[Background Material and Data on Programs within the Jurisdiction of the Committee on Ways and Means (Green Book)]
[Program Descriptions]
[Section 13. Tax Provisions Related to Retirement, Health, Poverty, Employment, Disability, and Other Social Issues]
[From the U.S. Government Printing Office, www.gpo.gov]




 
SECTION 13 - TAX PROVISIONS RELATED TO RETIREMENT, HEALTH, POVERTY, 
EMPLOYMENT, DISABILITY AND OTHER SOCIAL ISSUES

CONTENTS

Introduction
Net Exclusion of Pension Contributions and Earnings
Individual Retirement Arrangements
Exclusion of Social Security and Railroad Retirement Benefits
Exclusion of Employer Contributions for Medical Insurance Premiums 
  and Medical Care
Tax Credit for Health Insurance of Eligible Individuals
Medical Savings Accounts
Health Savings Accounts
Cafeteria Plans
Health Care Continuation Rules
Group Health Plan Requirements
Tax Benefits for Accelerated Death Benefits and Long-Term Care 
Insurance
Deduction for Health Insurance Expenses of Self-Employed Individuals
Exclusion of Medicare Benefits
Deductibility of Medical Expenses
Earned Income Credit
Exclusion of Public Assistance and SSI Benefits
Dependent Care Tax Credit
HOPE Credit and Lifetime Learning Credit
Qualified Tuition Programs and Coverdell Education Savings 
  	Accounts
Student Loan Interest Deduction
Qualified Tuition Deduction
Exclusion for Employer-Provided Dependent Care
Work Opportunity Tax Credit
Welfare-to-Work Tax Credit
Exclusion of Workers' Compensation and Special Benefits for Disabled 
Coal Miners
Additional Standard Deduction for the Elderly and Blind
Tax Credit for the Elderly and Certain Disabled Individuals
Tax Provisions Related to Housing
Tax Credit and Exclusion for Adoption Expenses
Child Tax Credit
Effect of Tax Provisions on the Income and Taxes of the Elderly and 
the Poor 

References

INTRODUCTION
	
	The preceding sections of this publication discuss direct 
payments to individuals for retirement, health, public assistance, 
employment, and disability benefits provided through entitlement 
programs within the jurisdiction of the Committee on Ways and Means. 
The Federal Government also provides benefits to individuals through 
elements of the income tax set forth in the Internal Revenue Code of 
1986 (the Code). The Code is entirely within the jurisdiction of the 
Committee on Ways and Means.

TAX PROVISIONS

	Several different types of income tax provisions are 
available to provide economic incentives. Examples include: 
exclusions, exemptions, deductions, preferential rates, deferrals 
and credits. Measuring the amount of benefit afforded by a tax 
provision is difficult. However, one way to measure the benefit 
is to review the total estimated amounts excluded, exempted, or 
otherwise afforded special treatment under various provisions of the 
income tax.

USE OF DISTRIBUTIONAL ANALYSIS

	Analyzing the effectiveness of tax provisions at achieving 
their policy goals often involves examining the distribution of 
benefits from the provisions allocated by the income class of those 
who take advantage of the provisions. The income concept used to 
show the distribution of tax expenditures by income class is adjusted 
gross income (AGI) plus: (1) tax-exempt interest; (2) employer 
contributions for health plans and life insurance; (3) employer share 
of FICA taxes; (4) workers' compensation; (5) nontaxable Social 
Security benefits; (6) insurance value of Medicare benefits; 
(7) alternative minimum tax preferences; and (8) excluded income of 
U.S. citizens living abroad.
	This definition of income includes items that clearly increase 
the ability to pay taxes, but that are not included in the definition 
of AGI. However, it omits certain items that clearly affect ability 
to consume goods and services either now or in the future, including 
accrual of pension benefits, other fringe benefits (such as military 
benefits, veterans benefits, and parsonage allowances), and means-
tested transfer payments (such as Aid to Families with Dependent 
Children (AFDC), Supplemental Security Income, food stamps, housing 
subsidies, and general assistance).  The tax return is the unit of 
analysis. Table 13-1 shows the distribution of all tax returns for 
2003 by income class.
	Unless specifically indicated, all distributional tables 
exclude returns filed by dependents. All projections of income 
and deduction items and tax parameters are based on economic 
assumptions consistent with the December 2002 forecast of the 
Congressional Budget Office.


TABLE 13-1 -- DISTRIBUTION BY INCOME CLASS OF ALL RETURNS, TAXABLE 
RETURNS, ITEMIZED RETURNS, AND INDIVIDUAL INCOME TAX LIABILITY FOR
TAXABLE YEAR 2003




[GRAPHICS NOT AVAIABLE IN TIFF FORMAT]


TAX PROVISION ESTIMATES

	Table 13-2 provides various estimates for 37 tax provisions 
related to retirement, health, poverty, employment, disability, and
housing. These provisions are examined in detail in this chapter 
including their legislative history, an explanation of current law, 
and a brief assessment of their effects.

NET EXCLUSION OF PENSION CONTRIBUTIONS AND EARNINGS

LEGISLATIVE HISTORY

	Prior to 1921, no special tax treatment applied to employee 
retirement trusts. Retirement payments to employees and contributions 
to pension trusts were deductible by the employer as an ordinary and 
necessary business expense. Employees were taxed on amounts actually 
received as well as on employer contributions to a trust if there was 
a reasonable expectation of benefits accruing from the trust. The 
1921 Code provided an exemption for a trust forming part of a 
qualified profit sharing or stock bonus plan.
	The rules relating to qualified plans were substantially 
revised by the Employee Retirement Income Security Act of 1974 
(ERISA), which added overall limitations on contributions and 
benefits and other requirements on


TABLE 13-2 -- ESTIMATED TAX BASE EXCEPTIONS AND CREDITS UNDER THE 
PRESENT INCOME TAX FOR VARIOUS  ITEMS,1 CALENDAR YEARS 2003-2007 



[GRAPHICS NOT AVAIABLE IN TIFF FORMAT]




minimum participation, coverage, vesting, benefit accrual, and 
funding. Many revisions of these rules have been made since 1974.  
Since ERISA, Congress has also acted to broaden the range of 
qualified plans. In the Revenue Act of 1978, Congress provided 
special rules for qualified cash or deferred arrangements under 
section 401(k). Under these arrangements, known popularly as 401(k) 
plans, employees can elect to receive cash or have their employers 
contribute a portion of their earnings to a qualified profit sharing, 
stock bonus, or pre-ERISA money purchase pension plan.
	An employee stock ownership plan is a special type of 
qualified plan that is designed to invest primarily in securities 
of the employer maintaining the plan. Certain qualification rules 
and tax benefits apply to employee stock ownership plans that do 
not apply to other types of qualified plans.

EXPLANATION OF PROVISION

In General
	Under a plan of deferred compensation that meets the 
qualification standards of the Internal Revenue Code (sec. 
401(a)), an employer is allowed a deduction for contributions 
to a tax-exempt trust to provide employee benefits. Similar 
rules apply to plans funded with annuity contracts. An employer 
that makes contributions to a qualified plan in excess of the 
deduction limits generally is subject to a 10-percent excise 
tax on such excess (sec. 4972).
	The qualification rules limit the amount of benefits that 
can be provided through a qualified plan and require that benefits 
be provided on a basis that does not discriminate in favor of highly 
compensated employees. In addition, qualified plans are required to
meet minimum standards relating to participation (the restrictions 
that may be imposed on participation in the plan), coverage (the 
number of employees participating in the plan), vesting (the time at 
which an employee's benefit becomes nonforfeitable), and benefit 
accrual (the rate at which an employee earns a benefit). Also, 
minimum funding standards apply to the rate at which employer 
contributions are required to be made to defined benefit plans to 
ensure the solvency of such plans.
	
	If a defined benefit pension plan is terminated, any assets 
remaining after satisfaction of the plan's liabilities may revert 
to the employer. Such reversions are included in the gross income of 
the employer and are subject to income tax plus an additional excise 
tax (sec. 4980). The excise tax is 20 percent if the employer 
establishes a qualified replacement plan or provides certain benefit 
increases. Otherwise, the excise tax is 50 percent. Transfers of 
excess assets can be made from an ongoing defined benefit plan to 
pay certain retiree health benefits if certain requirements are 
satisfied (sec. 420). The assets transferred are not includible in 
the income of the employer or subject to the tax on reversions.

Minimum Participation Rules
	A qualified plan generally may not require as a condition 
of participation that an employee complete more than 1 year of 
service or be older than age 21 (sec. 410(a)).

Vesting Rules
	In general a plan is not a qualified plan unless a 
participant's employer-provided benefit vests at least as rapidly 
as under one of two alternative minimum vesting schedules (sec. 411).  
More rapid vesting applies to employer matching contributions.  In 
addition, elective contributions to a section 401(k) plan and after-
tax employee contributions must be fully vested at all times.

Benefit Accrual Rules
	The protection afforded employees under the minimum vesting 
rules depends not only on the minimum vesting schedules, but also on 
the accrued benefits to which these schedules are applied. In the 
case of a defined contribution plan, the accrued benefit is the 
participant's account balance. In the case of a defined benefit 
plan, a participant's accrued benefit is determined under the plan 
benefit formula, subject to certain restrictions. In general, the 
accrued benefit is defined in terms of the benefit payable at 
normal retirement age and does not include certain ancillary 
nonretirement benefits.
	Each defined benefit plan is required to satisfy one of 
three accrued benefit tests. The primary purpose of these tests is 
to prevent undue backloading of benefit accruals (i.e., by providing 
low rates of benefit accrual in the employee's early years of 
service when the employee is most likely to leave and by 
concentrating the accrual of benefits in the employee's later years 
of service when the employee is most likely to remain with the 
employer until retirement) (sec. 412).

Coverage Rules
	A plan is not qualified unless the plan satisfies at least 
one of the following coverage requirements: (1) the plan benefits 
at least 70 percent of all nonhighly compensated employees, (2) 
the plan benefits a percentage of nonhighly compensated employees 
that is at least 70 percent of the percentage of highly compensated 
employees benefiting under the plan, or (3) the plan meets an 
average benefits test (sec. 410(b)). In addition, a defined benefit 
plan is not a qualified plan unless it benefits at least the lesser 
of: (1) 50 employees, or (2) the greater of 40 percent of the 
mployees of the employer or two employees (or if there is only one 
employee, such employee) (sec. 401(a)(26)).

General Nondiscrimination Rule
	In general, a plan is not a qualified plan if the 
contributions or benefits under the plan discriminate in favor of 
highly compensated employees  (sec. 401(a)(4)).

Limitations on Contributions and Benefits
		The maximum annual benefit that may be provided 
by a defined benefit pension plan (payable at age 65) is the lesser 
of 100 percent of average compensation, or $160,000 for 2003 
(sec. 415(b)). The dollar limit is adjusted annually for inflation. 
The dollar limit is reduced if payments of benefits begin before 
age 62 and increased if benefits begin after age 65.  The maximum 
contributions that may be made to a defined contribution plan with 
respect to a participant is the lesser of 100 percent of the 
participant's compensation, or $40,000 for 2003 (sec.415(c)).  
The dollar limit is adjusted annually for inflation.

Funding Rules
	Pension plans are required to meet a minimum funding standard 
for each plan year (sec. 412). In the case of a defined benefit 
pension plan, an employer must contribute an annual amount sufficient 
to fund a portion of participants' projected benefits determined in 
accordance with one of several prescribed funding methods, using 
reasonable actuarial assumptions. Certain plans with asset values of 
less than 100 percent of current liabilities are subject to 
additional, faster funding rules.

Taxation of Distributions
	An employee who participates in a qualified plan is taxed when 
the employee receives a distribution from the plan to the extent the 
distribution is not attributable to after-tax employee contributions 
(sec. 402). With certain exceptions, a 10-percent additional income 
tax is imposed on early distributions from a qualified plan 
(sec. 72(t)).

Failure to Satisfy Qualification Requirements
	If a plan fails to satisfy the qualification requirements, the 
trust that holds the plan's assets is not tax exempt. An employer's 
deduction for plan contributions is only allowed when the employee 
includes the contributions or benefits in income, and benefits 
generally are includable in an employee's income when they are no 
longer subject to a substantial risk of forfeiture.

SIMPLE Retirement Plans
	The Small Business Job Protection Act of 1996 created a 
simplified retirement plan for small business called the Savings 
Incentive Match Plan for Employees (SIMPLE) (secs. 408(p) and 
401(k)(11)). SIMPLE plans may be adopted by employers with 100 or 
fewer employees and who do not maintain another employer-sponsored 
retirement plan. A SIMPLE plan can be either an individual retirement 
arrangement (IRA) for each employee or part of a qualified cash or 
deferred arrangement (401(k) plan). If established in IRA form, a 
SIMPLE plan is not subject to the nondiscrimination rules generally 
applicable to qualified plans and simplified reporting requirements 
apply. If adopted as part of a 401(k) plan, the plan does not have 
to satisfy the special nondiscrimination tests applicable to 401(k) 
plans and is not subject to the top-heavy rules. The other qualified 
plan rules continue to apply. SIMPLE plans are subject to special 
rules regarding eligibility of employees to participate and special 
contribution limits.

Other Employer-Sponsored Retirement Arrangements
	Certain other types of employer-sponsored retirement plans 
provide tax benefits similar to those provided under qualified 
retirement plans, including tax-sheltered annuities (sec. 403(b) 
annuities), eligible deferred compensation plans of State and local 
governmental employers (governmental sec.  457 plans), and simplified 
employee pensions, referred to as "SEPs" (sec. 408(k)). Each of 
these arrangements is subject to different requirements, including 
contribution limits.  These arrangements are not subject to many of 
the requirements applicable to qualified plans.

Saver's Credit
	The Economic Growth and Tax Relief Reconciliation Act,
"EGTRRA," provides a temporary nonrefundable tax credit for eligible 
taxpayers for qualified retirement saving contributions, effective 
for taxable years beginning after December 31, 2001, and before 
January 1, 2007.  The credit is available with respect to (1) elective 
deferrals to 401(k) loans, tax-sheltered annuities, governmental 457 
plans, SIMPLE retirement plans, or SEPs; (2) contributions to a 
traditional or Roth IRA; and (3) voluntary after-tax employee 
contributions to a tax sheltered annuity or qualified retirement plan.  
The amount of any contribution eligible for the credit is reduced by 
certain distributions received from these arrangements.
	The maximum annual contribution eligible for the credit is 
$2,000.  The credit rate varies from 10 percent to 50 percent, 
depending on the adjusted gross income (AGI) of the taxpayer. Taxpayers 
filing joint returns with AGI of $50,000 or less, head of household 
returns of $37,500 or less, and single returns of $25,000 or less are 
eligible for the credit. The AGI limits applicable to single taxpayers 
apply to married taxpayers filing separate tax returns.  The credit is 
in addition to any deduction or exclusion that would otherwise apply 
with respect to the contribution.  The credit offsets minimum tax 
liability as well as regular tax liability.  The credit is available 
to individuals who are 18 or over, other than individuals who are 
full-time students or claimed as a dependent on another taxpayer's 
return.
	
