |
Their taxes decrease by more than $4,000 and income tax
as a fraction of their pre-401(k) income drops to roughly 14 percent.
"The implementation of the tax-saving provisions of
the 2001 law – whether that happens sooner or later – will save this
family a significant amount of money, but they still end up paying more
in tax than many people earn as their entire income," Luscombe
observed. "Families like this will benefit significantly from tax
reductions, but they still end up bearing a large part of the total
income tax burden."
What’s more, this family is at the lower end of the
top tier of taxpayers. Millionaires and billionaires, despite the best
efforts of their tax advisors, usually pay much more.
"It may not be much consolation to someone of
modest means who has to scrape and borrow to pay his light bill, but
very few wealthy individuals escape the income tax, and they provide a
large chunk of all the income tax paid," Luscombe said.
About CCH INCORPORATED
CCH INCORPORATED, headquartered in Riverwoods,
Ill., was founded in 1913 and has served four generations of business
professionals and their clients. CCH is a wholly owned subsidiary of
Wolters Kluwer North America. The CCH web site can be accessed at cch.com.
The CCH tax and accounting destination site can be accessed at
tax.cchgroup.com.
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nb-03-38
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