Federal Income Taxes on Middle-Income Families at Historically Low Levels

By Chuck Marr and Gillian Brunet

Middle-income Americans are now paying federal taxes at or near historically low levels, according to the latest available data. That’s true whether it comes to their federal income taxes or their total federal taxes.

■Income taxes: A family of four in the exact middle of the income spectrum will pay only 4.6 percent of its income in federal income taxes this year, according to a new analysis by the Urban Institute-Brookings Institution Tax Policy Center. This is the second-lowest percentage in the past 50 years.

■ Overall federal taxes: Middle-income households are paying overall federal taxes — which include income as well as payroll and excise taxes — at or near their lowest levels in decades, according to the latest data from the Congressional Budget Office (CBO).

Federal Income Taxes Have Declined Significantly in Recent Decades

Federal income taxes on middle-income families have declined significantly in recent decades (see Figure 1).

In 2000, the year before the 2001 tax cut that President Bush and Congress enacted, the median-income family of four paid 8.0 percent of its income in individual income taxes, according to Tax Policy Center estimates — a smaller share than in any year since 1967 (except for 1998 and 1999). [1] The Bush tax cuts further reduced middle-income tax obligations.

This year, the Making Work Pay tax credit, which President Obama and Congress enacted as part of the 2009 American Recovery and Reinvestment Act, is providing a credit of $800 to married joint filers ($400 to single filers). A median-income family with two children thus will receive an $800 tax cut in the return it files this year.

With the new tax cut, the median family’s federal income taxes will equal just 4.6 percent of its income in 2009. That is lower than in any year since 1955 (the first year for which these data are available) except for 2008, when another stimulus-related tax cut was in effect.

The 4.6 percent effective tax rate — the percentage of its income that a family pays in taxes — is well below the 15 percent marginal tax rate that a family of four in the exact middle of the income spectrum faces. Typically, such a family reduces its effective tax rate by taking the standard deduction (or, in some cases, itemized deductions), personal exemptions, and tax credits such as the child tax credit. The Making Work Pay tax credit further reduces that family’s effective tax rate.

Overall Federal Taxes Also at Low Levels

The decline in income taxes on middle-class households in recent years has driven a decline in these households’ overall federal taxes.

Households in the middle fifth of the income spectrum paid an average of 14.2 percent of their income in overall federal taxes in 2006, the latest year for which data are available, according to CBO.[2] This is just slightly above this group’s effective tax rate of 13.8 percent in 2003, which was the lowest level since at least 1979.

Most Americans pay more in payroll taxes, which support Social Security and Medicare, than they do in income taxes. Thus, the 14.2 percent figure reflects the impact of payroll taxes far more than income taxes.

Due to the impact of the recession and the temporary tax cuts in the Recovery Act, particularly the Making Work Pay tax credit, CBO data for 2009 (when they become available) will likely show that middle-income families faced significantly lower effective overall federal tax rates than in 2006.

End Notes:

[1] Tax Policy Center, “Historical Federal Income Tax Rates for a Family of Four,” April 12, 2010. The Tax Policy Center’s estimates were derived by updating (using Treasury’s methodology) a 1998 Treasury Department analysis that examined changes since 1955 in the percentage of income that the median-income family of four pays in federal income taxes.

[2] The CBO study covers the 1979-2006 period and includes federal income, payroll, and excise taxes. Congressional Budget Office, “Historical Effective Federal Tax Rates, 1979-2006,” April 2009.

Common Tax Schemes

Tricks of the Trade 

Income tax returns are soon due to the IRS.  If you’re like most people, you’re hoping for a nice lump sum refund.  However, as you prepare your forms, be aware that others are plotting ways to steal your hard-earned money.  Avoid falling into common tax traps by reading up on some of the ways con artists are targeting their victims. 

The Miami-Dade Consumer Services Department lists some of the common schemes to steer clear of. 

Common Rip-offs 

·         Making Work Pay Refund.  This phishing e-mail, which claims to come from the IRS, references the president and the Making Work Pay provision of the 2009 economic recovery law. It says that there is a refundable credit available to workers, consumers and retirees that can be paid into the recipient’s bank account if the recipient registers their account information with the IRS. The e-mail contains links to register the account and to claim the tax refund.

In reality, most taxpayers receive their Making Work Pay tax credit, which was designed for wage earners, in their paychecks as a result of decreased tax withholding, not as a lump sum distribution from a federal fund. Additionally, consumers and retirees who are not wage earners are not eligible for this tax credit. 

·         Instant Rebate Scams. Some unscrupulous and predatory tax preparers prey upon low-income earners with promises of “fast money” at tax refund time.  Their victims often do not realize that an instant refund is actually a “refund anticipation loan” that could drain away as much as half their refunds in the form of interest rates and fees.  

Consumer Smarts 

·         Taxpayers do not have to complete a special form to obtain a refund. Taxpayer refunds are based on the tax return they submit to the IRS.   

·         The IRS does not initiate taxpayer contact via unsolicited e-mail or ask for personal identifying or financial information via e-mail. If you receive a suspicious e-mail claiming to come from the IRS, take the following steps:

*         Do not open any attachments to the e-mail, in case they contain malicious code that will infect your computer.