EFFECT OF PROVISION

	The tax treatment of pension contributions and earnings has 
encouraged employers to establish qualified retirement plans and to 
compensate employees in the form of pension contributions to such 
plans. There are two potential tax advantages of being compensated 
through pension contributions. One advantage is the ability to earn 
tax-free returns to savings. When saving is done through a pension 
plan, the employee earns a higher rate of return than on fully taxed 
savings.  The second advantage is that an employee's tax rate may be 
lower during retirement than during the working years.
	These tax provisions directly benefit only persons who work 
for employers with qualified plans and who work for a sufficient 
period of time before their benefits vest in such plans. The current 
extent of this coverage and recent trends in coverage are described 
below.

COVERAGE

	The term "covered," as used here, means that an employee is 
accruing benefits in an employer pension or other retirement plan. The 
most recent data regarding pension coverage is the March 2003 Current 
Population Survey. The data referred to below come from that survey 
unless otherwise noted.
	As of March 2003, 57 percent of the nonelderly full-time wage
and salary workers employed in the private sector reported that they
worked in firms with an employer-sponsored pension plan in 2002 
(Table 13-3). Slightly less than half (46 percent) of the full-time 
wage and salary workers employed in the private sector were covered 
by an employer-sponsored pension plan.
	Pension coverage varies substantially among full-time, 
privately employed workers. Differences depend on the age of the 
worker, job earnings, the industry of employment, and the size of the 
firm.
	Younger workers are much less likely to be covered by a 
pension than middle aged and older workers. Coverage rates rise 
steadily from 19 percent for those under age 25 to about 60 percent 
for those between ages 40 and 60 before falling off substantially for 
those over age 65. This pattern holds for both men and women. However, 
the jump in coverage for middle aged men is slightly larger than the 
increase for middle aged women (Table 13-4).
	Higher paying jobs are more likely to offer pensions. Just 
10 percent of full-time private wage and salary workers earning less 
than $10,000 per year in 2002 were covered compared to 68 percent or 
more of those earning $50,000 or more (Table 13-5). Coverage may be 
higher for higher paying jobs because of the greater value of the 
pension tax benefits to workers in higher tax brackets and because of 
the declining replacement rate of Social Security at higher earnings 
levels.




TABLE 13-3 -- EMPLOYER SPONSORSHIP AND EMPLOYEE PARTICIPATION IN 
RETIREMENT PLANS, 2002 


[GRAPHICS NOT AVAIABLE IN TIFF FORMAT]



TABLE 13-4 -- PARTICIPATION IN EMPLOYER-SPONSORED RETIREMENT PLANS 
AMONG PRIVATE-SECTOR WAGE AND SALARY WORKERS EMPLOYED FULL-
TIME IN 2002,  BY WORKERS' AGE


[GRAPHICS NOT AVAIABLE IN TIFF FORMAT]


TABLE 13-5 -- PARTICIPATION IN EMPLOYER-SPONSORED RETIREMENT PLANS 
AMONG PRIVATE-SECTOR WAGE AND SALARY WORKERS EMPLOYED FULL TIME 
IN 2002, BY WORKER'S EARNINGS



[GRAPHICS NOT AVAIABLE IN TIFF FORMAT]



	Coverage is much lower for smaller firms.  Smaller firms are 
less likely to offer comprehensive fringe benefit packages as part of 
total compensation. Only 19 percent of full-time private wage and 
salary workers in firms with fewer than 10 employees are covered. The 
rate rises with employer size but does not reach 46 percent (the 
average across all firm sizes) until firms have 100 or more employees 
(Table 13-6).
	Significant differences in coverage also are apparent between 
full-time private wage and salary workers and other wage and salary 
workers. Coverage is much lower among part-time workers and much 
higher among public employees.  Among part-time, private wage and 
salary workers, 13 percent are covered. Seventy-two percent of public 
sector wage and salary workers are covered including 80 percent of 
those who are full-time workers (Table 13-7).

TABLE 13-6 -- PARTICIPATION IN EMPLOYER-SPONSORED RETIREMENT PLANS 
AMONG PRIVATE-SECTOR WAGE AND SALARY WORKERS EMPLOYED FULL TIME 
IN 2002, BY SIZE OF FIRM

[GRAPHICS NOT AVAIABLE IN TIFF FORMAT]


				
TRENDS IN COVERAGE

	At the outset of World War II, private employer pensions were 
offered by about 12,000 firms. Pensions spread rapidly during and 
after the war, encouraged by high marginal tax rates and wartime wage 
controls that exempted pension benefits. By 1972, when the first 
comprehensive survey was undertaken, 48 percent of full-time private 
employees were covered. Subsequent surveys in 1979, 1983, 1988, and 
1993 showed that coverage remained fairly constant, never falling below 
46 percent or rising above 50 percent. However, the survey in 1998 
showed a drop in coverage to 43 percent.  The most recent survey in 
2003 showed coverage at 46 percent (Table 13-3).
	For workers with pension coverage, there has been a shift 
away from defined benefit plans.  Of the private wage and salary 
workers covered by a pension plan in 1975, 87 percent were covered by 
a defined benefit plan (Turner & Beller, 1989, pp. 65 & 357). This 
proportion dropped to 83 percent by 1980 and to 71 percent by 1985. 
This proportion dropped even lower to 65 percent in 1993 (Department
of Labor, 1994, tables A2, B1, B2). This shifting composition has 
largely been the result of rapid growth in primary defined 
contribution plans. Employee stock ownership plans and 401(k) plans 
have been among the most rapidly growing defined contribution plans.

TABLE 13-7 -- PARTICIPATION IN EMPLOYER-SPONSORED RETIREMENT PLANS 
AMONG ALL WAGE AND SALARY WORKERS IN 2002, BY SECTOR OF EMPLOYMENT


[GRAPHICS NOT AVAIABLE IN TIFF FORMAT]



		INDIVIDUAL RETIREMENT ARRANGEMENTS "IRAS"	

LEGISLATIVE HISTORY
		
	ERISA added section 219 to the Internal Revenue Code, 
providing a tax deduction for certain contributions to IRAs and 
permitting the deferral of tax on amounts held in such arrangements 
until withdrawal. Active participants in employer plans were not 
permitted to make deductible IRA contributions.
	The Economic Recovery Tax Act of 1981 expanded eligibility 
to individuals who were active participants and increased the amount 
of the permitted deduction. The Tax Reform Act of 1986 limited the 
full IRA deduction to individuals with income below certain levels 
and to individuals who are not active participants in employer plans. 
Individuals who are not entitled to the full IRA deduction may 
make nondeductible contributions to an IRA. The Small Business Job 
Protection Act of 1996 increased contributions that can be made to 
the IRA of a nonworking spouse. The Health Insurance Portability and 
Accountability Act provided that the early withdrawal tax does not 
apply to withdrawals from IRAs: (1) for medical expenses that would 
be deductible (i.e., to the extent that total medical expenses exceed 
7.5 percent of AGI); and (2) for health insurance expenses of 
unemployed individuals.
	The Taxpayer Relief Act of 1997, effective for years 
beginning after December 31, 1997, made the following changes to the 
IRA provisions: (1) the income limits on deductible IRA contributions 
that apply to active participants in an employer-sponsored retirement 
plan were increased; (2) the nonworking spouse of an active 
participant in an employer-sponsored retirement plan may make a 
deductible contribution of up to $2,000 to an IRA; (3) a new tax-free 
nondeductible IRA, the Roth IRA, was added; and (4) the 10-percent 
early withdrawal tax was waived for distributions from IRAs for 
education and first-time home buyer expenses.
	The annual limit on aggregate IRA contributions was increased 
again by The Economic Growth and Tax Relief Reconciliation Act of 2001 
("EGTRRA").   EGTRRA also allows individuals who have attained age 50 
to make additional catch-up contributions to an IRA.

EXPLANATION OF PROVISION

Traditional IRAs
	An individual who is an active participant in an employer-
sponsored retirement plan may deduct annual IRA contributions up to 
the lesser of $3,000 (for 2003) or 100 percent of compensation if the 
individual's adjusted gross income (AGI) does not exceed certain 
limits.
	The maximum deduction for IRA contributions for an individual 
who has attained age 50 before the end of the year is increased by a 
certain dollar amount ($500 for 2003).  (The maximum dollar limit on 
IRA contributions applies to aggregate IRA contributions of an 
individual, including contributions to a Roth IRA.)
	If an individual (or the individual's spouse) is an active 
participant in an employer-sponsored retirement plan, the deduction is
phased out for taxpayers with adjusted gross income over certain 
levels for the taxable year.  The adjusted gross income phase-out 
limits for taxpayers who are active participants in employer-sponsored 
plans are as follows:

                                 Single Taxpayers
Taxable years beginning in:			Phase-out range
2003	                                        40,000-50,000                                                                                    	40,000-50,000
2004	                                        45,000-55,000                                                                                   	45,000-55,000
2005 and thereafter				50,000-60,000

                                 Joint Returns
Taxable years beginning in:			Phase-out range
2003						60,000-70,000
2004						65,000-75,000
2005						70,000-80,000
2006						75,000-85,000										
2007 and thereafter				80,000-100,000

	The adjusted gross income phase-out range for married 
taxpayers filing a separate return is $0 to $10,000.
	An individual who is not an active participant, but whose 
spouse is, may make a full deductible IRA contribution if the AGI for 
the couple does not exceed $150,000.  The deduction limit in such 
cases is phased out for AGI between $150,000 and $160,000. An 
individual who is not an active participant in an employer-sponsored 
retirement plan may deduct IRA contributions up to the limits 
described above without limitation based on income.
	The investment income of IRA accounts is not taxed until 
withdrawn. Withdrawn amounts attributable to deductible contributions
and all earnings are includible in income. A 10-percent additional 
income tax applies unless the withdrawal: (1) is made after the IRA 
owner attains age 59ï¿½ or dies; (2) is made on account of the 
disability of the IRA owner; (3) is one of a series of substantially 
equal periodic payments made not less frequently than annually over 
the life or life expectancy of the IRA owner (or the IRA owner and 
his or her beneficiary); (4) is made to pay medical expenses in 
excess of 7.5 percent of AGI or for health insurance premiums for 
unemployed individuals; or (5) is made for first-time home buyer 
expenses (subject to a $10,000 lifetime cap) or for qualified 
higher education expenses.

Nondeductible IRAs
	An individual may make nondeductible contributions to a 
traditional IRA to the extent the individual does not or cannot make 
deductible contributions to an IRA or contributions to a Roth IRA.  
Earnings on contributions to a nondeductible IRA accumulate tax free, 
and are includible in income when withdrawn.  The 10-percent early 
withdrawal tax applies to such earnings, subject to the exceptions 
for IRAs as described above.

Roth IRAs
	Individuals with adjusted gross income below certain levels 
may make nondeductible contributions to a Roth IRA.  The maximum 
annual contribution that may be made to a Roth IRA is the lesser of 
a certain dollar amount ($3,000 for 2003) or the individual's 
compensation for the year.  An individual who has attained age 50 
before the end of the taxable year also may make catch-up 
contributions to a Roth IRA up to a certain dollar amount ($500 for 
2003).  The contribution limit is reduced to the extent an individual 
makes contributions to any other IRA for the same taxable year. The 
maximum annual contribution that can be made to a Roth IRA is phased 
out for single individuals with adjusted gross income between $95,000 
and $110,000 and for joint filers with adjusted gross income between 
$150,000 and $160,000.  The adjusted gross income phase-out range for 
married taxpayers filing a separate return is $0 to $10,000.	
	Qualified distributions from a Roth IRA are not includable in 
income. Qualified distributions are distributions: (1) made after the 
5-year taxable period beginning with the first taxable year for which 
a contribution is made, and (2) which are made on or after the date 
the individual attains age 59ï¿½, are made to a beneficiary on or after 
the death of the individual, are attributable to the individual's 
being disabled, or are for a qualified special purpose distribution. 
A qualified special purpose distribution is a distribution for 
first-time home buyer expenses, as described above. Distributions 
that are not qualified distributions are includible in income, to 
the extent earnings are included in the distribution, and are 
subject to the 10-percent tax on early withdrawal, unless an 
exception applies, as described above for traditional IRAs.
	Taxpayers with AGI of less than $100,000 may convert an IRA 
to a Roth IRA at any time. If the conversion was made before 
January 1, 1999, the amounts that would have been includible in 
income had the amounts converted been withdrawn are includible in 
income ratably over four years. The 10-percent tax on early 
withdrawals does not apply to conversions of IRAs to Roth IRAs.

EFFECT OF PROVISION

	Use of IRAs expanded significantly when eligibility was 
expanded in 1982 to all persons with earnings and contracted 
correspondingly in 1987 when deductibility was restricted for higher 
income taxpayers who were covered by an employer-provided pension. 
The number of taxpayers claiming a deductible IRA contribution jumped 
from 3.4 million in 1981 to 12.0 million in 1982 and peaked at 16.2 
million in 1985. In 1987, only 7.3 million taxpayers reported 
deductible contributions. Since then, the number generally has 
continued to fall (Table 13-8).
	Upper-income taxpayers facing higher marginal tax rates 
receive more benefit per dollar of IRA deduction than do low-income 
taxpayers facing lower marginal tax rates. When IRAs were available to 
all workers, the percentage of taxpayers contributing to an IRA was 
substantially higher among taxpayers with higher income. For example, 
in 1985, 13.6 percent of taxpayers with AGI between $10,000 and 
$30,000 contributed to an IRA compared with 74.1 percent of taxpayers 
with AGI between $75,000 and $100,000.
	The decline in IRA use between 1985 and 1990 among those with 
AGI between $10,000 and $30,000 appears to be larger than the 
reduction required by the change in law since the restrictions on 
deductible contributions apply only to a small fraction of taxpayers 
with AGI below $30,000.
	Before EGTRRA, eligibility percentages and the real value of 
the IRA contribution limits declined over time because prior law did 
not index the contribution limits or the income eligibility limits for 
inflation. For example, the real value of a $2,000 contribution 
declined more than 38 percent between 1986 and 2001 because of 
inflation.  Under EGTRRA, the IRA contribution limit increases to 
$5,000 in 2008 and is indexed for inflation (subject to the general 
EGTRRA sunset for years beginning after December 31, 2010).
	Congress established IRAs to allow workers not covered by 
employer pension plans to have tax-advantaged retirement saving. 
Nonetheless, since 1981 IRA participation rates have been higher 
among those covered by an employer-provided pension plan than those 
without one, and many of those who are not covered by a pension plan 
do not contribute to an IRA. In 1987, 10 percent of full-time 
private-sector earners without pension coverage contributed 
to an IRA, while 15 percent of those with coverage contributed 
(Woods, 1989, p. 9).

