Poverty Levels and Federal Tax Thresholds: 1992

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2 Copyright 1992 by the National Clearinghouse for Legal Services. All Rights Reserved. 26 Clearinghouse Review 519 (September 1992) Poverty Levels and Federal Tax Thresholds: 1992 By Jonathan Barry Forman. Jonathan Barry Forman is a Professor of Law at the University of Oklahoma College of Law, 300 Timberdell Rd., Norman, OK 73019, (405) I. Introduction Every year, the American Bar Association Section of Taxation Committee on Low Income Taxpayers prepares a report on the relationship between poverty levels and federal tax thresholds. This article addresses how federal income and social security taxes affect lowincome families in /1/ In particular, this article examines the extent to which families with incomes below the federal poverty income guidelines ("low-income families") are required to pay federal income and social security taxes. This article sets forth HHS's poverty income guidelines for 1992 for various sizes of family units, and discusses how the federal income tax and social security taxes affect low-income families in Although most low-income families are not liable for federal income taxes in 1992, all lowincome families with covered wages or self-employment earnings are liable for social security taxes. In that regard, the earned income credit offsets the social security tax liabilities of many low-income families with children. However, any family whose social security tax liability exceeds its earned income credit amount will have a net federal tax liability. Moreover, because they are ineligible for the earned income credit, low-income families without children and single individuals will have net federal tax liabilities. Thus, many low-income people who arguably should not have to pay any federal taxes do, in fact, have net federal tax liabilities. II. Poverty Income Guidelines Each year, HHS updates its poverty income guidelines to reflect the prior year's change in the Consumer Price Index. /2/ These poverty income guidelines are used as eligibility criteria by a number of social welfare programs. /3/ The poverty income guidelines are a simplified version of the federal government's statistical poverty thresholds used by the Department of Commerce, Bureau of the Census, to prepare statistical estimates of the number of persons and families in poverty. The 1992 poverty income guidelines for all states (except Alaska and Hawaii) and the District of Columbia are as follows: Size of family unit Poverty income guideline 1 $ 6,810

3 2 9, , , , , , ,470 For family units with more than 8 members, $2,380 is added for each additional member. III. The Federal Income Tax A. The Income Tax in 1992 The federal income tax is imposed on a taxpayer's taxable income. /4/ In general, the taxable income of a low-income taxpayer is equal to the taxpayer's adjusted gross income /5/ less a standard deduction and personal exemptions. /6/ A low-income taxpayer's tentative tax liability, if any, is equal to 15 percent of taxable income. /7/ The amount that the taxpayer must pay or, alternatively, will receive as a refund, is equal to the taxpayer's tentative tax liability minus allowable credits. Other than the credit for withheld income taxes, /8/ the principal credits used by low-income taxpayers are the dependent care credit /9/ and the earned income credit. /10/ Each year, the Department of Treasury indexes the standard deduction amounts, the personal exemption amounts, the maximum earned income credit, and the income tax rate tables to reflect the prior year's change in the Consumer Price Index. /11/ For 1992, the basic standard deduction amounts are $6,000 for married couples filing jointly and surviving spouses; $5,250 for heads of households; $3,600 for unmarried individuals; and $3,000 for married individuals filing separately. Aged or blind taxpayers generally are entitled to claim an additional standard deduction amount of $700, except that aged or blind single individuals can claim an additional standard deduction amount of $900. The personal exemption amount for 1992 is $2,300. The rate tables also have been modified so that for 1992 the 15-percent marginal tax rate extends to all taxable incomes up to $35,800 for married couples filing jointly and surviving spouses; $28,750 for heads of households; $21,450 for unmarried individuals; and $17,900 for married individuals filing separately. For taxable incomes above those amounts, marginal tax rates of 28 percent and 31 percent are applicable. For 1992, the maximum basic earned income credit for a family with one qualifying child is $1,324, and the maximum basic earned income credit for a family with two or more qualifying children is $1,384. For 1992, a taxpayer with a child under age one may elect to claim a supplemental young child earned income credit of up to $376; however, if the taxpayer claims the supplemental young child credit, the taxpayer cannot claim that child for purposes of the dependent care credit. A taxpayer also is entitled to a health insurance earned income credit of up to $451 for health insurance premiums on a policy that includes at least one qualifying child.

