News reports of the President's proposed stimulus plan have given us three major pieces of information. First, there would be approximately $50 billion in tax relief for businesses, mostly relating to more friendly treatment of depreciation. Second, the 10% marginal income tax rate would be adjusted. And third, possibly $800 rebate checks for singles and $1,600 for married couples would be sent out.
While we could find no news report stating exactly how this would work, it appears as if on the individual side, the 10% rate would drop to zero for one year. And then the rebate would work similar to the 2001 rebate checks. Individuals would essentially receive within the next few months an advance rebate check for their 2008 tax return (which would be filed a year from now in spring 2009) equivalent to the amount that they would save from the 10% rate dropping to zero.
This would make sense given the numbers cited because the 10% bracket in 2008 for singles tops out at $8,025, meaning a reduction of the 10% rate to zero would cut their tax bill by $802.50. For married couples filing a joint return, the 10% bracket kicks in at $16,050 (twice that of singles). Therefore, a reduction of the 10% bracket to zero would cut their tax bill by $1,605.
We could be wrong in this analysis, and/or there may be more to it. But one issue that would likely come up in negotations regarding this plan would be that since so many tax returns pay nothing already to the IRS, a reduction in the 10% tax rate would do nothing for them. And these are individuals that are typically low-income.
And furthermore, if this is the way it works and everyone receives the rebate, here's an interesting question: what about those in AMT?
The new edition of Tax Watch, the Tax Foundation's bimonthly newsletter, is now available. Tax Watch presents Tax Foundation research and analysis in a simple, non-technical format—ideal for the non-economist looking for a clear explanation of current tax issues.
Highlights from the January-February 2008 issue include:
- What Do Corporate Income Taxes Cost American Families?
- Some States Win, Others Lose from Federal Taxing and Spending
- Congress Delays AMT Fix
- Victory for Taxpayers in Supreme Court
- Tax Foundation Celebrates 70th Birthday
- A message from Tax Foundation President Scott Hodge: "A New Year's Helping of Political Reality"
- An update on our work in the states
Click here to read the January-February 2008 issue of Tax Watch.
Click here for a free subscription to Tax Watch.
The tax fraud trial of Wesley Snipes began this week in Florida, and the actor faces up to 16 years in prison for his failure to file tax returns between 1999 and 2004, or pay tax on the estimated $38 million he earned in that period.
Snipes faces an uphill battle, as few succeed in convincing juries of a genuine, good-faith belief that he or she had no obligation to pay income taxes. Snipes has relied on the "§ 861" argument, which asserts that only items listed in Section 861 of the Internal Revenue Code are taxable, and therefore, the domestic income of U.S. citizens is not taxable.
If only. All income, earned inside and outside the country, of U.S. citizens is taxable under Sections 1, 61, 63, and others. Section 861, and accompanying regulation 26 C.F.R. § 1.861-8, list what income is earned "inside" the country, and that's relevant only to non-residents and foreign corporations because they only pay tax on domestic income. The list is typically not important for U.S. citizens, because they are taxed on all income, whether it is earned domestically or foreign. (One exception is that U.S. taxpayers who earn income overseas can receive a credit for taxes paid overseas, and the § 861 list can be used to determine what qualifies for the credit.)
Even putting that aside, among the taxable items on the § 861 list is "[c]ompensation for labor or personal services performed in the United States." § 861(a)(3). So any income earned in the United States is taxable even under Section 861. IRS regulations re-iterate this point, stating:
"In general, all citizens of the United States, wherever resident, and all resident alien individuals are liable to the income taxes imposed by the Code whether the income is received from sources within or without the United States."
26 C.F.R. § 1.1-1(b). § 861 advocates argue that regulation § 1.861-8 (which provides more detail on types of income that are to be treated as "domestic") overrides § 861(a)(3), but laws always override regulations.
Courts have conducted a similar analysis in reviewing the § 861 argument, and those who rely on it to avoid income taxes routinely face fines and imprisonment. The taxpayer often gets much harder than scammer who gives him or her fraudulent advice. For a list of cases and penalties, see here.
The Internal Revenue Code is long and complicated, and we at the Tax Foundation work for a tax system that is simple and transparent, and doesn't inhibit our economy with excessive burdens on individuals. But we're not there yet. If someone tries to convince you that there's no obligation to pay income taxes, remember that if it sounds too good to be true, it often isn't true.
President Bush's 2001 tax rebate eventually got mostly good reviews, even grudging praise from the Washington Post editorial board. And so it would be unsurprising if, as media reports suggest, the president now proposed that a new fiscal stimulus be administered the same way: by cutting the lowest income tax rate for the current year, then pre-paying the tax savings.
[The Tax Foundation has historically been critical of fiscal stimulus plans and retroactive tax changes. Here's our critique of Bush's 2001 tax "prebate", and here's our recent warning that stimulus now will distract the nation from needed long-term reforms.]
In May 2001, the first Bush tax cut was enacted with a fiscal stimulus built in. The lowest income tax rate, then 15%, was cut to 10% retroactively to January 2001. Then instead of waiting for taxpayers to file their 2001 tax returns at the beginning of 2002, the Treasury Department mailed out checks for the difference (5% of $6,000 for individuals equaled a $300 rebate; and 5% of $12,000 equaled a $600 rebate).
Gerald Prante has worked out the arithmetic for 2008, which comes to about $800 for individuals and $1,600 for couples. But this similar implementation won't translate into similarly good reviews for at least three reasons:
- One reason is timing. The 2001 stimulus was enacted before 9/11 but paid out afterward in the fall, just beore Christmas, when the IRS had time to administer it and when almost everyone agreed that the stimulus's timing was fortuitous. The 2008 stimulus is undoubtedly dreaded at the IRS, and the checks will seemingly arrive at the same time as regular tax refunds.
- Secondly, unlike 2001, 2008 is an election year. Anything Bush does will become the ammunition of the day, and that will spoil the psychological effect of the boost.
- Third is the nonpayer problem. In 2001 there were only about 30 million tax returns filed by people who owed nothing and got back every dollar withheld. Now there are 44 million non-payers thanks to the Bush tax cuts which took many low-to-middle income people off the rolls. The more people there are who pay nothing, the more awkward it is to use tax cuts to help them.
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