TABLE 13-8 -- USE OF DEDUCTIBLE IRAs, 1980-2000



[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]


EXCLUSION OF SOCIAL SECURITY AND RAILROAD RETIREMENT BENEFITS

LEGISLATIVE HISTORY

	The exclusion from gross income for Social Security benefits 
was not initially established by statute. Prior to the Social Security 
Amendments of 1983, the exclusion was based on a series of 
administrative rulings issued by the Internal Revenue Service in 1938 
and 1941. 
	Under the Social Security Amendments of 1983, a portion of 
the Social Security benefits paid to higher income taxpayers is 
included in gross income. In 1993, the Omnibus Budget Reconciliation 
Act increased the amount of benefits subject to tax and increased the 
rate of tax for some benefit recipients.
	The exclusion from gross income of benefits paid under the 
Railroad Retirement System was enacted in the Railroad Retirement Act 
of 1935. A portion of the benefits payable under the Railroad 
Retirement System (generally, tier 1 benefits) is equivalent to Social 
Security benefits. The tax treatment of tier 1 railroad retirement 
benefits was modified in the Social Security Amendments of 1983 to 
conform to the tax treatment of Social Security benefits. Other 
railroad retirement benefits are taxable in the same manner as 
employer-provided retirement benefits. The Consolidated Omnibus Budget 
Reconciliation Act of 1985 provided that tier 1 benefits are taxable 
in the same manner as Social Security benefits only to the extent that 
Social Security benefits otherwise would be payable. Other tier 1 
benefits are taxable in the same manner as all other railroad 
retirement benefits (for further details, see section 5).

EXPLANATION OF PROVISION

	For taxpayers whose modified AGI exceeds certain limits, a 
portion of Social Security and tier 1 railroad retirement benefits is 
included in taxable income. Modified AGI is AGI plus interest on tax-
exempt bonds plus 50 percent of Social Security and tier 1 railroad 
retirement benefits. A two-tier structure applies. The base tier is 
$25,000 for unmarried individuals and $32,000 for married couples 
filing joint returns, and zero for married persons filing separate 
returns who do not live apart at all times during the taxable year. 
The amount of benefits includable in income is the lesser of 
50 percent of the Social Security and tier 1 railroad retirement 
benefits or 50 percent of the excess of the taxpayer's combined income 
over the base amount.
	The second tier applies to taxpayers with modified AGI of at 
least $34,000 (unmarried taxpayers) or $44,000 (married taxpayers 
filing joint returns). For these taxpayers, the amount of benefits 
includable in gross income is the lesser of 85 percent of Social 
Security benefits or the sum of 85 percent of the amount by which 
modified AGI exceeds the second-tier thresholds, and the smaller of 
the amount included under prior law or $4,500 (unmarried taxpayers) 
or $6,000 (married taxpayers filing jointly). The portion of tier 1 
railroad retirement benefits potentially includable in taxable income 
under the above formula is the amount of benefits the taxpayer would 
have received if covered under Social Security. Pursuant to section 
72(r) of the Internal Revenue Code, all other benefits payable under 
the Railroad Retirement System are includable in income when received 
to the extent they exceed employee contributions.

EFFECT OF PROVISION

	Approximately one-third of all Social Security recipients pay 
taxes on their benefits. This percentage is likely to increase over 
time because the thresholds are not adjusted annually for past 
inflation or other factors.

EXCLUSION OF EMPLOYER CONTRIBUTIONS FOR MEDICAL INSURANCE PREMIUMS 
AND MEDICAL CARE

LEGISLATIVE HISTORY

	In 1943, the Internal Revenue Service (IRS) ruled that 
employer contributions to group health insurance policies were not 
taxable to the employee. Employer contributions to individual health 
insurance policies, however, were declared to be taxable income in 
an IRS revenue ruling in 1953.
	Section 106 of the Internal Revenue Code, enacted in 1954, 
reversed the 1953 IRS ruling. As a result, employer contributions to
all accident or health plans generally are excluded from gross income 
and therefore are not subject to tax. Under section 105 of the 
Internal Revenue Code, benefits received under an employer's accident 
or health plan generally are not included in the employee's income.
	In the Revenue Act of 1978, Congress added section 105(h) to 
tax the benefits payable to highly compensated employees under a 
self-insured medical reimbursement plan if the plan discriminated in 
favor of highly compensated employees.

EXPLANATION OF PROVISION

	Gross income of an employee generally excludes employer-
provided coverage under an accident or health plan. The exclusion 
applies to coverage provided to former employees, their spouses, or 
dependents. Amounts excluded include those received by an employee 
for personal injuries or sickness if the amounts are paid directly 
or indirectly to reimburse the employee for expenses incurred for
medical care. However, this exclusion does not apply in the case of 
amounts paid to a highly compensated individual under a self-insured 
medical reimbursement plan if the plan violates the nondiscrimination 
rules of section 105(h).
	Present law permits employers to prefund medical benefits for 
retirees. Postretirement medical benefits may be prefunded by the 
employer in two basic ways: (1) through a separate account in a 
tax-qualified pension plan (sec. 401(h)); or (2) through a welfare 
benefit fund (secs. 419 and 419A). Generally, the amounts contributed 
are excluded from the income of the plan or participants. Although 
amounts held in a section 401(h) account are accorded tax-favored 
treatment similar to assets held in a pension trust, the benefits 
provided under a section 401(h) account are required to be incidental 
to the retirement benefits provided by the plan. Amounts contributed 
to welfare benefit funds are subject to certain deduction limitations
(secs. 419 and 419A). In addition, the fund is subject to income tax 
relating to any set-aside to provide postretirement medical benefits.

EFFECT OF PROVISION

	The exclusion for employer-provided health coverage provides 
an incentive for compensation to be furnished to the employee in the 
form of health coverage, rather than in cash subject to current 
taxation. For example, an employer designing a compensation package 
for an employee would be indifferent between paying the employee one 
dollar in cash and purchasing one dollar's worth of health insurance 
for the employee. 3 On the other hand, because the employee is likely 
to pay Federal and State income taxes and payroll taxes on cash 
compensation and no tax on health insurance contributions made on his 
behalf, the employee would likely prefer that some compensation be in 
the form of health insurance. Employees subject to tax at the highest 
marginal tax rates have the greatest incentive to receive compensation 
in nontaxable forms.
	The tax preference that the exclusion provides is substantial 
and has resulted in widespread access to health coverage. A majority 
of the population now receives health insurance as a consequence of
their own employment or of a family member's employment. According to 
a special analysis of data from the Current Population Survey 
conducted by the Congressional Budget Office, nearly 75 percent of
all workers under age 65 were covered by employment-based health 
insurance. Slightly over 4 percent of the workers under age 65 
purchased insurance privately and nearly 3 percent received public 
insurance either through Medicare, Medicaid, or the Department of 
Veterans Affairs. The analysis reveals that slightly more than 18 
percent of the workers under age 65 had no health insurance, up from 
15 percent in 1996 (Committee, 1998, pp. 853-54).
	Health coverage through employer-based plans tends to be 
more prevalent in the finance, government, manufacturing, mining, 
professional service, transportation, and wholesale trade sectors 
of the economy; among medium and large firms; for more highly paid 
workers; and among those over age 30 (Table 13-9).

TAX CREDIT FOR HEALTH INSURANCE OF ELIGIBLE 
INDIVIDUALS

	The Trade Act of 2002 created a refundable tax credit equal 
to 65 percent of an eligible taxpayer's expenses for qualified health 
insurance of the taxpayer and qualifying family members for certain 
periods.  Eligible individuals include eligible TAA recipients, 
eligible alternative TAA recipients, and eligible PBGC pension 
recipients.  The credit is payable on an advanced basis.

MEDICAL SAVINGS ACCOUNTS

	The Health Insurance Portability and Accountability Act of 
1996 included provisions for medical savings accounts (MSAs), 
effective for years beginning after December 31, 1996. MSAs were 
renamed Archer MSAs by the Community Renewal Tax Relief Act of 2000 
(P.L. 106-554).  Within limits, contributions to an Archer MSA are 
deductible if made by an eligible individual and are excludable from 
income and employment taxes if made by the employer (other than 
contributions made through a cafeteria plan). Earnings on amounts in 
an Archer MSA are not currently taxable. Distributions from an Archer 
MSA for medical expenses are not includible in gross income. 
Distributions from an Archer MSA that are not for medical expenses 
are includible in gross income and are subject to an additional tax 
of 15 percent, unless the distribution is made after death, 
disability, or age 65.

TABLE 13-9--PRIMARY SOURCE OF HEALTH INSURANCE FOR WORKERS UNDER 
AGE 65, BY DEMOGRAPHIC CATEGORY, MARCH 2003





[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]



	Archer MSAs are available to employees covered under an 
employer-sponsored high deductible health plan of a small employer 
and to self-employed individuals covered under a high deductible 
health plan (regardless of the size of the entity for which the self-
employed individual performs services). A small employer is defined 
as an employer with 50 or fewer employees.
	In order to be eligible for an Archer MSA contribution, an 
otherwise eligible individual must be covered under a high deductible 
health plan and no other health plan. A high deductible health plan 
is a plan with an annual deductible of at least $1,500 and no more 
than $2,250 in the case of individual coverage (and at least $3,000 
and no more than $4,500 in the case of family coverage). The 
adjusted annual deductible amounts for tax years beginning in 2003 
are between $1,700 and $2,500 for individual coverage and between 
$3,350 and $5,050 for family coverage.  The dollar limits are 
indexed for inflation. High deductible plans must also meet certain 
limits on out-of-pocket expenses.
	The number of taxpayers benefiting annually from an Archer 
MSA contribution is limited to a threshold level (generally, 750,000 
taxpayers). If it is determined in a year that the threshold level 
has been exceeded (called a cutoff year), then, in general, for 
succeeding years during the pilot period 1997-2003, only those 
individuals who (1) made an MSA contribution or had an employer 
Archer MSA contribution for the year or a preceding year (i.e., 
are active Archer MSA participants) or (2) are employed by a 
participating employer, would be eligible for an MSA contribution. 
In determining whether the threshold for any year has been exceeded, 
Archer MSAs of previously uninsured individuals are not taken into 
account.
	After December 31, 2003, no new contributions may be made 
to Archer MSAs except by or on behalf of an individual who previously 
had Archer MSA contributions and employees who are employed by a 
participating employer. Self-employed individuals who made 
contributions to an Archer MSA during the period 1997-2003 also may 
continue to make contributions after 2003.

HEALTH SAVINGS ACCOUNTS

	The Medicare Prescription Drug, Improvement, and 
Modernization Act of 2003 (P.L. 108-173) added provisions for health 
savings accounts (HSAs), effective for taxable years beginning after 
December 31, 2003.  Within limits, contributions to an HSA made by 
or on behalf of an eligible individual are deductible by the 
individual. Contributions to an HSA are excludable from income and 
employment taxes if made by the employer.  Earnings on amounts in 
HSAs are not taxable.  Distributions from an HSA for qualified medical 
expenses are not includible in gross income. Distributions from an 
HSA that are not used for qualified medical expenses are includible 
in gross income and are subject to an additional tax of 10 percent, 
unless the distribution is made after death, disability, or the 
individual attains the age of Medicare eligibility (i.e., age 65).  
	Eligible individuals for HSAs are individuals who are covered 
by a high deductible health plan and no other health plan that is not 
a high deductible health plan.  A high deductible health plan is a 
health plan that has a deductible that is at least $1,000 for self-
only coverage or $2,000 for family coverage (indexed for inflation) 
and that has an out-of-pocket expense limit that is no more than 
5,000 in the case of self-only coverage and $10,000 in the case of 
family coverage.
	The maximum aggregate annual contribution that can be made to 
an HSA is the lesser of (1) 100 percent of the annual deductible 
under the high deductible health plan, or (2) the maximum deductible 
permitted under an Archer MSA high deductible health plan under 
present law, as adjusted for inflation.  For 2004, the amount of the 
maximum deductible under an Archer MSA high deductible health plan is 
$2,600 in the case of self-only coverage and $5,150 in the case of
family coverage.  The annual contribution limits are increased for 
individuals who have attained age 55 by the end of the taxable year.  
In the case of policyholders and covered spouses who are age 55 or 
older, the HSA annual contribution limit is greater than the 
otherwise applicable limit by $500 in 2004, $600 in 2005, $700 in 
2006, $800 in 2007, $900 in 2008, and $1,000 in 2009 and thereafter.

CAFETERIA PLANS

LEGISLATIVE HISTORY

	Under present law, compensation generally is includible in 
gross income when received. An exception applies if an employee may 
choose between cash and certain employer-provided nontaxable benefits 
under a cafeteria plan.
	Prior to 1978, ERISA provided that an employer contribution 
made before January 1, 1977, to a cafeteria plan in existence on 
June 27, 1974, had to be included in an employee's gross income only 
to the extent that the employee actually elected taxable benefits. If 
a plan did not exist on June 27, 1974, the employer contribution was 
to be included in income to the extent the employee could have elected 
taxable benefits. The Revenue Act of 1978 set up permanent rules for 
plans that offer an election between taxable and nontaxable benefits.
	The Deficit Reduction Act of 1984 (P.L. 98-369) clarified the 
types of employer-provided benefits that could be provided through a 
cafeteria plan, added a 25-percent concentration test, and required 
annual reporting to the IRS by employers.
	The Tax Reform Act of 1986 also modified the rules relating 
to cafeteria plans in several respects.



EXPLANATION OF PROVISION

	A participant in a cafeteria plan (sec. 125) is not treated 
as having received taxable income solely because the participant had 
the opportunity to elect to receive cash or certain nontaxable 
benefits. In order to meet the requirements of section 125, the plan 
must be in writing, must include only employees (including former 
employees) as participants, and must satisfy certain nondiscrimination 
requirements.

	In general, a nontaxable benefit may be provided through a 
cafeteria plan if the benefit is excludable from the participant's 
gross income by reason of a specific provision of the Code. These 
include employer-provided health coverage, group-term life insurance 
coverage, and benefits under dependent care assistance programs. A 
cafeteria plan may not provide qualified scholarships or tuition 
reduction, educational assistance, miscellaneous employer-provided 
fringe benefits, or deferred compensation except through a qualified 
cash or deferred arrangement.
	If the plan discriminates in favor of highly compensated 
individuals regarding eligibility to participate, to make 
contributions, or to receive benefits under the plan, then the 
exclusion does not apply to such individuals. For purposes of these 
nondiscrimination requirements, a highly compensated individual is an 
officer, a shareholder owning more than 5 percent of the employing 
firm, a highly compensated individual determined under the facts and 
circumstances of the case, or a spouse or dependent of the above 
individuals.

