Who's Not Paying Federal Income Tax?

Surprise! Who's Not Paying Federal Income Tax?

October 12, 2011

Detroit Free Press - Amid complaints that nearly half of tax filers in the U.S. won't pay federal income taxes this year, this has been lost: Those making $75,000-$100,000 a year are the fastest-growing share of people who don't pay federal income taxes. Not working poor people — but those who are firmly middle class. They still make up less than 1% of the total number of income tax filers who pay no tax at all, but their overall number has exploded, from fewer than 5,000 not paying taxes in 1996 to nearly 500,000 in 2009, the most recent year of available data.

The lowest-income Americans — those who make less than $25,000 a year — account for the largest number of those not paying any federal income tax: 76% as of 2009. But that share has been decreasing for years. Meanwhile, the percentage of nontaxable returns has been growing for people with higher incomes. As of 2009, more than 20,000 filers making more than $200,000 a year — 1,470 of whom had adjusted gross income of more than $1 million — owed no income tax, a Detroit Free Press analysis showed.

On Wednesday, Senate Democrats were talking up an added 5% tax on millionaires, a proposal Republicans almost certainly will block. But as the debate on tax revenue continues, the question of who pays — and who does not — is certain to keep coming up.

Tax breaks, credits ease tax burden

In recent years, the tax code has exploded with more ways for Americans to be forgiven part of their income tax burden, so much so that more Americans seem to avoid paying taxes at all.

Well, there are still those pesky Social Security and Medicare payroll taxes, as well as various state and local sales taxes that are harder to avoid. But more middle- and even upper-income taxpayers are avoiding federal income taxes.

In recent months, estimates that as many as half of all U.S. tax filers might owe no federal income tax at all this year have caused critics to argue the issue of fairness — especially as President Obama and Democratic members of Congress push for higher taxes on wealthier earners.

Here's a look at who doesn't pay, and why.

Question: So the reports that half the U.S. doesn't pay taxes are true?

Answer: No, they're not. According to the nonpartisan Tax Policy Center in Washington, D.C., 46% of tax filers will owe no federal income tax this year. But when you figure in payroll taxes — such as those for Social Security, Medicare and unemployment — more than 80% of tax filers pay some kind of federal tax. And that doesn't include sales taxes, state taxes, local taxes, gas taxes, etc., which catch just about everyone.

Q: But almost half the filers don't pay federal income tax. How come?

A: It's because of the way the tax code is written. In 2010, a married couple filing jointly didn't have to pay any income taxes if their income was less than $18,700; couples older than 65, if their income was $20,900 or less. And even if you make more than that, the standard deduction — which goes up each year — and a myriad of other deductions and tax breaks reduce income tax exposure. In 2009, the most recent year for which Internal Revenue Service data is available, filers with adjusted gross income of less than $30,000 made up 83% of all the nontaxable returns. According to the Tax Policy Center's calculator, a couple with two kids younger than 13 that makes $30,000 would get $5,000 back under current laws.

Q: Isn't it poor people who aren't paying?

A: No, at least not them alone. A Free Press analysis of IRS data shows that, in 1996, people with incomes of less than $30,000 made up 99.5% of all the nontaxable returns. In 2009, that group made up 76% of those returns. On the other hand, people making more than $30,000 went from less than 1% of nontaxable returns in 1996 to 17% in 2009.

Q: But $30,000's not a big income — is most of that growth among nonpayers coming near the bottom of that scale?

A: Much of it is — the number of nontaxable returns for filers with incomes of $30,000-$40,000 went from about 85,000 — about a third of 1% of the total — to 4.8 million, or 8% of the total, by 2009. That's an increase of more than 5,000%. (By way of comparison, the overall number of tax returns went up by about 17%, and the total number of nontaxable returns doubled in that time.)

But the percentage increase was even bigger for higher wage earners. Nontaxable returns from people with income between $75,000 and $100,000 went from 4,025 in 1996 to 476,624 in 2009 — an increase of almost 12,000%. More than 1,400 millionaires didn't pay income taxes in 2009, either.

Q: Why the change?

A: Tax cuts and tax breaks. As Clint Stretch, tax policy expert at Deloitte, explains it, the tax cuts won by President George W. Bush in 2001 and 2003 not only reduced income tax rates, they doubled the child tax credit from $500 to $1,000; eliminated the marriage penalty by giving couples twice the standard single deduction (rather than a slightly smaller amount), increased the earned income tax credit, cut capital gains taxes and more. All of those items — as well as breaks like those for mortgage interest, charitable deductions and medical expenses — can mean a huge savings.

But it didn't stop there. President Barack Obama added other breaks, too, like the Making Work Pay credit — worth $800 to a couple or $400 to an individual filer — as well as the American Opportunity Credit for college, worth up to $2,500 per student, usually more advantageous than the existing $4,000 deduction for tuition and fees.

