Reasons for Change A principal objective of the Act was to reduce marginal tax rates on income earned by individuals and by corporations. Congress believed that lower tax rates promote economic growth by increasing the rate of return on investment. Lower tax rates also improve the allocation of resources within the economy by reducing the impact of tax considerations on business and investment decisions. In addition, lower tax rates promote compliance by reducing the potential gain from engaging in transactions designed to avoid or evade income tax. Under the Act, the maximum corporate rate is reduced from 46 percent to 34 percent. Although Congress believed that the graduated rate structure should be retained to encourage growth in small business, it felt that the benefit of the lower rates should be limited to smaller corporations. Accordingly, under the Act the benefit of the graduated rate structure is phased out beginning at $100,000 of taxable income as compared to $1 million under prior law. In addition, Congress simplified the graduated rate structure for corporations by reducing the number of brackets from five to three. Explanation of Provision Under the Act, tax would be imposed on corporations under the schedule shown in the following table. An additional 5-percent tax is imposed on a corporation's taxable income in excess of $100,000. The maximum additional tax is $11,750. This provision phases out the benefit of graduated rates for corporations with taxable income between $100,000 and $335,000; corporations with income in excess of $335,000, in effect, will pay a flat tax at a 34-percent rate. Effective Date The revised corporate tax rates are effective for taxable years beginning on or after July 1, 1987. Income in taxable years that include July 1, 1987 (other than as the first date of such year) is subject to a blended rate under the rules specified in section 15 of the Code. Under section 15, tentative taxes for the entire taxable year are first computed by 1) applying the rates (including the applicable phaseout of the graduated rates) for the period before July 1, 1987 to the taxable income for the entire taxable year, and 2) applying the rates (including the applicable phaseout of the graduated rates) for the period on and after July 1, 1987 to the entire taxable year. The actual tax for the taxable year is then computed as the sum of that proportion of each tentative tax which the number of days in each period bears to the number of days in the entire taxable year. 3 As one example, in the case of a calendar year corporate taxpayer with $2 million of ordinary taxable income, the tax for 1987 is computed by first determining a tentative tax under prior law of $920,000 (46 percent of $2 million) and a tentative tax under the amended law of $680,000 (34 percent of $2 million). The actual tax equals the sum of $456,219.18 (181/365 of $920,000) and $342,794.52 (184/365 of $680,000) or $799,013.70.4 Revenue Effect The provision is estimated to reduce fiscal year budget receipts by $6,711 million in 1987, $20,068 million in 1988, $27,505 million in 1989, $29,999 million in 1990, and $32,415 million in 1991. See Treas. Reg. sec. 1.21-1(b). 181 is the number of days in the calendar year 1987 prior to July 1; 184 is the number of days in the calendar year 1987 on or after July 1. B. Corporate Dividends Received Deduction (Sec. 611 of the Act and secs. 243-246A of the Code) 5 Prior Law Under prior law, corporations that received dividends generally were entitled to a deduction equal to 85 percent of the dividends received (sec. 243(a)(1)). Under prior and present law, dividends received from a small business investment company operating under the Small Business Investment Act of 1958 (sec. 243(a)(2)), and "qualifying dividends" received from certain members of an affiliated group, are eligible for a 100-percent dividends received deduction (sec. 243(a)(3)). In addition, under prior and present law, pursuant to Treasury regulations, dividends received by one member of an affiliated group filing a consolidated return from another member of the group are not taxed to the recipient (Treas. Reg. sec. 1.1502-14). There are exceptions for certain dividends received by a U.S. corporation from a foreign corporation and from certain other entities. The dividends received deduction is limited in certain other circumstances. Reasons for Change Under prior law, dividends eligible for the 85-percent dividends received deduction were taxed at a maximum rate of 6.9 percent (15 percent of the top corporate rate of 46 percent). The Congress did not believe that the reduction in corporate tax rates generally should result in a significant reduction in this effective rate. Thus, the dividends received deduction has been reduced to 80 percent, resulting in a maximum rate of 6.8 percent on dividends subject to the reduced top corporate rate (20 percent of the top corporate rate of 34 percent). Explanation of Provision Under the Act, the 85-percent dividends received deduction is lowered to 80 percent. Effective Date The reduction in the dividends received deduction is applicable to dividends received or accrued after December 31, 1986, in taxable years ending after such date. For legislative background of the provision, see: H.R. 3838, as reported by the House Committee on Ways and Means on December 7, 1985, sec. 303; H.Rep. 99-426, pp. 243-246; H.R. 3838, as reported by the Senate Committee on Finance on May 29, 1986, sec. 611; S.Rep. 99-313, pp. 221; and H.Rep. 99-841, Vol. II (September 18, 1986), p. 161 (Conference Report). Revenue Effect The provision is estimated to increase fiscal year budget receipts by $140 million in 1987, $223 million in 1988, $225 million in 1989, $239 million in 1990, and $253 million in 1991. C. Dividend Exclusion for Individuals (Sec. 612 of the Act and sec. 116 of the Code) 6 Prior Law Under prior law, the first $100 of qualified dividends received by an individual shareholder ($200 by a married couple filing jointly) from domestic corporations was excluded from income (sec. 116(a)). The dividend exclusion for individuals did not apply to dividends received from an organization that was exempt from tax under section 501 or a tax-exempt farmers' cooperative in either the year of distribution or the preceding year (sec. 166(b)(1)), dividends received from a real estate investment trust (sec. 116(b)(2)), dividends received from a mutual savings bank that received a deduction for the dividend under section 591 (sec. 116(c)(1)), or to an ESOP dividend for which the corporation received a deduction (sec. 116(e)). The exclusion was limited with respect to dividends received from a regulated investment company (sec. 116(c)(2)). Reasons for Change The Congress believed that the dividend exclusion for individuals under prior law provided little relief from the two-tier corporate income tax because of the low limitation. As an exclusion from income, it also tended to benefit high-bracket taxpayers more than low-bracket taxpayers. On balance, the Congress believed it is preferable to eliminate the exclusion and use the revenues to reduce tax rates. Explanation of Provision Under the Act, the dividend exclusion for individuals is repealed. Effective Date The provision is effective for taxable years beginning after December 31, 1986. Revenue Effect The provision is expected to increase fiscal year budget receipts by $212 million in 1987, $573 million in 1988, $580 million in 1989, $605 million in 1990, and $631 million in 1991. For legislative background of the provision, see: H.R. 3838, as reported by the House Committee on Ways and Means on December 7, 1985, sec. 313; H.Rep. 99-426, p. 247; H.R. 3838, as reported by the Senate Committee on Finance on May 29, 1986, sec. 612; S.Rep. 99-313, p. 222; and H.Rep. 99-841, Vol. II (September 18, 1986), p. 162 (Conference Report). |