EFFECT OF PROVISION

	The optimal compensation of employees (in a tax planning 
sense) would require that employers and employees arrive at the 
compensation package that provides the largest after-tax benefit 
to the employee at minimum after-tax cost to the employer (see 
Scholes & Wolfson, 1992, chapter 10). Both the potential taxation 
of compensation provided to employees and the deductibility of 
compensation provided by the employer would be considered. If only 
income taxes were considered, employers would be indifferent between 
the payment of $1 in salary or wages and the payment of $1 in fringe 
benefits to an employee, because both types of compensation are 
fully deductible. When the employer payments for FICA and Federal 
Unemployment Tax Act (FUTA) taxes are considered, however, the 
employer might actually find it less costly to compensate an 
employee with a dollar's worth of fringe benefit not subject to FICA 
and FUTA taxes rather than a dollar of wage or salary payments that 
are subject to these taxes.
	The employee, however, would prefer to be compensated in the 
form that provides the highest after-tax value. An additional dollar 
of salary or wage paid to the employee will be subject to tax. If a 
fringe benefit is excludable from the employee's income, the employee 
pays no tax on receipt of the benefit. Consequently, the employee 
receives greater compensation via the fringe benefit. This 
differential treatment of salary or wage payments and excludable 
fringe benefits implies that compensation packages designed to 
minimize the joint tax liability of employers and employees could 
include substantial amounts of excludable fringe benefits.
	Employees may have different preferences about the allocation 
of their compensation. For example, an employee with no dependents may 
place little value on employer provided life insurance. Cafeteria 
plans permit employees some discretion as to the provided benefits, 
and will tend to be preferred to benefit plans in which all employees 
of the firm receive the identical benefit package.
	Cafeteria plans are a growing part of compensation plans, 
particularly for larger employers. The Bureau of Labor Statistics 
estimated that in 1997, 52 percent of employees at large- and medium-
sized firms were eligible for some type of cafeteria plan. This 
figure has grown from an estimated 5 percent in 1986 (U.S. Bureau of 
Labor Statistics, 1993). Smaller firms generally do not offer 
cafeteria plans to their workers. For example, in 1996, only 
23 percent of the workers in small, private establishments (nonfarm 
establishments with fewer than 100 employees) were eligible to 
participate in a cafeteria plan (U.S. Bureau of Labor Statistics, 
1996). The lower figure for smaller firms reflects in part the 
less generous fringe benefit packages provided by smaller firms.
	Like any income exclusion, the exclusion from gross income 
for cafeteria plan benefits can lead to disparities in the tax 
system. Employees with the same total compensation can have taxable 
incomes that are substantially different because of the form in which 
compensation is received. The exclusion for cafeteria plan benefits 
also may be used in some cases to avoid the 7.5 percent of AGI floor 
on deductible medical expenses. The use of cafeteria plans reduces 
the aftertax cost of health care to employees using these plans, which 
could cause these employees to purchase a larger amount of health 
care services. On the other hand, cafeteria plans could encourage 
employers to increase the share of premiums, copayments, and 
deductibles paid by employees, resulting in increased employee 
awareness of the costs of their health plans. This incentive could 
result in reduced health care costs.

HEALTH CARE CONTINUATION RULES

LEGISLATIVE HISTORY

	The Consolidated Omnibus Budget Reconciliation Act of 1985 
added sections 106(b), 162(i)(2), and 162(k) to the Internal Revenue 
Code under which certain group health plans are required to offer 
health coverage to certain employees and former employees, as well 
as to their spouses and dependents. Parallel requirements were added 
to title I of ERISA and the Public Health Services Act. If an 
employer failed to satisfy the health care continuation rules, the 
employer was denied a deduction for contributions to its group health 
plans and highly compensated employees were required to include in 
taxable income the employer-provided value of the coverage received 
under such plans.
	The Technical and Miscellaneous Revenue Act of 1988 made 
several changes to the health care continuation rules. Sections 
106(b), 162(i)(2), and 162(k) were repealed and replaced by section 
4980B. Section 4980B imposes an excise tax on the employer or other 
responsible party who fails to satisfy the rules instead of denying 
deductions and the exclusion. The Health Insurance Portability and 
Accountability Act of 1996 made some changes to the health care 
continuation rules in cases of disability.

EXPLANATION OF PROVISION

	The health care continuation rules in section 4980B require 
that an employer provide qualified beneficiaries with the opportunity 
to participate for a specified period in the employer's health plan 
after that participation otherwise would have terminated. If the 
employee elects such continuation coverage, the employee may be 
required to pay for the coverage. The amount the employee can be 
required to pay is subject to certain limits.
	The qualifying events that may trigger rights to continuation 
coverage are: (1) the death of the employee; (2) the voluntary or 
involuntary termination of the employee's employment (other than by 
reason of gross misconduct); (3) a reduction of the employee's hours; 
(4) the divorce or legal separation of the employee; (5) the employee 
becoming entitled to benefits under Medicare; and (6) a dependent 
child of the employee ceasing to be a dependent under the employer's 
plan. The maximum period of continuation coverage is 36 months, 
except in the case of termination of employment or reduction of hours 
for which the maximum period is 18 months. The 18-month period is 
extended to 29 months in certain cases involving the disability of 
the qualified beneficiary. Certain events, such as the failure by the 
qualified beneficiary to pay the required premium, may trigger an 
earlier cessation of the continuation coverage.
	A beneficiary has a prescribed period of time during which to 
elect continuation coverage after the employee receives notice from 
the plan administrator of the right to continuation coverage.

GROUP HEALTH PLAN REQUIREMENTS

	The Health Insurance Portability and Accountability Act of 
1996 imposes certain requirements regarding health coverage 
portability through limitations on preexisting condition exclusions, 
prohibitions on excluding individuals from coverage based on health 
status, and guaranteed renewability of health insurance coverage. An 
excise tax is imposed with respect to failures of a group health 
plan to comply with the requirements. The tax is usually imposed on 
the employer sponsoring the plan. The amount of the tax is generally 
equal to $100 per day for each day during which the failure occurs 
until the failure is corrected. The maximum tax that can be imposed 
is the lesser of 10 percent of the employer's payments during the 
taxable year in which the failure occurred under group health plans 
or $500,000. The Secretary of the Treasury may waive all or part of 
the tax to the extent that payment of the tax would be excessive 
relative to the failure involved (see discussion of health care 
continuation rules).

TAX BENEFITS FOR ACCELERATED DEATH BENEFITS AND LONG-TERM CARE 
INSURANCE

LEGISLATIVE HISTORY

Accelerated Death Benefits
	If a contract meets the definition of a life insurance 
contract, gross income does not include insurance proceeds that are 
paid pursuant to the contract by reason of the death of the insured 
(sec. 101(a)). In addition, the undistributed investment income 
(inside buildup) earned on premiums credited under the contract is 
not subject to current taxation to the owner of the contract. The 
exclusion under section 101 applies regardless of whether the 
death benefits are paid as a lump sum or otherwise.
	If a contract fails to be treated as a life insurance 
contract under section 7702(a), inside buildup on the contract is 
generally subject to tax (sec. 7702(g)).
	To qualify as a life insurance contract for Federal income 
tax purposes, a contract must be a life insurance contract under 
the applicable State or foreign law and must satisfy either of two 
alternative tests: (1) a cash value accumulation test, or (2) a 
test consisting of a guideline premium requirement and a cash value 
corridor requirement (sec. 7702(a)). A contract satisfies the cash 
value accumulation test if the cash surrender value of the contract 
may not at any time exceed the net single premium that would have 
to be paid at such time to fund future benefits under the contract. 
A contract satisfies the guideline premium and cash value corridor 
tests if the premiums paid under the contract do not at any time 
exceed the greater of the guideline single premium or the sum of the 
guideline level premiums, and if the death benefit under the 
contract is not less than a varying statutory percentage of the cash 
surrender value of the contract.

Long-Term Care Insurance
	Prior to the Health Insurance Portability and Accountability 
Act of 1996, tax law generally did not provide explicit rules 
relating to the tax treatment of long-term care insurance contracts 
or long-term care services. Thus, the treatment of long-term care 
contracts and services was unclear. Prior and present law provide 
rules relating to medical expenses and accident or health insurance.  
Amounts received by a taxpayer under accident or health insurance for 
personal injuries or sickness generally are excluded from gross 
income to the extent that the amounts received are not attributable 
to medical expenses that were allowed as a deduction for a prior 
taxable year (sec. 104).

EXPLANATION OF PROVISION

Accelerated Death Benefits
	The Health Insurance Portability and Accountability Act of 
1996 provides an exclusion from gross income as an amount paid by 
reason of the death of an insured for amounts received under a life 
insurance contract and for amounts received for the sale or 
assignment of a life insurance contract to a qualified viatical 
settlement provider, provided that the insured under the life 
insurance contract is either terminally ill or chronically ill.
	The exclusion does not apply in the case of an amount paid to 
any taxpayer other than the insured, if such taxpayer has an 
insurable interest by reason of the insured being a director, 
officer, or employee of the taxpayer, or by reason of the insured 
being financially interested in any trade or business carried on by 
the taxpayer.
	A terminally ill individual is defined as one who has been 
certified by a physician as having an illness or physical condition 
that reasonably can be expected to result in death within 24 months 
of the date of certification.
	A chronically ill individual has the same meaning as provided 
under the long-term care rules (see below). In the case of a 
chronically ill individual, the exclusion with respect to amounts 
paid under a life insurance contract and amounts paid in a sale or 
assignment to a viatical settlement provider applies if the payment 
received is for costs incurred by the payee (not compensated by 
insurance or otherwise) for qualified long-term care services for 
the insured person for the period, and two other requirements 
(similar to requirements applicable to long-term care insurance 
contracts) are met.
	The first requirement is that under the terms of the contract 
giving rise to the payment, the payment is not a payment or 
reimbursement of expenses reimbursable under Medicare (except where
Medicare is a secondary payor under the arrangement, or the 
arrangement provides for per diem or other periodic payments without 
regard to expenses for qualified long-term care services). No 
provision of law shall be construed or applied so as to prohibit the 
offering of such a contract giving rise to such a payment on the basis 
that the contract coordinates its payments with those provided under 
Medicare. The second requirement is that the arrangement complies 
with the consumer protection provisions applicable to long-term 
care insurance contracts and issuers that are specified in 
Treasury regulations.

Long-Term Care Insurance
	Exclusion of Long-Term Care Insurance Proceeds-The Health 
Insurance Portability and Accountability Act of 1996 provides that a 
long-term care insurance contract generally is treated as an accident 
and health insurance contract. Amounts (other than policyholder 
dividends or premium refunds) received under a long-term care 
insurance contract generally are excludable as amounts received for 
personal injuries and sickness, subject to a dollar cap on aggregate 
payments under per diem contracts. A reporting requirement applies 
to payors of excludable amounts.
	The amount of the dollar cap on aggregate payments under per 
diem contracts with respect to any one chronically ill individual 
(who is not also terminally ill) is $220 per day for calendar year 
2003 ($80,520 annually) as indexed,4 reduced by the amount of 
reimbursements and payments received by anyone for the cost of
qualified long-term care services for the chronically ill individual. 
If more than one payee receives payments with respect to any one 
chronically ill individual, then everyone receiving periodic payments 
with respect to the same insured is treated as one person for purposes 
of the dollar cap. The amount of the dollar cap is used first by the 
chronically ill person, and any remaining amount is to be allocated 
in accordance with Treasury regulations. If payments under such 
contracts exceed the dollar cap, then the excess is excludable only 
to the extent of actual costs (in excess of the dollar cap) incurred 
for long-term care services. Amounts in excess of the dollar cap, with
respect to which no actual costs were incurred for long-term care 
services, are fully includible in income without regard to rules 
relating to return of basis under section 72. A grandfather rule 
applies to any per diem-type contract issued to a policyholder on 
or before July 31, 1996.
	Exclusion for Employer-Provided Long-Term Care Coverage-A plan 
of an employer providing coverage under a long-term care insurance 
contract generally is treated as an accident and health plan. Thus,
employer-provided long-term care coverage is generally excludable from 
income and wages and deductible by the employer. Employer-provided 
coverage under a long-term care insurance contract is not, however, 
excludable by an employee if provided through a cafeteria plan; 
similarly, expenses for long-term care services cannot be reimbursed 
under a flexible spending arrangement.
	Definition of Long-Term Care Insurance Contract-A long-term 
care insurance contract is defined as any insurance contract that 
provides only coverage of qualified long-term care services and that 
meets other requirements. The other requirements are that: (1) the 
contract is guaranteed renewable; (2) the contract does not provide 
for a cash surrender value or other money that can be paid, assigned, 
pledged or borrowed; (3) refunds (other than refunds on the death of 
the insured or complete surrender or cancellation of the contract) 
and dividends under the contract may be used only to reduce future 
premiums or increase future benefits; and (4) the contract generally 
does not pay or reimburse expenses reimbursable under Medicare 
(except where Medicare is a secondary payor, or the contract makes 
per diem or other periodic payments without regard to expenses).
	A contract does not fail to be treated as a long-term care 
insurance contract solely because it provides for payments on a per 
diem or other periodic basis without regard to expenses incurred 
during the period.
	Medicare Duplication Rules-No provision of law may be 
applied to prohibit the offering of a long-term care insurance 
contract on the basis that the contract coordinates its benefits 
with those provided under Medicare.
	Definition of Qualified Long-Term Care Services-Qualified 
long-term care services means necessary diagnostic, preventive, 
therapeutic, curing, treating, mitigating and rehabilitative 
services, and maintenance or personal care services that are 
required by a chronically ill individual and that are provided 
pursuant to a plan of care prescribed by a licensed health care 
practitioner.
	Chronically Ill Individual-A chronically ill individual 
is one who has been certified within the previous 12 months by a 
licensed health care practitioner as: (1) being unable to perform 
(without substantial assistance) at least two activities of daily 
living for at least 90 days due to a loss of functional capacity; 
(2) having a similar level of disability as determined by the 
Secretary of the Treasury in consultation with the Secretary of 
Health and Human Services; or (3) requiring substantial 
supervision to protect such individual from threats to health 
and safety due to severe cognitive impairment. Activities of daily 
living are eating, toileting, transferring, bathing, dressing and 
continence. For purposes of determining whether an individual is 
chronically ill, the number of activities of daily living that are 
taken into account under the long-term care insurance contract may 
not be less than five.
	Expenses for Long-Term Care Services Treated as Medical 
Expenses-Unreimbursed expenses for qualified long-term care services 
provided to the taxpayer or the taxpayer's spouse or dependents are 
treated as medical expenses for purposes of the itemized deduction 
for medical expenses (subject to the present-law floor of 7.5 percent 
of AGI). For this purpose, amounts received under a long-term care 
insurance contract (regardless of whether the contract reimburses 
expenses or pays benefits on a per diem or other periodic basis) are 
treated as reimbursement for expenses actually incurred for medical 
care.
	For purposes of the deduction for medical expenses, qualified 
long-term care services do not include services provided to an 
individual by a relative or spouse (directly, or through a 
partnership, corporation, or other entity), unless the relative is a 
licensed professional with respect to such services, or by a 
related corporation (within the meaning of Code section 267(b) or 
707(b)).
	Long-Term Care Insurance Premiums Treated as Medical 
Expenses-Long-term care insurance premiums that do not exceed 
specified dollar limits are treated as medical expenses for purposes 
of the itemized deduction for medical expenses.
	Consumer Protection Provisions-Certain consumer protection 
provisions apply with respect to the terms of a long-term care 
insurance contract, for purposes of determining whether the contract 
is a qualified long-term care insurance contract. In addition, certain 
consumer protection provisions apply to issuers of long-term care 
insurance contracts.

DEDUCTION FOR HEALTH INSURANCE EXPENSES OF SELF-EMPLOYED INDIVIDUALS

	Self-employed individuals may currently deduct 100 percent of
their health insurance expenses for themselves and their spouses and 
dependents. The deduction also applies to certain long-term care 
premiums treated as medical expenses. 

EXCLUSION OF MEDICARE BENEFITS

LEGISLATIVE HISTORY

	The exclusion from income of Medicare benefits has never been 
expressly established by statute. A 1970 IRS ruling, Rev. Rul. 70-341, 
1970-2 C.B. 31, provided that the benefits under part A of Medicare 
are not includible in gross income because they are disbursements 
made to further the social welfare objectives of the Federal 
Government. The Internal Revenue Service relied on a similar ruling, 
Rev. Rul. 70-217, 1970-1 C.B. 13, with respect to the excludability of 
Social Security disability insurance benefits in reaching this 
conclusion. (For background on the exclusion of Social Security 
benefits, see above section on pension contributions.) Rev. Rul. 
70-341 also held that benefits under part B of Medicare are excludable 
as amounts received through accident and health insurance (though the 
subsidized portion of part B also may be excluded under the same 
theory applicable to the exclusion of part A benefits).