4 For 1992, a taxpayer's total earned income credit begins phasing out at $11,840 of adjusted gross income (or, if greater, earned income) and will be entirely phased out at $22,370 of adjusted gross income (or, if greater, earned income). B. Effect on Low-Income Family Units Together, the standard deduction and personal exemptions result in a simple income tax threshold (also known as a "tax entry point"). In 1992, a family of four consisting of a husband and wife filing a joint tax return and two dependents would be entitled to a $6,000 standard deduction and four $2,300 personal exemptions. Consequently, the family would not have to pay any income tax until its income exceeded a $15,200 income tax threshold. The following table compares the poverty income guidelines with this simple income tax threshold for family units of up to eight persons: Size and type of Applicable poverty Simple income family unit income guideline tax threshold 1 $ 6,810 $ 5,900 1 (over 65 or blind) 6,810 6,800 2 (head of household 9,190 9,850 and 1 child) 2 (couple) 9,190 10,600 3 (head of household and 2 children) 11,570 12,150 3 (couple and child) 11,570 12,900 4 (couple and 2 children) 13,950 15,200 5 (couple and 3 children) 16,330 17,500 6 (couple and 4 children) 18,710 19,800 7 (couple and 5 children) 21,090 22,100 8 (couple and 6 children) 23,470 24,400

5 The above table shows that for family units larger than one, the simple income tax threshold exceeds the applicable poverty income guideline; that is, all families with incomes below the applicable poverty income guideline are not subject to federal income taxation. /12/ On the other hand, a typical single individual with income over the income tax threshold ($5,900 = $3,600 standard deduction + $2,300 personal exemption) but below the applicable poverty income guideline ($6,810) must pay at least some federal income tax. /13/ IV. Social Security Taxes A. Social Security Taxes in 1992 Social security taxes are levied on earnings in employment and self-employment covered by social security, /14/ with portions of the total tax allocated by law to the Old Age and Survivors Insurance trust fund (OASI), the Disability Insurance trust fund (DI), and the Medicare Hospital Insurance trust fund (HI). All persons who work in covered employment pay social security taxes on their earnings up to certain maximum dollar amounts, known as earnings caps. For 1992, employees pay social security taxes of 7.65 percent on the first $55,500 of earnings, 1.45 percent on earnings from $55,500 to $130,200, and nothing on earnings in excess of $130,200. /15/ Employers are required to match the social security taxes paid by their employees. That is, for each employee, employers also pay social security taxes of 7.65 percent of the first $55,500 of earnings and 1.45 percent of earnings from $55,500 to $130,200. Most economists believe that the burden of both the employee's and the employer's portion of social security taxes falls on the employee. /16/ Under this view, the effective marginal tax rate on low-income employee earnings as a result of social security taxes is 15.3 percent. /17/ Similarly, self-employed workers pay social security taxes that are equivalent to the combined social security employer-employee rates. Thus, for 1992, the self-employment tax rate is 15.3 percent of the first $55,500 of net earnings from self-employment and 2.9 percent of net earnings from self-employment from $55,500 to $130,200. In order to put self-employed taxpayers in roughly the equivalent tax situation with employees, self-employed individuals can deduct half of these taxes for income and social security tax purposes. /18/ B. Effect on Low-Income Family Units Because the social security tax system has no standard deductions or personal exemptions, families earning less than the poverty income guidelines are required to pay social security taxes. /19/ The earned income credit offsets the social security tax liabilities of those lowincome families with dependent children who are eligible for the credit. However, any eligible family whose social security tax liability exceeds its earned income credit amount will have a net federal tax liability. /20/

6 Also, low-income families without children and individuals are not entitled to claim the earned income credit. Accordingly, low-income families without children and individuals who have no income tax liabilities will have net federal tax liabilities as a result of social security taxes from the very first dollar of covered wages or earnings from self-employment. /21/ V. Conclusion Most taxpayers with incomes below the poverty income guidelines will not be required to pay any federal income taxes in On the other hand, all low-income taxpayers with earned income are liable for social security taxes from the very first dollar of covered earnings. The earned income credit offsets the social security tax liabilities of many low-income families with children. Still, any low-income family with children whose social security tax liability exceeds its earned income credit amount will pay a net federal tax. Also, because of their liability for social security taxes on all covered earnings and their ineligibility for the earned income credit, many low-income families without children and single individuals will have net federal tax liabilities even if their incomes are well below the applicable poverty income guidelines. Finally, certain low-income individuals also will have to pay at least some income taxes. footnotes 1. Thomas G. Collins of Gadsby & Hannah, Boston, Mass., is the Chair of the Committee, and Jonathan B. Forman prepared this year's report. The report was presented to the Committee at the Section of Taxation's May meeting in Washington, D.C., on May 16, This report represents the individual views of Committee members and does not necessarily represent the position of the American Bar Association or the Section of Taxation. For prior reports, see Jonathan B. Forman, First Annual Report on Poverty Levels and the Tax Threshold, (1) A.B.A. SEC. TAX'N NEWSL (Fall 1990); and Jonathan B. Forman, Poverty Levels and Federal Tax Thresholds: 1991, 52 TAX NOTES (1991). 2. See, e.g., HHS, Office of the Secretary, Annual Update of the Poverty Income Guidelines, 57 Fed. Reg (Feb. 14, 1992). 3. In certain cases, as noted in the relevant authorizing legislation or program regulations, a program uses the poverty income guidelines as only one of several eligibility criteria, or uses a percentage multiple of the guidelines. For example, the maximum income eligibility levels for Legal Services Corporation services is equivalent to 125 percent of the guidelines. See, e.g., LSC, Eligibility: Income Level for Individuals Eligible for Assistance, 56 Fed. Reg (Mar. 7, 1991). 4. I.R.C. Sec. 1.