*         Do not click on any links, for the same reason. Also, be aware that the links often connect to a phony IRS Web site that appears authentic and then prompts the victim for personal identifiers, bank or credit card account numbers or PINs. The phony Web sites appear legitimate because the appearance and much of the content are directly copied from an actual page on the IRS Web site and then modified by the scammers for their own purposes.

·         Be cautious when choosing a tax preparer.  Filing false income tax returns with inflated personal or business expenses, false deductions, unallowable credits or excessive exemptions could result in penalties.  Regardless of whether the preparer is responsible for manipulating income figures, it is ultimately the taxpayer who is faulted and required to pay additional taxes.  

·         The IRS advises:

*         Avoid tax preparers who claim they can obtain larger refunds than other preparers.

*         Ask about service fees and be wary of preparers who base their fee on a percentage of the   amount of the refund.

*         Use a reputable tax professional who signs your tax return and provides you with a copy for  your records.

*         Consider whether the individual or firm will be around to answer questions about the preparation of your tax return months, or even years, after the return has been filed.

*         Review your return before you sign it and ask questions on entries you don’t understand.

*         Find out the preparer’s credentials. Only attorneys, certified public accountants (CPAs) and enrolled agents can represent taxpayers before the IRS in all matters including audits, collection and appeals. Other return preparers may only represent taxpayers for audits of returns they actually prepared.

*         Find out if the preparer is affiliated with a professional organization that provides its members with continuing education and resources and holds them to a code of ethics.

Contact the IRS at 1-800-829-1040 to determine whether the IRS is trying to contact you.  If you think you have been targeted by a fraudulent tax scheme, forward the suspicious e-mail or URL address to the IRS mailbox phishing@irs.gov, then delete the e-mail from your inbox. 

You can learn the status of your refund by going to the IRS.gov website and clicking on “Where’s my refund?”

The American Recovery and Reinvestment Act of 2009

The American Recovery and Reinvestment Act of 2009: Information Center

Updated Nov. 6, 2009: The newly-enacted Worker, Homeownership And Business Assistance Act Of 2009 extends and expands the first-time homebuyer credit. The new law also expands the Net Operating Loss (NOL) provision. Información en Español Information for Individuals Some of the provisions of the law primarily affect individuals. Making Work Pay Tax Credit. This tax credit means more take-home pay for many Americans. To make sure enough tax is withheld from their pay, taxpayers can use the IRS withholding calculator. See Making Work Pay for more. First-Time Homebuyer Credit Expands. Homebuyers who purchased in 2009 can get a credit of up to $8,000 with no payback requirement. November 2009 legislation extends and expands this credit to homes purchased by April 30, 2010. New documentation requirements apply. See the First-Time Homebuyer Page and special information on signatures for more. Money Back for New Vehicle Purchases. Taxpayers who buy certain new vehicles in 2009 can deduct the state and local sales taxes they paid or other taxes and fees they paid in states with no sales tax. Education benefits. The new American opportunity credit and enhanced benefits for 529 college savings plans help families and students find ways to pay higher education expenses. Enhanced Credits for Tax Years 2009, 2010. Find details on the earned income tax credit and the additional child tax credit. Increased Transportation Subsidy. Employer-provided benefits for transit and parking are up in 2009. Up to $2,400 in Unemployment Benefits Tax Free in 2009. Individuals should check their tax withholding. $250 for Social Security Recipients, Veterans and Railroad Retirees. The Economic Recovery Payment will be paid by the Social Security Administration, Department of Veterans Affairs and the Railroad Retirement Board. Energy Efficiency and Renewable Energy Incentives. See what individuals can do to reap tax rewards. COBRA. Workers who lose their jobs may qualify for reduced COBRA health insurance premiums for a period of up to 15 months. Visit the U.S. Department of Labor’s COBRA Web site, www.dol.gov/cobra, for details on this recently-extended and expanded subsidy. Health Coverage Tax Credit. The credit increases from 65 percent to 80 percent of qualified health insurance premiums, and more people are eligible. Information for Businesses Some of the provisions of the law primarily affect businesses. Making Work Pay Tax Credit. The 2010 withholding rates, contained in Notice 1036, reflect reduced withholding as directed by the ARRA. An optional withholding procedure is available for pension plan administrators. Work Opportunity tax credit. This newly-expanded credit adds returning veterans and “disconnected youth” to the list of new hires covered by the credit that businesses may claim. COBRA: Health Insurance Continuation Subsidy. The IRS has extensive guidance for employers, including an updated Form 941, as well as information for qualifying individuals. Energy Efficiency and Renewable Energy Incentives. See what businesses can do to reap tax rewards. Net Operating Loss Carryback. Small businesses can offset losses by getting refunds on taxes paid up to five years ago. Information on the carryback, an expanded section 179 deduction and other business-related provisions, is now available.  The Worker, Homeownership And Business Assistance Act Of 2009 (WHBAA) further expands the five-year NOL carryback to most businesses. Municipal Bond Programs. There are new ways to finance school construction, energy and other public projects. 2008 and 2009 Tax Returns The law could affect some 2008 tax returns due in 2009. However, most of the changes in ARRA will affect 2009 individual tax returns due April 15, 2010. Related Items: IRS news releases, multimedia and legal guidance Marketing products for partners Summary of the key provisions from the Senate Finance and House Ways and Means committees