EXPLANATION OF PROVISION

	Benefits under part A and part B of Medicare are excludable 
from the gross income of the recipient. In general, part A pays for 
certain inpatient hospital care, skilled nursing facility care, home 
health care, and hospice care for eligible individuals (generally the 
elderly and the disabled). Part B covers certain services of a 
physician and other medical services for elderly or disabled 
individuals who elect to pay the required premium.

DEDUCTIBILITY OF MEDICAL EXPENSES

LEGISLATIVE HISTORY

	An itemized deduction for unreimbursed medical expenses above 
a specified floor has been allowed since 1942. From 1954 through 1982, 
the floor under the medical expense deduction was 3 percent of the 
taxpayer's adjusted gross income (AGI); a separate floor of 1 percent
of AGI applied to expenditures for medicine and drugs.
	In the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), 
the floor was increased to 5 percent of AGI (effective for 1983 and 
thereafter) and was applied to the total of all eligible medical 
expenses, including prescription drugs and insulin. TEFRA made 
nonprescription drugs ineligible for the deduction and eliminated the 
separate floor for drug costs.
	The Tax Reform Act of 1986 increased the floor under the 
medical expense deduction to 7.5 percent of AGI, beginning in 1987.

EXPLANATION OF PROVISION

	Individuals who itemize deductions may deduct amounts they pay 
during the taxable year, if not reimbursed by insurance or otherwise,
for medical care of the taxpayer and of the taxpayer's spouse and 
dependents, to the extent that the total of such expenses exceeds 
7.5 percent of AGI (sec. 213).
	Medical care expenses eligible include: (1) health insurance 
(including after-tax employee contributions to employer health plans); 
(2) diagnosis, treatment, or prevention of disease, or for the purpose 
of affecting any structure or function of the body; (3) transportation 
primarily for and essential to medical care; (4) lodging away from
home primarily for and essential to medical care, up to $50 per night; 
and (5) prescription drugs and insulin.
	Expenses paid for the general improvement of health, such as 
fees for exercise programs, are not eligible for the deduction unless 
prescribed by a physician to treat a specific illness. A deduction is
not allowed for cosmetic surgery or similar procedures that do not 
meaningfully promote the proper function of the body or treat disease. 
However, such expenses are deductible if the cosmetic procedure is 
necessary to correct a deformity arising from a congenital abnormality, 
an injury resulting from an accident, or disfiguring 
disease.
	Medical expenses are not subject to the general limitation on 
itemized deductions applicable to taxpayers with AGIs above a certain 
limit ($139,500 for 2003, and adjusted annually for inflation.

EFFECT OF PROVISION

	The Tax Code allows taxpayers to claim an itemized deduction 
if unreimbursed medical expenses absorb a substantial portion of 
income and thus adversely affect the taxpayer's ability to pay taxes. 
In order to limit the deduction to extraordinary expenses, medical 
expenses are deductible only to the extent that they exceed 7.5 
percent of the taxpayer's AGI.
	Table 13-10 shows the effect on medical expense deductions 
of the increases in the floor on medical deductions. In the absence 
of those increases, one would have expected the number of taxpayers 
claiming the deduction to have increased because of inflation of 
medical costs. However, increasing the floor should reduce the number 
of taxpayers claiming the deduction because many taxpayers with 
relatively modest expenses no longer qualify. Taxpayers in higher 
tax rate brackets receive more of a benefit from each dollar of 
deductible medical expense than do taxpayers in lower tax rate 
brackets. However, because the floor automatically rises with a 
taxpayer's income, higher income taxpayers are able to deduct a 
smaller amount (if any) of medical expenses above their floor than 
are low-income taxpayers incurring the same aggregate amount of 
medical expenses (Table 13-11).

TABLE 13-10 -- TAX RETURNS CLAIMING DEDUCTIBLE MEDICAL AND DENTAL 
EXPENSES, 1980-2000


[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]


TABLE 13-11 -- DISTRIBUTION OF ITEMIZED DEDUCTIONS FOR MEDICAL 
EXPENSES, 2003


[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]


EARNED INCOME CREDIT

LEGISLATIVE HISTORY

	The earned income credit (EIC; Code sec. 32), enacted in 1975, 
generally equals a specified percentage of wages up to a maximum 
dollar amount.  The maximum amount applies over a certain income 
range and then diminishes to zero over a certain income range. The 
income ranges and percentages have been revised several times since 
original enactment, expanding the credit (Table 13-12).  
	In 1987, the credit was indexed for inflation.  In 1990 and 
again in 1993, Congress enacted substantial expansions of the credit.  
Auxiliary credits were added for very young children and for health 
insurance premiums paid on behalf of a qualifying child in 1990.  
They were repealed in 1993.  Also, in 1993, eligibility for the 
credit was expanded to include childless workers.  The Personal 
Responsibility and Work Opportunity Reconciliation Act of 1996 
incorporated new rules relating to taxpayer identification numbers 
and modified AGI phase-out of the credit in addition to amending the 
credit's unearned income test (described below).  
	The Taxpayer Relief Act of 1997 also included provisions to 
improve compliance. The provisions: (1) deny the EIC for 10 years to 
taxpayers who fraudulently claimed the EIC, 2 years for EIC claims 
which are a result of reckless or intentional disregard of rules or 
regulations); (2) require EIC recertification for a taxpayer who is 
denied the EIC; (3) imposes due diligence requirements on paid 
preparers of returns involving the EIC; (4) requires information 
sharing between the Treasury Department and State and local 
governments regarding child support orders; and (5) allows expanded 
use of Social Security Administration records to enforce the tax 
laws, including the EIC. The Balanced Budget Act of 1997 also 
increased the IRS authorization to improve enforcement of the EIC.
	EGTRRA made several changes to the EIC to provide marriage 
penalty relief and promote simplification, including: (1) increasing 
the beginning and ending amounts of the phase out ranges by $1,000 
(for 2002-2004), $2,000 (for 2005-2007), and $3,000 (in 2007, indexed 
thereafter) for married taxpayers who file a joint return; (2) 
excluding nontaxable employee compensation from the definition of 
earned income; (3) repealing the reduction of the EIC by the  amount 
of an individual's alternative minimum tax; (4) eliminating the need 
to calculate modified adjusted gross income for EIC purposes; (5) 
expanding the relationship test for purposes of qualifying child, 
and eliminating the requirement that certain individuals have the 
same principal place of abode as the taxpayer for the entire year; 
(6) simplifying the tie-breaker rule that applies if multiple 
taxpayers claim the same qualifiying child; and  (7) effective 
January 1, 2004, with respect to noncustodial parents, expanding 
the math error authority of the Internal Revenue Service based on 
the Federal Case Registry of Child Support Orders.

EXPLANATION OF PROVISION

	The EIC is available to low-income working taxpayers. Three 
separate schedules apply.
	Taxpayers with one qualifying child may claim a credit in 
2003 of  34 percent of their earnings up to $7,490, resulting in a 
maximum credit of $2,547.  The maximum credit is available for those 
with earnings between $7,490 and $13,730 ($14,730 if married filing 
jointly).  The credit begins to phase down at a rate of 15.98 percent 
of earnings above $13,730 ($14,730 if married filing jointly). The 
credit is phased down to $0 at $33,692 of earnings ($34,692 if 
married filing jointly).
	Taxpayers with more than one qualifying child may claim a 
credit in 2003 of 40 percent of earnings up to $10,510, resulting in 
a maximum credit of $4,204.  The maximum credit is available for 
those with earnings between $10,510 and $13,730 ($14,720 if married 
filing jointly).  The credit begins to phase down at a rate of 21.06 
percent of earnings above $13,730 ($14,730 if married filing jointly).  
The credit is phased down to $0 at $33,692 of earnings ($34,692 if 
married filing jointly).
	Taxpayers with no qualifying children may claim a credit if 
they are over age 24 and below age 65.  The credit is 7.65 percent of 
earnings up to $4,990, resulting in a maximum credit of $382. The 
maximum credit is available for those with incomes between $4,990 and 
$6,240 ($7,240 if married filing jointly).  The credit begins to 
phase down at a rate of 7.65 percent of earnings above $6,240 ($7,240 
if married filing jointly) resulting in a $0 credit at $11,230 of 
earnings ($12,230 if married filing jointly).
	All income thresholds are indexed for inflation annually.  
In order to be a qualifying child, an individual must satisfy a 
relationship test, a residency test, and an age test. The relationship 
test requires that the individual be (1) a child, stepchild, or 
descendant of a child or of a sibling or stepsibling.  The residency 
test requires that the individual have the same place of abode as the 
taxpayer for more than half the taxable year.  The households must be 
located in the United States.  The age test requires that the 
individual be under 19 (24 for a full time student) or be permanently 
and totally disabled.


TABLE 13-12 -- EARNED INCOME CREDIT PARAMETERS, 1975-2003


[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]



	An individual is not eligible for the EIC if the aggregate 
amount of disqualified income of the taxpayer for the taxable year 
exceeds $2,600 (for 2003). This threshold is indexed. Disqualified 
income is the sum of:	
1.	Interest (taxable and tax exempt),
2.	Dividends,
3.	Net rent and royalty income (if greater than zero),
4.	Capital gains net income, and
5.	Net passive income (if greater than zero) that is not
self-employment income.
	For taxpayers with earned income (or AGI, if greater) in 
excess of the beginning of the phaseout range, the maximum EIC amount 
is reduced by the phaseout rate multiplied by the amount of earned 
income (or AGI, if greater) in excess of the beginning of the 
phaseout range. For taxpayers with earned income (or AGI, if greater) 
in excess of the end of the phaseout range, no credit is allowed.
	Individuals are ineligible for the credit if they do not 
include their taxpayer identification number and their qualifying 
child's number (and, if married, their spouse's taxpayer 
identification number) on their tax return. Solely for these purposes 
and for purposes of the present-law identification test for a 
qualifying child, a taxpayer identification number is defined as a 
Social Security number issued to an individual by the Social Security 
Administration other than a number issued under section 205(c)(2)(B)
(i)(II) (or that portion of sec. 205(c)(2)(B)(i)(III) relating to it) 
of the Social Security Act regarding the issuance of a number to an 
individual applying for or receiving federally funded benefits.
	If an individual fails to provide a correct taxpayer 
identification number, such omission will be treated as a mathematical 
or clerical error by the Internal Revenue Service. Similarly, if an 
individual who claims the credit with respect to net earnings from 
self-employment fails to pay the proper amount of self-employment tax 
on such net earnings, the failure will be treated as a mathematical 
or clerical error for purposes of the amount of credit allowed.
	The EIC is relatively unique because it is a refundable tax 
credit; i.e., if the amount of the credit exceeds the taxpayer's 
Federal income tax liability, the excess is payable to the taxpayer 
as a direct transfer payment. In this sense, the EIC is like other 
Federal programs that provide poor and low-income families with 
public benefits. However, the EIC differs from other Federal programs 
in that its benefits require earnings.
	Under an advance payment system, available since 1979, 
eligible taxpayers may elect to receive the credit in their 
paychecks, rather than waiting to claim a refund on their tax return 
filed by April 15 of the following year. In 1993, Congress required 
that the IRS begin to notify eligible taxpayers of the advance 
payment option.
	
	
	INTERACTION WITH MEANS-TESTED PROGRAMS
	
	The treatment of the EIC for purposes of Aid to Families with 
Dependent Children (AFDC) and food stamp benefit computations has 
varied since inception of the credit. When enacted in 1975, the 
credit was not considered income in determining AFDC and food stamp 
benefits, and the credit could not be received on an advance basis. 
From January 1979 through September 1981, the credit was treated as 
earned income when actually received.
	From October 1981 to September 1984, the amount of the 
credit was treated as earned income and was imputed to the family 
even though it may not have been received as an advance payment. 
Pursuant to the Deficit Reduction Act of 1984, the credit was treated 
as earned income only when received, either as an advance payment or 
as a refund after the conclusion of the year.
	Under the Family Support Act of 1988, States generally were 
required to disregard any advance payment or refund of the EIC when 
calculating AFDC eligibility or benefits. However, the credit was 
counted against the gross income eligibility standard (185 percent 
of the State need standard) for both applicants and recipients.
	OBRA 1990 specified that, effective January 1, 1991, the EIC 
was not to be taken into account as income (for the month in which 
the payment is received or any following month) or as a resource (for 
the month in which the payment is received or the following month) for 
determining the eligibility or amount of benefit for AFDC, Medicaid, 
SSI, food stamps, or low-income housing programs.
	
	EFFECT OF PROVISION
	
	More than 19.2 million taxpayers are expected to take advantage 
of the EIC for 2003 (Table 13-13). Their claims are expected to total 
$34 billion, approximately 90 percent of which will be refunded as 
direct payments to these families (Table 13-14). As Table 13-13 also 
shows, approximately 75 percent of the tax relief or direct spending 
from the EIC accrues to taxpayers who file as singles or heads of 
households.
	Table 13-14 shows the total amount of EIC received for each 
of the calendar years since the inception of the program, the number 
of recipient families, the amount of the credit received as refunded 
payments, and the average amount of credit received per family.


	
TABLE 13-13 -- DISTRIBUTION OF EARNED INCOME CREDIT, 2003



[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]


			
TABLE 13-14 -- EARNED INCOME CREDIT: NUMBER OF RECIPIENTS 
AND AMOUNT OF CREDIT, 1975-2003

[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]


	
	EXCLUSION OF PUBLIC ASSISTANCE AND SSI BENEFITS
	
	LEGISLATIVE HISTORY
	
	While there is no specific statutory authorization, a number 
of revenue rulings under Code section 61 have held that specific 
types of public assistance payments are excludable from gross income. 
Revenue rulings generally exclude government transfer payments from 
income because they are considered to be general welfare payments. 
In addition, taxing benefits provided in kind, rather than in cash, 
would require valuation of these benefits, which could create 
administrative difficulties.
	
	EXPLANATION OF PROVISION
	
	The Federal Government provides tax-free public assistance 
benefits to individuals either by cash payments or by provision of 
certain goods and services at reduced cost or free of charge. Cash 
payments come mainly from the AFDC and Supplemental Security Income 
(SSI) Programs. Inkind payments include food stamps, Medicaid, and 
housing assistance. None of these payments is subject to income tax.
	