7 5. Id. at Sec. 62. A taxpayer's "adjusted gross income" is defined as equal to the taxpayer's "gross income" less certain deductions. I.R.C. Sec. 61 defines a taxpayer's "gross income" as all income from whatever source derived by the taxpayer during the taxable year, including but not limited to wages, salary, tips, dividends, interest, rents, and royalties. Because few of the allowable deductions under section 62 are likely to be claimed by low-income taxpayers, in most cases a low-income taxpayer's adjusted gross income will be exactly equal to gross income. 6. Id. at Secs. 63 and 151. In 1987, for example, less than 10 percent of taxpayers with adjusted gross income of $20,000 or less itemized their deductions, while over 85 percent of taxpayers with adjusted gross income of $50,000 or more itemized their deductions. I.R.S. PUB. NO. 1304, INDIVIDUAL INCOME TAX RETURNS 1988: RETURNS FILED, SOURCES OF INCOME, EXEMPTIONS, ITEMIZED DEDUCTIONS, AND TAX COMPUTATIONS 8, 10 (1991). 7. I.R.C. Sec Id. at Sec Id. at Sec. 21. The dependent care credit is a nonrefundable credit for up to 30 percent of a limited amount of employment-related dependent care expenses incurred by an individual who maintains a household that includes one or more qualifying individuals. Generally, a qualifying individual is a dependent under age 13 or a physically or mentally incapacitated dependent or spouse. The maximum 30 percent credit rate is reduced, but not below 20 percent, by one percentage point for each $2,000 (or fraction thereof) of adjusted gross income above $10,000. Eligible employment-related expenses are limited to $2,400 if there is one qualifying individual (maximum credit $720 = 30 percent x $2,400), or $4,800 if there are two or more qualifying individuals (maximum credit $1,440 = 30 percent x $4,800). 10. I.R.C. Sec. 32. The earned income credit is a refundable credit available to taxpayers who maintain a home for at least one child. Thus, childless, single individuals and childless couples are ineligible for the credit. As restructured by the Omnibus Budget Reconciliation Act of 1990 (OBRA-90), Pub. L. No , 104 Stat (1990), the earned income credit now includes a basic earned income credit for a taxpayer with one qualifying child, a larger basic earned income credit for a taxpayer with two or more qualifying children, a supplemental young child credit, and a supplemental health insurance credit. For 1992, the maximum basic earned income credit for a family with one qualifying child is $1,324 (17.6 percent of the first $7,520 of earned income), the maximum basic earned income credit for a family with two or more qualifying children is $1,384 (18.4 percent of the first $7,520 of earned income), the maximum supplemental young child credit is $376 (5 percent of the first $7,520 of earned income), and the maximum supplemental health insurance credit is $451 (6 percent of the first $7,520 of earned income). Of note, OBRA-90 provided for substantial increases in the maximum basic earned income credit amounts to be phased in over a period of years. When the transition is completed in 1995, the maximum basic earned income credit for a family with one qualifying child is