"Mathematically, you're not going to pay taxes" if you have a modest income and qualify for a lot of those breaks, Stretch said.

Q: If we get rid of those breaks, will more people pay?

A: Yes, but that would have a lot of other effects, as well — some of which are difficult to predict. Let the child tax credit decrease and Obama's Making Work Pay credit expire, and it takes money out of people's pockets. Reduced spending by families could further slow the economy. Reduce the mortgage-interest deduction, and people may choose to use more of their savings — potentially reducing spending on other items — or restrict themselves to less-expensive homes, holding down the housing market. And if people have to spend more on college, without the breaks offered there, or if senior citizens pay more in taxes, that money can't be used in the consumer market.

Q: Did the recession play a role in the increase?

A: It did and it does. As of 2009, the total number of tax returns had increased slightly over 2006. But the number of taxable returns actually fell — by close to 12%, or more than 10 million returns — during that period. Total adjusted gross income (AGI) fell by 5%, a drop of about $400 billion to $7.6 trillion.

By comparison, from 1996 to 2006, the total number of returns rose by 18 million — about 15% — and the total number of taxable returns rose by 1.8 million — 2%. That's modest growth, but during that period, total AGI nearly doubled, from $4.5 trillion to more than $8 trillion. In short: more people making less with more deductions and bigger exemptions means more nontaxed returns.

Q: But the trend was already in that direction?

A: Yes. In 1996, 76% of all returns were taxed. In 2006, 67% were taxable. But the recession deepened the trend. In 2009, 58% were taxable, 42% were not — and the Tax Policy Center estimates 46% will be nontaxable this year.

Q: Is it likely to continue?

A: That's unclear. Obama wants to extend some of his and Bush's tax cuts for middle- and lower-income earners, but there's very little political chance of Republicans in control of the House allowing higher taxes for higher earners — even those making $1 million or more annually — to be enacted. But a stalemate could lead to the Bush-era tax cuts — including the child tax credit, capital gains cut and more — expiring at the end of next year, which would lower the number and the amount of the breaks.

There is talk of reforming and simplifying the whole system. In the meantime, Len Burman, a tax policy expert who has worked for the Treasury Department and the Congressional Budget Office, said that although almost everybody pays some kind of tax, "over the last 30-40 years, there's been a shift toward providing more and more public services through the tax system."

From a political standpoint, that has been easier than raising taxes to fund new programs. And changing that will be difficult, politically.

As Burman asked rhetorically when GOP presidential candidate and Texas Gov. Rick Perry said he was "dismayed" by the number of Americans not paying income taxes,

"So you're going to raise taxes on middle-income people?"

Notes:

Soldiers enlisted with the United States' military are required to pay taxes on their gross income over the previous calendar year each April. The Internal Revenue Service considers a soldier's taxable gross income to include his base pay for active duty as well as special pay for drills, diving duty, foreign duty and student loan repayment and bonus pay for enlistment, reenlistment or any officer ranking. Any pay for life insurance benefits, death allowances, housing, travel and moving expenses is excluded from a soldier's normally taxable gross income.

Soldiers serving in an area of the world that is designated as a combat zone by the United States are exempt from paying federal taxes on income they earn while stationed in the combat zone. Official combat zones that applied toward this tax exclusion in 2010 were Afghanistan, certain sections of the Balkans and the Persian Gulf region. Even if soldiers serve only part of one month in a combat zone, that entire month's pay is exempt from regular federal taxes.

Taxpayers Owe $385 Billion in 2006 Taxes: IRS

January 8, 2012

Reuters - U.S. taxpayers owe an estimated $385 billion in unpaid taxes for 2006, up about a third from the "tax gap" five years before, the Internal Revenue Service (IRS) said.

Despite the wider shortfall between 2001 and 2006, voluntary compliance remained steady at about 83 percent for both years, the agency said on Friday in its five-year update on the amount of taxes that are never paid.

"On a relative basis, the tax gap is largely in line with the growth in total tax liabilities," the IRS said in a statement.

"In addition, some growth in the tax gap estimate is attributed to better data and improved estimation methods."

The gross tax gap, or the amount that was not paid on time, was estimated at $450 billion in 2006, up from $345 billion in 2001.

The net tax gap, or the amount that was never paid, was $385 billion in 2006, compared with $290 billion five years before, the tax agency said.

Most of the wider tax gap over the five years was concentrated in underreporting and underpayment. The non-filing portion was largely unchanged.

Underreporting climbed to $376 billion from $285 billion, and more than a third of the growth was from corporate income taxes.

Underreporting on corporate income taxes more than doubled to $67 billion, the IRS said.