	DEPENDENT CARE TAX CREDIT
	
	LEGISLATIVE HISTORY
	
	Under section 21 of the Internal Revenue Code, taxpayers are 
allowed an income tax credit for certain employment-related expenses 
for dependent care. The Internal Revenue Code of 1954 provided a 
deduction to gainfully employed women, widowers, and legally separated 
or divorced men for certain employment-related dependent care expenses. 
The deduction was limited to $600 per year and phased out for families 
with incomes between $4,500 and $5,100.
	The Revenue Act of 1964 made husbands with incapacitated wives 
eligible for the dependent care deduction and raised the threshold for 
the income phaseout from $4,500 to $6,000.
	The Revenue Act of 1971: (1) made any individual who maintained 
a household and was gainfully employed eligible for the deduction; (2) 
modified the definition of a dependent; (3) raised the deduction limit 
to $4,800 per year; (4) increased from $6,000 to $18,000 the income 
level at which the deduction began to phase out; (5) allowed the 
deduction for household services in addition to direct dependent care; 
and (6) limited the deduction with respect to services outside the 
taxpayer's household.
	The Tax Reduction Act of 1975 increased from $18,000 to 
$35,000 the income level at which the deduction began to be phased 
out.
	The Tax Reform Act of 1976 replaced the deduction with a 
nonrefundable credit. This change broadened eligibility to those who 
do not itemize deductions and provided relatively greater benefit to 
low-income taxpayers. In addition, the act eased the rules related to 
family status and simplified the computation.	
	In the Economic Recovery Tax Act of 1981, Congress provided 
a higher ceiling on creditable expenses, a larger credit for low-
income individuals, and modified rules relating to care provided 
outside the home.
	The Family Support Act of 1988 reduced to 13 the age of a 
child for whom the dependent care credit may be claimed, reduced the 
amount of eligible expenses by the amount of expenses excludable from 
that taxpayer's income under the dependent care exclusion, lowered 
from five to two the age at which a taxpayer identification number 
had to be submitted for children for whom the credit was claimed, 
and disallowed the credit unless the taxpayer reports on her tax 
return the correct name, address, and taxpayer identification number 
(generally, an employer identification number or a Social Security 
number) of the dependent care provider.
	The Small Business Job Protection Act of 1996 required a 
TIN for all children for whom a dependent care credit may be claimed.
	EGTRRA increased the credit rate for lower-income taxpayers, 
as well as the maximum eligible expense amount for the credit for all 
taxpayers.
	
	EXPLANATION OF PROVISION
	
	A taxpayer may claim a nonrefundable credit against income 
tax liability for up to 35 percent of a limited amount of employment-
related dependent care expenses. Eligible employment-related expenses 
are limited to $3,000 if there is one qualifying dependent or $6,000 
if there are two or more qualifying dependents. Generally, a 
qualifying individual is a dependent under the age of 13 or a 
physically or mentally incapacitated dependent or spouse.
	Employment-related dependent care expenses are expenses for 
the care of a qualifying individual incurred to enable the taxpayer 
to be gainfully employed, other than expenses incurred for an 
overnight camp. For example, amounts paid for the services of a 
housekeeper generally qualify if such services are performed at 
least partly for the benefit of a qualifying individual; amounts paid 
for a chauffeur or gardener do not qualify.
	Expenses that may be taken into account in computing the 
credit generally may not exceed an individual's earned income or, in 
the case of married taxpayers, the earned income of the spouse with 
the lesser earnings. Thus, if one spouse is not working, no credit 
generally is allowed. Also, the amount of expenses eligible for the 
dependent care credit is reduced, dollar for dollar, by the amount 
of expenses excludable from that taxpayer's income under the 
dependent care exclusion (discussed below).
	The 35-percent credit rate is reduced, but not below 20 
percent, by 1 percentage point for each $2,000 (or fraction thereof) 
of AGI above $15,000. Because married couples are required to file a 
joint return to claim the credit, a married couple's combined AGI 
is used for purposes of this computation.
	
	EFFECT OF PROVISION
	
	From 1976 to 2001, the number of families that claimed the 
dependent care credit increased from 2.7 to a projected 6.3 million, 
the aggregate amount of credits claimed increased from $0.5 to $2.7 
billion, and the average amount of credit claimed per family 
increased from $206 to $440 (table 13-15). 	
	Changes made in the Family Support Act of 1988 reduced the 
use of the credit in 1989. The number of families who claimed the 
credit dropped by about one-third and the amount of credit claimed 
declined by $1.373 billion.
	Data for 1997 from the Internal Revenue Service show that 
about 10 percent of the benefit from the credit accrues to families 
with AGI of less than $20,000; about 42 percent to families with AGI 
between $20,000 and $50,000; and about 48 percent to families with 
AGI above $50,000.
	
TABLE 13-15 -- DEPENDENT CARE TAX CREDIT: NUMBER OF FAMILIES AND
AMOUNT OF CREDIT, 1976-2001


[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]


	
	HOPE CREDIT AND LIFETIME LEARNING CREDIT
	
	The Taxpayer Relief Act of 1997 established the HOPE credit 
and the lifetime learning credit as nonrefundable credits against 
Federal income tax liability for qualified tuition and fees required 
for the attendance of an eligible student at an eligible educational 
institution.
	The HOPE credit rate is 100 percent of the first $1,000 of 
qualified tuition and fees per eligible student per year, and 
50 percent of the next $1,000 of qualified tuition and fees per 
eligible student per year. The HOPE credit is available only for the 
first two years of postsecondary education. The qualified tuition and 
fees must be incurred on behalf of the taxpayer, the taxpayer's 
spouse, or a dependent. Charges and fees associated with meals, 
lodging, books, student activities, athletics, insurance, 
transportation, and similar personal, living, or family expenses are 
not eligible for the credit. An eligible student for purposes of the 
HOPE credit is a student enrolled in a degree, certificate, or other 
program on at least a half-time basis. Eligible educational 
institutions are defined by reference to section 481 of the Higher 
Education Act of 1965. Such institutions generally are accredited 
postsecondary educational institutions offering credit toward a 
bachelor's degree, an associate's degree, or another recognized 
postsecondary credential. Certain proprietary institutions and 
postsecondary vocational institutions are also eligible educational 
institutions. The $1,500 maximum HOPE credit amount is indexed for 
inflation.
	The lifetime learning credit rate is 20 percent of up to 
$10,000 in qualified tuition and fees for a maximum credit of $2,000. 
In contrast to the HOPE credit, the lifetime learning credit is 
available for an unlimited number of years of education. Also in 
contrast to the HOPE credit, which requires a half-time or greater 
enrollment status, the lifetime learning credit is available with 
respect to any course of instruction at an eligible educational 
institution to acquire or improve job skills, regardless of 
enrollment status. Qualified tuition and fees are defined in the 
same manner as under the HOPE credit provisions. As with the HOPE 
credit, eligible students are the taxpayer, the taxpayer's spouse, 
or a dependent. In contrast to the HOPE credit, the maximum amount of 
the lifetime learning credit that may be claimed on a taxpayer's 
return will not vary with the number of students in the taxpayer's 
family. The maximum lifetime learning credit amount is not indexed 
for inflation.
	Eligibility for the HOPE credit and the lifetime learning 
credit is phased out ratably for taxpayers with modified adjusted 
gross income (AGI) between $41,000 and $51,000 ($83,000 and $103,000 
for joint returns).  These phase-outs are indexed for inflation.  
For a taxable year, a taxpayer may elect with respect to an eligible 
student either the HOPE credit, the lifetime learning credit, or the 
deduction for qualified tuition and related expenses. For purposes 
of both the HOPE credit and the lifetime learning credit, if a 
parent claims a child as a dependent, then only the parent may 
claim the credit.
	
	QUALIFIED TUITION PROGRAMS AND COVERDELL EDUCATION 
SAVINGS ACCOUNTS
	
	The Taxpayer Relief Act of 1997 and EGTRRA modified 
section 529 of the Tax Code, which governs the tax treatment of 
qualified tuition programs. Section 529 was enacted as part of the 
Small Business Job Protection Act of 1996, and provided tax-exempt 
status and deferral of tax on earnings of qualified State tuition 
programs. The Taxpayer Relief Act of 1997 also provided that taxpayers 
may establish education IRAs.  (Renamed Coverdell Education Savings 
Accounts by P.L. 107-22).  EGTRRA extended the provisions to programs 
established by eligible education institutions.
	Qualified State tuition programs are programs established 
and maintained by a State or agency or instrumentality thereof or by 
one or more eligible educational institutions under which persons 
may: (1) purchase tuition credits or certificates on behalf of a 
designated beneficiary that entitle the beneficiary to a waiver or 
payment of qualified higher education expenses of the beneficiary; 
or (2) in the case of a program established by a State agency or 
instrumentality thereof make contributions to an account that is 
established for the purpose of meeting qualified higher education 
expenses of a designated beneficiary. Qualified higher education 
expenses are defined as tuition, fees, books, supplies, and equipment 
required for the enrollment of or attendance at a college or 
university (or certain vocational schools). The Taxpayer Relief Act 
of 1997 expanded the definition of qualified expenses to include 
room and board expenses. Contributions to qualified tuition programs 
are not deductible. EGTRRA provided that earnings on qualified 
tuition programs are not includible in income if used for qualified
expenses. Distributions from a qualified tuition program also 
entitle the distributee to claim either the HOPE or the lifetime 
learning credit with respect to education expenses paid with such 
distributions, assuming the other requirements for claiming the HOPE 
credit or the lifetime learning credit are satisfied. There are no 
income limits for participation in qualified tuition programs, 
though contributions must be limited by the program to amounts no 
greater than an amount necessary to provide for the education of 
the beneficiary. Withdrawals of earnings that are not used for 
qualified expenses are includible in income and also are subject 
to an additional 10 percent tax.
	A Coverdell Education Savings Account is a trust or custodial 
account created exclusively for the purpose of paying qualified 
higher education expenses of a named beneficiary. Contributions to 
a Coverdell Education Savings Account are not deductible; earnings 
on contributions are not currently includable in income. Contributions 
to a Coverdell education savings account are limited to $2,000 per 
year per beneficiary.  The contribution limit is phased out ratably 
for contributions with modified AGI between $95,000 and $110,000 
($190,000 and $220,000 for joint returns).  With respect to post-
secondary education, qualified expenses are the same as those for 
qualified tuition programs.  Qualified expenses also include 
elementary and secondary education expenses.  Qualified elementary 
and secondary education expenses include tuition, fees, academic 
tutoring, special needs services, books, supplies, room and board, 
and education-related computer equipment and software. Withdrawals 
of earnings from education IRAs are excludable from income provided 
that such withdrawals are used to pay for qualified higher education 
expenses. If the earnings are not used for qualified expenses, they 
are includable in income and are also subject to an additional 
10-percent penalty tax. 
	
	STUDENT LOAN INTEREST DEDUCTION
	
	The Taxpayer Relief Act of 1997 provided for the above-the-
line deductibility of interest on qualified education loans.  A 
qualified education loan is generally defined as any indebtedness 
incurred to pay for the qualified higher education expenses of the 
taxpayer, the taxpayer's spouse, or any dependent of the taxpayer as 
of the time the indebtedness was incurred in attending either 
postsecondary educational institutions and certain vocational schools 
defined by reference to section 481 of the Higher Education Act of 
1965, or institutions conducting internship or residency programs 
leading to a degree or certificate from an institution of higher 
education, a hospital, or a health care facility conducting 
postgraduate training. Qualified higher education expenses are 
defined as the student's cost of attendance as defined in section 
472 of the Higher Education Act of 1965 (generally, tuition, fees, 
room and board, and related expenses), reduced by: (1) any amount 
excluded under section 135 (i.e., U.S. saving bonds used to pay 
higher education tuition and fees); (2) any amount distributed from 
a Coverdell education savings account or qualified tuition program 
and excluded from gross income; and (3) the amount of any scholarship 
or fellowship grants excludable from gross income under section 117, 
as well as any other tax-free education benefits, such as employer-
provided educational assistance that is excludable from the 
employee's gross income under section 127.
	The maximum deduction is $2,500 and is not indexed for 
inflation.  This deduction is phased out ratably for individuals 
with modified AGI of $50,000-$65,000 ($100,000 and $130,000 for 
joint returns).  These income ranges are indexed for inflation and 
rounded down to the closest multiple of $5,000.
	
	QUALIFIED TUITION DEDUCTION
	
The Economic Growth and Tax Relief Reconciliation Act of 2001 added 
an above-the-line deduction for qualified tuition and related expenses 
paid by the taxpayer during a taxable year.  Qualified expenses are 
defined in the same manner as for the purposes of the HOPE credit.

In 2002 and 2003, taxpayers with adjusted gross income that does not 
exceed $65,000 ($130,000 in the case of married couples filing joint 
returns) are entitled to a maximum deduction of $3,000 per year.  
Taxpayers with adjusted gross income above these thresholds would 
not be entitled to a deduction.  In 2004 and 2005, taxpayers with 
adjusted gross income that does not exceed $65,000 ($130,000 in the 
case of married taxpayers filing joint returns) are entitled to a 
maximum deduction of $4,000 and taxpayers with adjusted gross income 
that does not exceed $80,000 ($160,000 in the case of married 
taxpayers filing joint returns) are entitled to a maximum deduction 
of $2,000. The deduction is not available in 2006 and thereafter.

Taxpayers are not eligible to claim the deduction and a HOPE or 
Lifetime Learning Credit in the same year with respect to the same
student.  A taxpayer may not claim a deduction for amounts taken 
into account in determining the amount excludable due to a 
distribution (i.e., the earnings and contribution portion of a 
distribution) from a Coverdell education savings account or the 
amount of interest excludable with respect to education savings 
bonds.  A taxpayer may not claim a deduction for the amount of a 
distribution from a qualified tuition program that is excludable 
from income; however, a taxpayer may claim a deduction for the
amount of a distribution from a qualified tuition program that is 
not attributable to earnings.
	
	EXCLUSION FOR EMPLOYER-PROVIDED DEPENDENT CARE
	
	LEGISLATIVE HISTORY
	
	The value of certain employer-provided dependent care is 
excluded from the employee's gross income. The Economic Recovery 
Tax Act of 1981 added this exclusion (sec. 129) and amended Code 
sections 3121(a)(18) and 3306(b)(13) to exclude such employer-
provided dependent care from wages for purposes of the Federal 
Insurance Contributions Act (FICA) and the Federal Unemployment 
Tax Act (FUTA). The Tax Reform Act of 1986 modified the 
nondiscrimination rules and limited the exclusion to $5,000 a 
year ($2,500 in the case of a separate  return by a married 
individual). The Family Support Act of 1988 required the amount 
of employer-provided dependent care excluded from the taxpayer's 
income to reduce, dollar for dollar, the amount of expenses eligible 
for the dependent care tax credit.
	
	EXPLANATION OF PROVISION
	
	Amounts paid or incurred by an employer for dependent care 
assistance provided to an employee generally are excluded from the 
employee's gross income if the assistance is furnished under a 
program meeting certain requirements. These requirements include 
that the program be described in writing, satisfy certain 
nondiscrimination rules, and provide for notification to all 
eligible employees. The type of dependent care eligible for the 
exclusion is the same as the type eligible for the dependent 
care credit.
	
	The dependent care exclusion is limited to $5,000 per year 
except that a married taxpayer filing a separate return may exclude 
only $2,500. Amounts excluded from gross income generally are 
excludable from wages for employment tax purposes. Dependent care 
expenses excluded from income are not eligible for the dependent 
care tax credit.
	