8 projected to be $1,934 (23 percent of the first $8,410 of earned income), and the maximum basic earned income credit for a family with two or more qualifying children is projected to be $2,103 (25 percent of the first $8,410 of earned income). See generally STAFF OF HOUSE COMM. ON WAYS AND MEANS, 102D CONG., 1ST SESS., OVERVIEW OF ENTITLEMENT PROGRAMS: 1991 GREEN BOOK: BACKGROUND MATERIAL AND DATA ON PROGRAMS WITHIN THE JURISDICTION OF THE COMMITTEE ON WAYS AND MEANS (Comm. Print 1991) [hereinafter 1991 GREEN BOOK]. 11. See, e.g., Rev. Proc , I.R.B These simple income tax thresholds ignore the impact of the earned income credit. Factoring in the earned income credit for those families with dependent children that qualify for the credit would result in even higher income tax thresholds for some families. For example, in 1991, a married couple with two dependent children had a simple income tax threshold of $14,300 ($5,700 standard deduction plus four $2,150 personal exemptions); however, when the impact of the earned income credit was also taken into account, that family had no income tax liability until its income reached $17,436. See 1991 GREEN BOOK, supra note 10, at 60. Of note, the Tax Fairness and Economic Growth Act of 1992 would have repealed the supplemental young child credit and further increased the basic earned income credit amounts for families with two or more children; however, it was vetoed by President Bush. Tax Fairness and Economic Growth Act of 1992, H.R. 4210, 102d Cong., 2d Sess., Sec (1992); Adam Clymer, The 1992 Campaign: Economic Issues, Tax Bill is Passed by the Democrats and Bush Vetoes It, N.Y. TIMES, Mar. 21, 1992, at A Even single individuals who are entitled to the additional standard deduction of $900 because of age or blindness have an income tax threshold ($6,800) slightly below the applicable poverty guideline ($6,810). 14. I.R.C. Secs. 1401, 3101, and Id. at Sec. 3121(a)(1) and (x); HHS, Office of the Secretary, SSA, 1992 Cost-of-Living Increase and Other Determinations, 56 Fed. Reg , (Oct. 25, 1991). More specifically, the OASI and DI taxes (5.6 percent and 0.6 percent, respectively) are collected on the first $55,500 of covered wages, and the HI tax (1.45 percent) is collected on the first $130,200 of covered wages. 16. The lower take-home pay as a result of the tax is not expected to reduce the number of workers seeking jobs, nor does the tax increase worker productivity. Accordingly, employers have no reason to pay higher total compensation, so the burden of the tax is borne by workers. See, e.g., JOSEPH A. PECHMAN, WHO PAID THE TAXES, (1985); JOSEPH A. PECHMAN, FEDERAL TAX POLICY (5th ed. 1987); STAFF OF HOUSE COMM. ON WAYS AND MEANS, 101ST CONG., 2D SESS., BACKGROUND MATERIALS ON FEDERAL BUDGET AND TAX POLICY FOR FISCAL YEAR 1991 AND BEYOND 1 (Comm. Print 1990) [hereinafter BACKGROUND MATERIALS].

9 17. The effective tax rate is slightly lower than 15.3 percent of income, as a discount should be applied to take into account the fact that only the employee portion of the social security tax is included in the employee's income for income tax purposes--the employer portion is excluded from income. 18. I.R.C. Secs. 164(f) and 1402(a)(12). 19. Indeed, of those low-income families paying any federal taxes, at least 97 percent pay larger social security taxes than income taxes. See STAFF OF HOUSE COMM. ON WAYS AND MEANS, 101ST CONG., 2D. SESS., TAX PROGRESSIVITY AND INCOME DISTRIBUTION 33 (Comm. Print 1990). This report ignores any distributional impact that would result from considering future benefits that might result from current social security taxes paid. Cf. BACKGROUND MATERIALS, supra note 16, at 5. For a discussion of the distributional aspects of OASI taxes and benefits, see Jonathan B. Forman, Promoting Fairness in the Social Security Retirement Program: Partial Integration and a Credit for Dual-Earner Couples, 45 TAX LAWYER (forthcoming, Summer 1992). 20. For example, a family with one qualifying child and with earnings from self-employment may have a net tax liability soon after earnings reach about $8,600 ($1,324 (maximum basic earned income credit for a family with one qualifying child) divided by 15.3 percent (overall social security tax rate) = $8,653.59). Of note, OBRA-90 provided for significant increases in the basic earned income credit amounts available to low-income families with children in See note 9, supra. Accordingly, even fewer low-income families with children will have net federal tax liabilities in 1992 than did in prior years. 21. The Tax Fairness and Economic Growth Act of 1992 would have provided an additional tax credit based on the taxpayer's social security tax of up to $150 for single taxpayers and $300 for married taxpayers; however, it was vetoed by President Bush. Tax Fairness and Economic Growth Act of 1992, supra note 12, at Sec. 1001; Clymer, supra note 12.