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III. GENERAL EXPLANATION OF THE ACT
TITLE I-INDIVIDUAL INCOME TAX PROVISIONS
A. Basic Rate Structure:
Rate Reductions; Increase in Standard Deduction and Personal Exemptions; Repeal of Two-Earner Deduction and Income Averaging (Secs. 101-104, 131, 141, and 151 of the Act and secs. 1, 63, 151, and 221 of the Code) 1
Tax rate schedules
Filing status classifications
Separate tax rate schedules are provided for the four filing status classifications applicable to individuals—(1) married individuals filing jointly 2 and certain surviving spouses; (2) heads of household; (3) single individuals; and (4) married individuals filing separately.
In general, the term head of household means an unmarried individual (other than a surviving spouse) who pays more than onehalf the expenses of maintaining a home for himself or herself and for a child or dependent relative who lives with the taxpayer, or who pays more than one-half the expenses, and of the cost of maintaining their household, of his or her dependent parents. An unmarried surviving spouse may use the rate schedule for married individuals filing jointly in computing tax liability for the two years following the year in which his or her spouse died if the surviving spouse maintains a household that includes a dependent child.
Computation of tax liability
Federal income tax liability is calculated by applying the tax rates from the appropriate schedule to the individual's taxable income, and then subtracting any allowable tax credits. Under prior law, taxable income equalled adjusted gross income (gross income less certain exclusions and deductions) minus personal exemptions, and minus itemized deductions to the extent they exceeded the zero bracket amount (ZBA). For 1986, individuals who did
1 For legislative background of the provision, see: H.R. 3838, as reported by the House Committee on Ways and Means on December 7, 1985, secs. 101-03, 131; H.Rep. 99-426, pp. 80-93; H.R. 3838, as reported by the Senate Committee on Finance on May 29, 1986, secs. 101-04, 131, and 151; S.Rep. 99-313, pp. 29-42; Senate floor amendment, 132 Cong. Rec. S 7665-73 (June 17, 1986), and H.Rep. 99-841, Vol. II (September 18, 1986), pp. 1-11 (Conference Report).
2 For tax purposes, an individual's marital status for a year generally is determined on the last day of the year. If one spouse dies during the year, the surviving spouse generally is eligible to file a joint return for that year.
not itemize were allowed a deduction for charitable contributions in addition to the ZBA.
The prior-law rate schedules included the zero (tax rate) bracket amount as the first bracket; the ZBA was provided in lieu of a standard deduction. The prior-law rate structure consisted of up to 15 taxable income brackets and tax rates beginning above the ZBA.
1986 tax-rate schedules
The following rate schedule provisions applied for 1986 and reflected an adjustment for 1985 inflation.
Married individuals; surviving spouses.-There were 14 taxable income brackets above the ZBA of $3,670. The minimum 11-percent rate started at taxable income above $3,670; the maximum 50-percent rate started at taxable income above $175,250.
For married individuals filing separate returns, the ZBA was one-half the ZBA on joint returns, and the taxable income bracket amounts began at one-half the amounts for joint returns.
Heads of household.-There were 14 taxable income brackets above the $2,480 ZBA. The minimum 11-percent tax rate started at taxable income above $2,480; the maximum 50-percent rate started at taxable income above $116,870. The tax rates applicable to a head of household were lower than those applicable to other unmarried individuals on taxable income above $13,920. Thus, a head of household in effect received a portion of the benefits of the lower rates accorded to a married couple filing a joint return.
Single individuals.-There were 15 taxable income brackets above the $2,480 ZBA for single individuals (other than heads of household or surviving spouses). The minimum 11-percent tax rate started at taxable income above $2,480; the maximum 50-percent rate started at taxable income above $88,270.
The bracket dollar amounts described above for 1986 were indexed to reflect an inflation rate of approximately four percent in the preceding fiscal year, i.e., for the 12-month period ending September 30, 1985. For 1987 and later years, prior law would have provided that the dollar figures defining the tax brackets were to be adjusted annually according to annual percentage changes in the consumer price index for the 12-month period ending September 30 of the preceding year.
Standard deduction (zero bracket amount)
Under prior law, the first positive taxable income bracket (i.e., the 11-percent marginal tax rate bracket) began just above the ZBA. The following ZBA amounts applied for 1986 and reflected an adjustment for 1985 inflation.
The ZBA also served under prior law as a floor under the amount of itemized deductions. Itemizers reduced their AGI by their personal exemptions and by the excess of their itemized deductions over the appropriate ZBA, in order to avoid doubling the benefit of the ZBA, and then used the appropriate tax rate schedule or tax table to compute or find their tax liability.
Exemption amount.-For 1986, the personal exemption amount for an individual, the individual's spouse, and each dependent was $1,080. Under prior law, one additional personal exemption was provided for an individual who was age 65 or older, and for an individual taxpayer who was blind.
Rules for dependents.-Under prior law, a taxpayer could claim a personal exemption for himself or herself and for each additional dependent-spouse, child, or other individual-whose gross income did not exceed the personal exemption amount. In addition, parents could claim a personal exemption for a dependent child (for whom they provided more than one-half the support) who had income exceeding the personal exemption amount if the dependent child was either under age 19 or a full-time student. The child or other dependent also could claim a full personal exemption on his or her return.