	EFFECT OF PROVISION
	
	The exclusion provides an incentive to taxpayers with 
expenses for dependent care to seek compensation in the form of 
dependent care assistance rather than in cash subject to taxation. 
This incentive is of greater value to employees in higher tax 
brackets.
	Many employees covered by the exclusion for employer-
provided dependent care also are eligible to use the dependent care 
tax credit. While the limitations on the exclusion and the credit 
differ, the credit generally is less valuable than the exclusion 
for taxpayers who are above the 15-percent tax bracket.
	According to a survey of private firms with 100 or more 
workers conducted by the U.S. Bureau of Labor Statistics (1993), 
nearly one-tenth of full-time workers at these firms were eligible 
for child care benefits provided by the employer in the form of 
on-site or near-site child care facilities or through direct 
reimbursement of employee expenses. A more prevalent form of 
providing dependent care benefits is through reimbursement accounts, 
which may cover other nontaxable fringe benefits, such as out-of-
pocket health care expenses, in addition to dependent care. Slightly 
over one-third of full-time employees at large- and medium-sized 
firms were eligible for such accounts in 1991.
	
	WORK OPPORTUNITY TAX CREDIT
	
	The work opportunity tax credit is available on an elective 
basis for employers hiring individuals from one or more of eight 
targeted groups. The targeted groups are: (1) families eligible to 
receive benefits under the Title IV-A Temporary Assistance for Needy 
Families Program (TANF; the successor to AFDC); (2) qualified 
ex-felons; (3) vocational rehabilitation referrals; (4) qualified 
summer youth employees; (5) qualified veterans; (6) youths who 
reside in an empowerment zone or enterprise community; (7) families 
receiving food stamps; and (8) persons receiving certain Supplemental 
Security Income (SSI) benefits.
	The credit generally is equal to 40 percent (25 percent for 
employment of 400 hours or less) of qualified wages. Qualified wages 
consist of wages attributable to service rendered by a member of a 
targeted group during the  1-year period beginning with the day the 
individual begins work for the employer. For a vocational 
rehabilitation referral, however, the period will begin on the day 
the individual begins work for the employer on or after the beginning 
of the individual's vocational rehabilitation plan as under prior 
law.
	Generally, no more than $6,000 of wages during the first 
year of employment is permitted to be taken into account with 
respect to any individual.
	Thus, the maximum credit per individual is $2,400. With 
respect to qualified summer youth employees, the maximum credit is 
40 percent of up to $3,000 of qualified first-year wages, for a 
maximum credit of $1,200.
	In general, an individual is not to be treated as a member 
of a targeted group unless: (1) on or before the day the individual
begins work for the employer, the employer received in writing a 
certification from the designated local agency that the individual 
is a member of a specific targeted group; or  (2) on or before the 
day the individual is offered work with the employer, a prescreening 
notice is completed with respect to that individual by the employer 
and within 21 days after the individual begins work for the employer, 
the employer submits such notice, signed by the employer and the 
individual under penalties of perjury, to the designated local agency 
as part of a written request for certification. The prescreening 
notice will contain the information provided to the employer by the 
individual that forms the basis of the employer's belief that the 
individual is a member of a targeted group.
	 No credit is allowed for wages paid unless the eligible 
individual is employed by the employer for at least 120 hours. The 
credit percentage is 25 percent for employment of 400 hours or less, 
assuming that the minimum employment period is satisfied with respect 
to that employee. For employment of more than 400 hours, the credit 
percentage is 40 percent.
	The credit is effective for wages paid or incurred to a 
qualified individual who begins work for an employer after September 
30, 1996, and before January 1, 2004.
	
	WELFARE-TO-WORK TAX CREDIT
	
	The Code provides to employers a tax credit on the first 
$20,000 of eligible wages paid to qualified long-term family 
assistance (TANF) recipients during the first 2 years of employment. 
The credit is 35 percent of the first $10,000 of eligible wages in 
the first year of employment and 50 percent of the first $10,000 of 
eligible wages in the second year of employment. The maximum credit 
is $8,500 per qualified employee.
	Qualified long-term family assistance recipients are: (1) 
members of a family that has received TANF benefits for at least 18 
consecutive months ending on the hiring date; (2) members of a family 
that has received TANF benefits for a total of at least 18 months 
(whether or not consecutive) after the date of enactment of this 
credit if they are hired within two years after the date that the 
18-month total is reached; and (3) members of a family who are no 
longer eligible for TANF because of either Federal or State time 
limits, if they are hired within two years after the Federal or State 
time limits made the family ineligible for family assistance.
	Eligible wages include cash wages paid to an employee plus 
amounts paid by the employer for the following: (1) educational 
assistance excludable under a section 127 program (or that would be 
excludable but for the expiration of sec. 127); (2) health plan 
coverage for the employee, but not more than the applicable premium 
defined under section 4980B(f)(4); and (3) dependent care assistance 
excludable under section 129.
	The welfare to work credit is effective for wages paid or 
incurred to a qualified individual who begins work for an employer 
on or after  January 1, 1998, and before January 1, 2004.
	
	EXCLUSION OF WORKERS' COMPENSATION AND SPECIAL 
BENEFITS FOR DISABLED COAL MINERS
	
	LEGISLATIVE HISTORY
	
	Workers' compensation benefits generally are not taxable under 
section 104(a)(1) of the Internal Revenue Code. Workers' compensation 
benefits are treated as Social Security benefits to the extent that 
they reduce Social Security benefits received (see above). This 
exclusion from gross income was first codified in the Revenue Act of 
1918. The Ways and Means Committee report for that act suggests that
such payments were not subject to tax even prior to the 1918 act.
	Payments made to coal miners or their survivors for death or 
disability resulting from pneumoconiosis (black lung disease) under 
the Federal Coal Mine Health and Safety Act of 1969 (as amended) are 
excluded from gross income. Payments made as a result of claims filed 
before December 31, 1972, originally were excluded from Federal income 
tax by the Federal Coal Mine Health and Safety Act of 1969. Later 
payments are excluded from gross income because they are considered 
to be in the nature of workers' compensation 
(Rev. Rul. 72-400, 1972-2 C.B. 75).
	
	EXPLANATION OF PROVISION
	
		
	Gross income does not include amounts received as workers' 
compensation for personal injuries or sickness. This exclusion also 
applies to benefits paid under a workers' compensation act to a 
survivor of a deceased employee.
	Benefits for disabled coal miners (black lung benefits) are
not includable in gross income.
	There are two types of black lung programs. The first 
involves Federal payments to coal miners and their survivors due to
death or disability, payable for claims filed before July 1, 1973 
(December 31, 1973, in the case of survivors). This program provided
total annual payments of around $672 million to approximately 
143,000 beneficiaries in December 1995 (Social Security 
Administration, 1996).
	The second program requires coal mine operators to ensure 
payment of black lung benefits for claims filed on or after July 1, 
1973 (December 31, 1973, in the case of survivors) in a federally 
mandated workers' compensation program. Benefits include medical 
treatment as well as cash payments. These benefits are paid from a 
trust fund financed by an excise tax on coal production if there is 
no responsible operator (an operator for whom the miner worked for at 
least 1 year) or if the responsible operator is in default. This 
program provided total annual payments of around $610 million to 
approximately 156,550 claimants in 1986 (U.S. Department of Labor, 
1989, tables 3 & 6).
	
	ADDITIONAL STANDARD DEDUCTION FOR THE ELDERLY AND BLIND
	
	LEGISLATIVE HISTORY
	
	From 1954 through 1986, an additional personal exemption was 
allowed for a taxpayer or a spouse who was 65 years or older at the 
close of the year. An additional personal exemption also was allowed 
for a taxpayer or a spouse who was blind.
	The Tax Reform Act of 1986 repealed the additional personal 
exemption for the elderly and blind and replaced it with an additional
standard deduction amount. These additional standard deduction amounts 
are adjusted for inflation.

	EXPLANATION OF PROVISION
	
	The additional standard deduction amount for the elderly or 
the blind is $950 in 2003 for an elderly or a blind individual who is 
married (whether filing jointly or separately) or is a surviving 
spouse, and $1,900 for such an individual who is both elderly and 
blind. The additional amount is $1,150 for a head of household who is 
elderly or blind ($2,300, if both), and for a single individual (i.e., 
an unmarried individual other than a surviving spouse or head of 
household) who is elderly or blind.
	The definitions of elderly and blind status have not been 
changed since 1954. An elderly person is an individual who is at least 
65 years of age. Blindness is defined in terms of the ability to 
correct a deficiency in distance vision or the breadth of the area of 
vision. An individual is blind only if central vision acuity is not 
better than 20/200 in the better eye with correcting lenses, or if 
visual acuity is better than 20/200 but is accompanied by a limitation 
in the fields of vision such that the widest diameter of the visual 
field subtends an angle no greater than 20 degrees.
	
	EFFECT OF PROVISION
	
	In 2000, approximately 11.3 million taxpayers claimed the extra 
standard deduction.  About 76 percent of the 11.3 million beneficiaries 
had incomes of less than $40,000.
		
	
	
	
	TAX CREDIT FOR THE ELDERLY AND CERTAIN DISABLED 
INDIVIDUALS
	
	LEGISLATIVE HISTORY
	
	The present tax credit for individuals who are age 65 or 
older, or who have retired on permanent and total disability, was 
enacted in the Social Security amendments of 1983 (Code sec. 22). This 
credit replaced the previous credit for the elderly, which had been 
enacted in the Tax Reform Act of 1976. Prior to that provision, the 
tax law provided a retirement income credit, which initially was 
enacted in the Internal Revenue Code of 1954.
	
	EXPLANATION OF PROVISION
	
	Individuals who are age 65 or older may claim a nonrefundable 
income tax credit equal to 15 percent of a base amount. The credit 
also is available to an individual, regardless of age, who is retired 
on disability and who was permanently and totally disabled at 
retirement. For this purpose, an individual is considered permanently 
and totally disabled if he is unable to engage in any substantial 
gainful activity by reason of any medically determinable physical or 
mental impairment that can be expected to result in death, or that 
has lasted or can be expected to last for a continuous period of not 
less than 12 months. The individual must furnish proof of disability 
to the IRS.
	The maximum base amount for the credit is $5,000 for 
unmarried elderly or disabled individuals and for married couples 
filing a joint return if only one spouse is eligible; $7,500 for 
married couples filing a joint return with both spouses eligible; 
or $3,750 for married couples filing separate returns. For a 
nonelderly, disabled individual the initial base amount is the 
lesser of the applicable specified amount or the individual's 
disability income for the year. Consequently, the maximum credit 
available is $750 (15 percent of $5,000), 
$1,125 (15 percent of $7,500), or $562.50 (15 percent of $3,750).
	The maximum base amount is reduced by the amount of certain 
nontaxable income of the taxpayer, such as nontaxable pension and 
annuity income or nontaxable Social Security, railroad retirement, 
or veterans' nonservice-related disability benefits. In addition, 
the base amount is reduced by one-half of the taxpayer's AGI in 
excess of certain limits: $7,500 for a single individual, $10,000 
for married taxpayers filing a joint return, or $5,000 for married 
taxpayers filing separate returns. These computational rules reflect 
that the credit is designed to provide tax benefits to individuals 
who receive only taxable retirement or disability income, or who 
receive a combination of taxable retirement or disability income 
plus Social Security benefits that generally are comparable to the 
tax benefits provided to individuals who receive only Social 
Security benefits (including Social Security disability benefits).
	
	
	EFFECT OF PROVISION
		
	In 2000, $33 million in elderly and disabled credit was 
claimed. Though the number of families claiming the credit has fallen 
significantly, the average credit granted has been relatively stable 
since the credit was modified by the Social Security Amendments of 
1983, as shown in Table 13-16.
	
TABLE 13-16 -- CREDIT FOR THE ELDERLY AND DISABLED 1976-2000



[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]

	
	TAX PROVISIONS RELATED TO HOUSING
	
	OWNER-OCCUPIED HOUSING
	
Legislative History
	Deductibility of Mortgage Interest-Prior to the Tax Reform 
Act of 1986, all interest payments on indebtedness incurred for 
personal use (e.g., to purchase consumption goods) were deductible in 
computing taxable income. The 1986 act amended section 163(h) of the 
Internal Revenue Code to disallow deductions for all personal interest 
except for interest on indebtedness secured by a first or second home.
	In the Omnibus Budget Reconciliation Act of 1987, Congress 
further restricted the deductibility of mortgage interest. Only two 
classes of interest were distinguished as deductible: interest on 
acquisition indebtedness and interest on home equity indebtedness. 
Acquisition indebtedness, defined as indebtedness secured by a 
residence and used to acquire or improve the residence by which it is 
secured, was limited to $1,000,000 ($500,000 in the case of a married 
individual filing a separate return). Home equity indebtedness, 
defined as any nonacquisition indebtedness secured by a residence 
(for example, a home equity loan), was limited to the lesser of 
$100,000 ($50,000 for married taxpayers filing separately) or the 
excess of the fair market value of the residence over the 
acquisition indebtedness.
	Exclusion of Capital Gains for Certain Taxpayers.-In the 
Revenue Act of 1964, Congress introduced section 121 of the Internal 
Revenue Code of 1954, which permitted a one-time exclusion of all or 
part of the gain on the sale of a principal residence by older 
individuals. This exclusion was limited to homeowners who had lived 
in the property as a principal residence for five out of the last 
eight years before the property's sale or exchange. Furthermore, full 
exclusion was permitted only for houses that sold for $20,000 or less.
	The parameters of this exclusion have been modified and 
expanded a number of times. Most recently, the Taxpayer Relief Act of 
1997 significantly expanded the exclusion by repealing the age 55 
requirements and one-time applicability, and increasing the maximum 
excludible amount.
	
Explanation of Provision
	Homeowners may deduct a number of expenses related to housing 
as itemized deductions in computing taxable income. These include 
payments of interest on qualified residence debt, certain interest 
on home equity loans, certain payments of points (i.e., up front 
interest payments) on the purchase of a house, and payments of real 
property taxes. Interest on acquisition debt of $1,000,000 or less 
is fully deductible, as is any interest on debt secured by a residence 
that was incurred on or before October 13, 1987. Interest on home 
equity indebtedness of $100,000 is fully deductible for regular tax 
purposes, as long as the total amount of debt (acquisition plus home 
equity indebtedness) does not exceed the fair market value of the 
house. Interest on home equity indebtedness exceeding $100,000 (and 
incurred after October 13, 1987) or exceeding the difference between 
the fair market value of the home and the acquisition indebtedness is 
not deductible. Interest paid on home equity loans is generally not 
deductible in computing the alternative minimum tax.
	Under present law, a taxpayer generally is able to exclude up 
to $250,000 ($500,000 if married filing a joint return) of gain 
realized on the sale or exchange of a principal residence. The 
exclusion is allowed each time a taxpayer selling or exchanging a 
principal residence meets the eligibility requirements, but generally 
no more frequently than once every two years.
	To be eligible for the exclusion, a taxpayer must have owned 
the residence and occupied it as a principal residence for at least 
two of the five years prior to the sale or exchange. A taxpayer who 
fails to meet these requirements by reason of a change of place of 
employment, health, or other unforeseen circumstances is able to 
exclude the fraction of the $250,000 ($500,000 if married filing a 
joint return) equal to the fraction of two years that these 
requirements are met.
	
