As a business owner, there are many things to manage, from products to services and customers to employees. Tax policy and legislation may not be the number one item on your list. However, it can have a significant impact on your business. Businesses that take the time to understand tax policy and legislation and plan for upcoming changes put themselves in a much stronger position for the future.
Tax and fiscal policy will loom large in President Obama's domestic policy agenda. Nearly all of the tax cuts enacted since 2001 expire at the end of 2010 and the individual alternative minimum tax (AMT) threatens to ensnare tens of millions of Americans.
Federal Tax Overview
The current Federal tax system has four main elements: (1) an income tax on individuals and corporations ,which consists of both a "regular" income tax and an alternative minimum tax; (2) payroll taxes on wages, and corresponding taxes on self-employment income; (3) estate, gift, and generation-skipping transfer taxes, and (4) excise taxes on selected goods and services.
A number of aspects of the Federal tax laws are subject to change over time. For example, some dollar amounts and income thresholds are indexed for inflation. The standard deduction, tax rate brackets, and the annual gift tax exclusion are examples of amounts that are indexed for inflation. In general, the Internal Revenue Service adjusts these numbers annually and publishes the inflation adjusted amounts in effect for a tax year prior to the beginning of that year.
In addition, a number of the provisions in the Federal tax laws have been enacted on a temporary basis or have parameters that vary by statute from year to year. For example, the Tax Relief and Health Care Act of 2006 extended a number of expired or soon to expire provisions on a temporary basis. In addition, many of the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 initially were to expire at the end of 2010; some provisions of that Act have been modified subsequently or made permanent.
Major Enacted Federal Tax Legislation 1940 - 2008
- Congress has passed at least one tax bill each year since 2001 and an average of one tax bill each year since 1940.
- Those bills lowered the top individual income tax rate from 91 percent in 1962 to 70 percent in 1980 and to 35 percent today.
- The top corporate income tax rate was 46 percent in 1980. Today, it is 35 percent.
- The Tax Reform Act of 1986 reduced the number of tax brackets from 11 to two. Tax acts in 1990, 1993, and 2001 added four more brackets.
- The Economic Recovery Tax Act of 1981 (ERTA) indexed some parameters of the individual income tax for inflation (effective in 1985), reducing "bracket creep" where inflation pushed taxpayers into ever-higher tax brackets.
- Tax acts since 1986 have created the child tax credit; increased the earned income tax credit (EITC) and the dependent care credit; and added tax incentives for retirement savings, education, and health insurance.
Additional Federal Tax Legislation
Here is a list of all the federal tax legislation enacted between 2001 and 2006
- Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA)
- The Job Creation and Worker Assistance Act of 2002 (JCWA)
- The Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA)
- Military Family Tax Relief Act of 2003
- The Medicare Prescription Drug, Improvement, and Modernization Act of 2003
- Working Families Tax Relief Act of 2004 (WFTRA)
- American Jobs Creation Act of 2004 (AJCA)
- Energy Tax Incentives Act of the Energy Policy Act of 2005
- Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA)
- Pension Protection Act of 2006
- Tax Relief and Health Care Act of 2006
Distribution of Taxes
Fiscal year 2008 federal revenues will come from four major sources: individual income tax (48 percent), corporate income tax (14 percent), payroll taxes (36 percent), and excise taxes (3 percent). Estate and gift taxes, customs duties, Federal Reserve earnings/losses, and miscellaneous receipts will account for -1 percent.
Overall federal taxes are progressive; that is, the effective tax rate rises as income grows. In 2008, the average combined rate of federal income, payroll, and estate taxes will be 1.1 percent for the lowest quintile (or fifth) of the income distribution, 15.1 percent for the middle quintile, and 26.2 percent for the highest quintile.
The individual income tax is highly progressive: in 2008, the lowest quintile will face an average rate of -8.1 percent while the top quintile pays 15.0 percent. In contrast, the payroll tax is regressive (the effective rate falls as income rises): the lowest quintile will pay an average of 8.4 percent but the top quintile pays 5.7 percent and the top 1 percent pays just 1.5 percent.
The progressivity of the federal tax system means that high-income taxpayers bear a high share of taxes. In 2008, the top quintile of the income distribution will receive 55 percent of income and pay 69 percent of federal taxes.
Congress has cut taxes every year since 2001, most importantly with the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA).
The 2001-2006 tax cuts reduced most individual tax rates including those on capital gains and dividends; expanded the child tax credit; increased incentives to save; phased out the limitations on itemized deductions and personal exemptions for high-income taxpayers; and phased out the estate tax. Virtually all of the cuts end by 2011 when EGTRRA and JGTRRA sunset.
The tax cuts have disproportionately benefited high-income taxpayers. In 2007, the tax cuts will raise after-tax income by 0.3 percent for the lowest quintile, by 2.4 percent for the middle quintile, and by 3.2 percent for the top quintile.
The revenue cost of the tax cuts totals approximately $2 trillion over the 2001-2010 period. Annual costs will rise if Congress extends the tax cuts beyond 2010 or continues AMT relief after 2006.
Tax policy and legislation can have a significant impact on your business. Businesses that take the time now to understand this legislation and plan for upcoming changes put themselves in a much stronger position for the future. If you would like more information on this tax legislation or any others please give us a call!
Note: The information contained in this material represents a general overview of tax regulations and should not be relied upon without an independent, professional analysis of how any of these provisions apply to a specific situation.
Sources: Joint Committee on Taxation - 2008, Budget of the United States Government Fiscal Year 2009 - Historical Tables, Tax Policy Center- Urban Institute and Brookings Institution