A child eligible to be claimed as a dependent on his or her parents' return could use the ZBA only to offset earned income. Thus, a child with unearned income exceeding the personal exemption amount was required to file a return and pay tax on the excess (reduced by any allowable itemized deductions).
Adjustments for inflation
Under prior law, the dollar amounts defining the tax rate brackets, the ZBA (standard deduction), and the personal exemption amount were adjusted annually for inflation, measured by changes in the Consumer Price Index for all urban consumers (CPI) over the 12-month period ending September 30 of the prior calendar year. If the inflation adjustment was not a multiple of $10, the increase was rounded (up or down) to the nearest multiple of $10. Two-earner deduction
Under prior law, married individuals filing a joint return were allowed a deduction equal to 10 percent of the lesser of the earned income of the lower-earning spouse or $30,000; the maximum deduction thus was $3,000.
An eligible individual could elect under prior law to have a lower marginal rate apply to the portion of the current year's taxable income that exceeded 140 percent of the average of his or her taxable income for the prior three years.
Reasons for Change
The approach of the Act in broadening the base of the individual income tax allows a considerable reduction in marginal tax rates and in the overall income tax burden on individuals.
The provisions in the Act reducing tax rates for individuals, as well as increasing the standard deduction, the personal exemption, and the earned income credit, were fashioned to achieve three important objectives: (1) to eliminate income tax burdens for families with incomes below the poverty line; (2) to provide an equitable distribution of tax reductions among individuals; and (3) to reduce the marriage penalty sufficiently so that there is no need for an additional deduction for two-earner couples. In addition, the increase in the standard deduction, coupled with changes to the itemized deductions, will reduce the number of individuals who must itemize their deductions, and thus will contribute to a simpler tax system. Relief for low-income families
A fundamental goal of the Congress was to relieve families with the lowest incomes from Federal income tax liability. Consequently, the Act increases the amounts of both the personal exemption and the standard deduction, as well as the earned income credit, so that the income level at which individuals begin to have tax liability (the tax threshold) will be raised sufficiently to remove six million poverty-level taxpayers from Federal income tax liability. This restores to the tax system an essential element of fairness that has been eroded since the last increase in the personal exemption.
The ZBA and personal exemption had been unchanged from the levels set in the Revenue Act of 1978, until inflation adjustments began in 1985. Notwithstanding these adjustments, inflation had reduced the real value of the standard deduction and personal exemption in setting a threshold level below which income was not taxed. Although the rate reductions in 1981 reduced tax liabilities partly in recognition of the burdens of inflation and social security taxes, those reductions did not provide relief for marginally taxable individuals who would not have been subject to tax liability but for past inflation.
The increase in the personal exemption to $1,900 in 1987 ($1,950 and $2,000 in 1988 and 1989) under the Act-the first statutory increase in the exemption since 1978-contributes both to removing the working poor from the tax rolls and extending relief to other low-income individuals. The personal exemption increase also recognizes the significant costs of raising children. The increases in the standard deduction and personal exemption reduce tax burdens for families (below the phase-out ranges) by raising the tax threshold.
Under the Act, all tax thresholds (the beginning point of income tax liability) are higher than the estimated poverty level for 1988 except for single individuals. In Table I-1 below, the columns showing calculations without taking into account the earned income credit reflect the fact that the tax threshold for heads of household (unmarried individuals who support children or certain dependent relatives) is raised proportionately more than the tax thresholds
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for married individuals filing jointly or single individuals. Married individuals receive a larger proportionate increase in the threshold than single individuals, in order to offset the effect of the repeal of the two-earner deduction. With the addition of the earned income credit to the computation, the tax threshold for those eligible for the credit rises even further.
Table I-1.-Income Tax Thresholds in 1988 Under Prior Law and Under the 1986 Act
NOTE.-These calculations are based on the following assumptions: (1) inflation is equal to the figures forecast by the Congressional Budget Office in January 1987; (2) families with dependents are eligible for the earned income credit; (3) all income consists of money wages and salaries; and (4) taxpayers are under age 65.
There are two principal reasons why the tax threshold for single persons (other than heads of household) is not above the poverty line. First, any further increases in the standard deduction for single taxpayers beyond those provided by the Act would cause significant marriage penalties for two single individuals who married. Second, because the income of family members (other than spouses) is not combined in computing tax liability, and because the tax rate structure does not recognize economies of sharing household costs with other individuals, the income of single individuals does not represent a good measure of whether or not the living conditions of these individuals are impoverished.
More than two-thirds of all single individuals with income less than $10,000 are under age 25, according to 1984 census data; these individuals are likely to be receiving significant support from other family members that is not reflected on the tax return. In addition, the census data reflects that the majority of single individuals between ages 25 and 64 live with other individuals; thus, their household costs are shared. Accordingly, within the existing framework of defining the unit of tax liability, the Congress believed that the poverty line is not an accurate guide to the true economic circumstances of the majority of those who file tax returns as single individuals.
Equitable distribution of tax burden
The Congress also believed that it was desirable for the tax reductions provided under the Act to be distributed equitably among