Effects of Provision
	Preliminary tax return information for 2000 indicates that 
35 million taxpayers claimed the deduction for mortgage interest. 
Reliable data are not yet available on how many claimed the one-
time exclusion.
	The favorable treatment of owner-occupied housing may 
affect both the home ownership rate and the share of total investment 
in housing in the United States.	
	The home ownership tax provisions may benefit neighborhoods 
because they encourage home ownership and home improvement. The 
United States has maintained a high rate of home ownership-66 
percent of all American households own the homes they live in (U.S. 
Census Bureau, 1999, p. 729, table 1212).
	The tax advantages for owner-occupied housing encourage 
people to invest in homes instead of taxable business investments. 
This shift may reduce investment in business assets in the United 
States. One study suggested that housing capital is 25 percent higher 
and other capital is 12 percent lower than it would be if tax policy 
provided equal treatment for all forms of capital (Mills, 1987). 
Currently, about one-third of net private investment goes into owner-
occupied housing, so even a modest shift of investment to other 
assets could have sizable effects.
	
	LOW-INCOME HOUSING CREDIT
	
Legislative History
	The low-income rental housing tax credit was first enacted 
in the Tax Reform Act of 1986. The Omnibus Budget Reconciliation Act 
of 1989 substantially modified the credit. The Omnibus Budget 
Reconciliation Act of 1993 modified the credit again and made it 
permanent.  The Community Renewal Tax Relief Act of 2000 increased 
and indexed the annual amount of allocable credits.
	
Explanation of Provision
	A tax credit may be claimed by owners of residential rental 
property used for low-income rental housing. The credit is claimed 
annually, generally for a period of 10 years. New construction and 
rehabilitation expenditures for low-income housing projects are 
eligible for a maximum 70-percent present value credit, claimed 
annually for 10 years. The acquisition cost of existing projects 
that meet the substantial rehabilitation requirements and the cost 
of newly constructed projects receiving other Federal subsidies 
are eligible for a maximum 30-percent present value credit, also 
claimed annually for 10 years. These credit percentages are adjusted 
monthly based on an Applicable Federal Rate.
	The credit amount is based on the qualified basis of the 
housing units serving the low-income tenants. A residential rental 
project will qualify for the credit only if: (1) 20 percent or more 
of the aggregate residential rental units in the project are 
occupied by individuals with 50 percent or less of area median 
income; or (2) 40 percent or more of the aggregate residential rental 
units in the project are occupied by individuals with 60 percent or 
less of area median income. These income figures are adjusted for 
family size. Maximum rents that may be charged families in units on 
which a credit is claimed depend on the number of bedrooms in the 
unit. The rent limitation is 30 percent of the qualifying income of a 
family deemed to have a size of 1.5 persons per bedroom (e.g., a two-
bedroom unit has a rent limitation based on the qualifying income for 
a family of three).
	Credit eligibility also depends on the existence of a 30-year 
extended low-income use agreement for the property. If property on 
which a low-income housing credit is claimed ceases to qualify as 
low-income rental housing or is disposed of before the end of a 
15-year credit compliance period, a portion of the credit may be 
recaptured. The 30-year extended use agreement creates a State law 
right to enforce low-income use for an additional 15 years after the 
initial 15-year recapture period.
	In order for a building to be a qualified low-income building, 
the building owner generally must receive a credit allocation from the 
appropriate credit authority. An exception is provided for property 
that is substantially financed with the proceeds of tax-exempt bonds 
subject to the State's private-activity bond volume limitation. The 
low-income housing credit is allocated by State or local government 
authorities subject to an annual limitation for each State based on 
State population. The annual credit allocation per State for 2003 is 
$1.75 per resident or $2.03 million in total, if larger.
	
Effect of Provision
	Comprehensive data from tax returns concerning the low-
income housing tax credit are unavailable. Table 13-17 presents data 
from a survey of State credit allocating agencies. These data indicate 
that annual allocation of available credit authority generally has 
been 90 percent or greater since 1994. Year-to-year variations in 
credit allocation probably reflect changes in Federal law affecting 
the credit and changing economic conditions affecting the construction 
and housing markets. For example, 1990 was the first year following 
substantial modification to the credit and included a temporary 
period during which State credit allocating agencies were limited 
to allocating authority of $0.9375 per capita rather than the 
$1.25 per capita of present and prior law.
	An allocation percentage of less than 100 percent does not 
imply that some credits available for allocation to low-income 
housing projects go unused. Since 1990, States are permitted to carry 
forward unused credit subsequently made available for allocation by 
other States. Thus, the amount allocated in any one year could be 
less than the States' authority, but such authority may ultimately 
be allocated.
	
TABLE 13-17 -- ALLOCATION OF THE LOW-INCOME HOUSING CREDIT, 1987-2000



[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]



	
	TAX CREDIT AND EXCLUSION FOR ADOPTION EXPENSES
	
The Small Business Job Protection Act of 1996 (Public Law 104-188) 
enacted two tax provisions designed to reduce economic barriers to 
adoption. First, a tax credit of up to $5,000 (or $6,000 in the case 
of families adopting special-needs children from the United States) 
was created to help defray one-time adoption expenses (Code 
section 23).  The credit was phased out for families with incomes 
above $75,000, and was unavailable to families with incomes above 
$115,000.  Second, employees could receive an income tax exclusion of 
up to $5,000 per child (or $6,000 in the case of special-needs 
children) for employer-provided adoption assistance (Code 
section 137).  Under the Act, the credit (other than for foreign 
special-needs adoptions) and the exclusion were not available after 
December 31, 2001.
	EGTRRA and the Job Creation and Worker's Assistance Act of 
2002 ("JCWAA") made several changes to these provisions.  EGTRRA, 
as clarified by JCWWA: (1) made permanent the adoption credit and 
exclusion for employer-provided assistance; (2) increased the maximum 
credit and exclusion amounts to $10,000; (3) provided that the 
maximum credit and exclusion amounts for special-needs adoption 
expenses are available regardless of whether the taxpayer has 
qualified adoption expenses (effective after 2002); and (4) increased 
the beginning and end points of the income phase out ranges to 
$150,000 and $190,000, respectively, for both the credit and the 
exclusion.  EGTTRA also provided that the dollar limits and the 
income limitations of the credit and the exclusion are adjusted for 
inflation in taxable years beginning after December 31, 2002. For 
2003, the maximum credit and exclusion amounts are $10,160 and the 
beginning and end points of the income phase out ranges are $152,390 
and $192,390, respectively.
	
	CHILD TAX CREDIT
	
	The Taxpayer Relief Act of 1997 provided for a $500 ($400 for 
taxable year 1998) tax credit for each qualifying child under the age 
of 17. A qualifying child is defined as an individual for whom the 
taxpayer can claim a dependency exemption and who is a son or 
daughter of the taxpayer (or a descendant of either), a stepson or 
stepdaughter of the taxpayer, or an eligible foster child of the 
taxpayer. For taxpayers with modified AGI in excess of certain 
thresholds, the allowable child credit is phased out.
	EGTRRA increased the child credit on a phased in basis, 
reaching  $1,000 in 2011, and provided for limited refundability of 
the credit.  JCWAA accelerated this increase in the credit to $1,000, 
effective for 2003 and 2004, and expanded the refundability of the 
credit.
	The child credit is refundable to the extent of 10 percent 
of the taxpayer's earned income in excess of $10,500 (indexed for 
inflation) in 2003.  This percentage is increased to 15 percent for
calendar year 2005 and thereafter. Families with three or more 
children are allowed a refundable credit for the amount by which the 
taxpayer's Social Security taxes exceed the taxpayer's earned income 
credit, if that amount is greater than the refundable credit based 
on the taxpayer's earned income in excess of $10,500.
	For taxpayers with modified AGI in excess of certain 
thresholds, the child credit is phased out. The phase out rate is $50 
for each $1,000 of modified AGI (or fraction thereof) in excess of the 
threshold. For these purposes modified AGI is computed by increasing 
the taxpayer's AGI by the amount otherwise excluded under Code 
sections 911, 931, and 933 (relating to the exclusion of income of 
U.S. citizens or residents living abroad; residents of Guam, American 
Samoa, and the Northern Mariana Islands; and residents of Puerto Rico, 
respectively).  
	For married taxpayers filing joint returns, the threshold is 
$110,000. For taxpayers filing single or head of household returns, 
the threshold is $75,000. For married taxpayers filing separate 
returns, the threshold is $55,000. These thresholds are not indexed 
for inflation.
	
	EFFECT OF TAX PROVISIONS ON THE INCOME AND TAXES OF 
THE ELDERLY AND THE POOR
	
	Tables 13-18 and 13-19 present actual and projected values of 
the personal exemptions, standard deductions, additional standard 
deductions for the elderly and the blind, and taxable income brackets 
for 1996-2013. The figures for 2004-13 are based on Congressional 
Budget Office projections. The value to taxpayers of personal 
exemptions, standard deductions, and additional standard deductions 
for the elderly and the blind (with the exception of joint filers 
after 2010) will grow steadily over the 10-year period.
	
	HYPOTHETICAL TAX CALCULATIONS FOR SELECTED FAMILIES
	
	Table 13-20 presents examples of tax liabilities for 
hypothetical taxpayers. The table presents 2003 Federal income and 
payroll tax burdens. The worker is assumed to bear both the employer 
and employee shares of FICA tax (7.65 percent for each). Taxpayers 
claim the EIC, if eligible, and they claim the standard deduction, 
except where noted in the footnotes. Income sources are listed in the 
table's footnotes for each example.
	
	TAX TREATMENT OF THE ELDERLY
	
	Present law contains several provisions that reduce, or in
some cases eliminate, the burden of Federal income tax on senior 
citizens. These provisions are: the exemption from income taxation of 
some or all of an individual's Social Security benefits; a tax credit 
for certain taxpayers who do not receive substantial Social Security 
income; and an additional standard deduction for taxpayers age 65 and 
older. These are described in detail in preceding portions of this 
section.
	As a result of these favorable tax provisions, the tax 
threshold (the level of income, excluding Social Security, at which 
tax liability is incurred) for elderly taxpayers is very close to or 
above the poverty level. For example, in 2002, a single elderly 
individual with $5,000 in Social Security benefits can have up to 
$8,850 in other income without incurring tax liability (or total 
income of $13,850). An elderly married couple filing jointly with 
$5,000 in excluded Social Security benefits has a tax threshold of 
$15,650 (or total income of $20,650). By comparison, the poverty 
thresholds in 2002 for a single elderly person and an elderly couple 
were $8,628 and $10,874, respectively.  Table 13-21 displays similar 
information for other years and for varying amounts of Social 
Security benefits.
	The combination of these tax provisions means that an 
estimated 50 percent of elderly individuals will have no tax 
liability, applying 2003 tax law to 2000 population and income data 
(Table 13-22).


TABLE 13-18 -- ACTUAL PERSONAL EXEMPTIONS, STANDARD DEDUCTIONS, 
AND TAXABLE INCOME LEVELS, 1996-2003

[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]


	
TABLE 13-19 -- PROJECTED PERSONAL EXEMPTIONS, STANDARD DEDUCTIONS, 
AND TAXABLE INCOME LEVELS, 2004-2013




[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]


	
TABLE 13-20 -- EXAMPLES OF FEDERAL INCOME AND PAYROLL TAX LIABILITIES 
OF HYPOTHETICAL TAXPAYERS, 2003


[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]


	
TABLE 13-21 -- INCOME TAX THRESHOLDS FOR ELDERLY INDIVIDUALS, 1996-2003 
(ACTUAL) AND 2004-2013 (PROJECTED)



[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]






	
TABLE 13-22 -- TAX FILING UNITS CLASSIFIED BY MARGINAL FEDERAL INCOME 
TAX RATE,1 2003 TAX LAW  (2000 POPULATION AND INCOME)  


[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]


	
	Table 13-23 is a more comprehensive version of Table 13-22. 
It illustrates for various types of wage earners the additional
(marginal) Federal tax these wage earners will pay if they earn one 
more dollar of wages. For purposes of this table, marginal tax rates 
include both Federal income and payroll taxes. The majority of 
single wage earners have income below $30,000 per year and face 
marginal tax rates of 20.0-24.9 percent. In addition, the phaseout of 
certain deductions or exclusions under the Code (e.g., the personal 
exemption phaseout) and the overall limitation on itemized deductions 
also have the effect of imposing additional dollars of tax liability 
on a taxpayer as the taxpayer's income increases. Hence, effective 
marginal tax rates can exceed the sum of the statutory individual 
income tax rate and payroll tax rate.
	
	FEDERAL TAX TREATMENT OF FAMILIES IN POVERTY
	
	During the 1970s and early 1980s, inflation gradually 
increased the tax burdens of the poor and lowered the real income 
level at which a poor family became liable for income taxation. 
Legislation passed by Congress reversed or slowed this trend, but in 
the absence of indexing, inflation during this period gradually offset 
these legislative efforts. One measure of this trend is the degree to 
which the income at which a poor family begins to pay income taxes 
(termed the tax threshold, or the tax entry point) exceeds or falls 
below the poverty threshold. A second measure is the actual amount 
of tax liability incurred by a family with income at the poverty 
line.

	Table 13-24 shows the income tax threshold, the poverty level, 
and the tax threshold as a percent of the poverty level for a married 
couple with two children in selected years. These figures demonstrate 
that before 1975 a family of four was generally liable for Federal 
income tax if the family's income was significantly below the poverty 
line. In 1975, following the enactment of the earned income credit 
(EIC), a family of four incurred no tax liability until its income 
exceeded the poverty threshold by 22 percent. Over the next decade 
this margin eroded; by 1984, a poor family of four incurred income 
tax liability when its income was 17 percent below the poverty line. 
By 1993, changes in the tax law resulted in no tax liability for a 
typical family of four until its income exceeded the poverty 
threshold by nearly 30 percent.
	Table 13-25 shows the income tax burden and payroll tax 
burden of households with incomes at the poverty line for families of 
different sizes. As a result of the refundable EIC, the table 
reflects that many individuals receive a substantial credit that 
more than offsets total income, and in many cases Social Security, 
taxes paid.
	


TABLE 13-23 -- DISTRIBUTION OF EARNERS BY INCOME AND MARGINAL TAX 
RATES ON WAGES,  2003 TAX LAW (2000 POPULATIONS AND INCOMES) 


[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]





TABLE 13-24 -- RELATIONSHIP BETWEEN INCOME TAX THRESHOLD AND POVERTY 
LEVEL FOR A FAMILY OF FOUR, SELECTED YEARS 1959-2013



[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]




TABLE 13-25 -- TAX THRESHOLDS, POVERTY LEVELS, AND FEDERAL TAX 
AMOUNTS FOR DIFFERENT FAMILY SIZES WITH EARNINGS EQUAL TO THE 
POVERTY LEVEL, 1995-2012


[GRAPHICS NOT AVAILABLE IN TIFF FORMAT]




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	  This applies to pension contributions made by employers. 
Employees may also be able to contribute to qualified plans. Employee 
contributions may be made with aftertax dollars. If so, the tax 
advantage given to these contributions is smaller than the tax-
advantage given to employer contributions, and consists of the 
deferral of tax on accumulated earnings.

	The provisions of EGTTRA generally do not apply for years 
beginning after December 31, 2010. See Internal Revenue Service, 
Internal Revenue Bulletin, 1938-1, Income Tax Unit 3154, p. 114; 
1938-2, Income Tax Unit 3229, p. 136; and 1941-1, Income Tax 
Unit 3447, p. 191.

	  To the extent the employer bears a portion of the payroll 
tax, the employer may actually prefer to provide compensation through 
health insurance (which is not subject to payroll tax).


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