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...Adjusted gross income (AGI) on these taxable returns rose 9.4 percent to $6,857 billion for 2005, while total income tax rose 12.4 percent to $935 billion. The average tax rate for taxable returns rose, increasing approximately 0.4 percentage points to 13.6 percent for 2005.
Taxpayers with an AGI of at least $364,657, the top percent of taxpayers, accounted for 21.2 percent of AGI for 2005. This represents an increase in income share of 2.2 percentage points from the previous year. These taxpayers accounted for 39.4 percent of the total income tax reported, an increase from 36.9 percent in 2004. The top 5 percent of taxpayers accounted for 35.7 percent of AGI and 59.7 percent of total income tax. To be included in the top 5 percent, a taxpayer must have reported an AGI of at least $145,283, whereas, in 2004, the cutoff for this group was $137,056.
This article discusses the individual income tax rates and tax shares and the computation of "total income tax" for 2005. To put this discussion into perspective, it also provides explanations of selected terms used in the article and describes the income tax structure, certain tax law changes, income and tax concepts (the "1979 income Tax Concept," "modified" taxable income, and marginal tax rates), the computation of "alternative minimum taxable income," and the data sources and limitations.
Income Tax Rates
Discussions of income tax rates generally center on measuring two distinct tax rates: average tax rates and marginal tax rates. Average tax rates are calculated by dividing some measure of tax by some measure of income. For the statistics in this article, the average tax rate is "total income tax" (see Explanation of Selected Terms) divided by AGI reported on returns showing some income tax liability.
Measures of marginal tax rates, on the other hand, focus on determining the tax rate imposed on the last (or next) dollar of income received by a taxpayer. For this article, the marginal tax rate is the statutory rate at which the last dollar of taxable income is taxed. (See Income and Tax Concepts for a more detailed explanation of marginal tax rates.) The following sections describe the measurement of the average and marginal tax rates in more detail, and discuss the statistics based on these rates for 2005.
Average Tax Rates
Figure A presents statistics for 1986 through 2005 on income (based on each year's definition of AGI and on the common 1979 Income Concept) and taxes reported. (See Income and Tax Concepts for a more detailed explanation of the 1979 Income Concept.) These tax years can be partitioned into seven distinct periods:
1) Tax Year 1986 was the last year under the Economic Recovery Tax Act of 1981 (ERTA81). The tax bracket boundaries, personal exemptions, and standard deductions were indexed for inflation, and the maximum tax rate was 50 percent.
2) Tax Year 1987 was the first year under the Tax Reform Act of 1986 (TRA86). For 1987, a 1-year, transitional, five-rate tax bracket structure was established with a partial phase-in of new provisions that broadened the definition of AGI. The maximum tax rate was 38.5 percent.
3) During Tax Years 1988 through 1990, there was effectively a three-rate tax bracket structure. (1) The phase-in of the provisions of TRA86 continued with a maximum tax rate of 33 percent.
4) Tax Years 1991 and 1992 brought a three-rate tax bracket structure (with a maximum tax rate of 31 percent), a limitation on some itemized deductions, and a phaseout of personal exemptions for some upper income taxpayers.
5) Tax Years 1993 through 1996 had a five-rate tax bracket structure (with a maximum statutory tax rate of 39.6 percent), a limitation on some itemized deductions, and a phaseout of personal exemptions for some upper income taxpayers.
6) Tax Years 1997 through 2000 were subject to the Taxpayer Relief Act of 1997 which added three new capital gain tax rates to the previous rate structure to form a new eight-rate tax bracket structure (with a maximum statutory tax rate of 39.6 percent). See Income and Tax Concepts for a more detailed description of the capital gain rates.
7) Tax Years 2001 through 2005 were affected by two new laws, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). EGTRRA included a new 10-percent tax rate bracket, as well as reductions in tax rates for brackets higher than 15 percent of one-half percentage point for 2001 and 1 percentage point for 2002. It also included increases in the child tax credit and an increase in alternative minimum tax exemptions. Tax Year 2003, under JGTRRA, saw additional rate reductions in ordinary marginal tax rates higher than the 15-percent rate, as well as expansions to particular income thresholds in the rates from 15 percent and below. Also, the rate for most long-term capital gains was reduced from 20 percent to 15 percent. Further, qualified dividends were taxed at this same 15-percent rate. These changes are detailed in the previously published article, "Individual Income Tax Rates and Shares, 2003" in Appendix C (under Tax Rate Reduction). Beginning in 2004, the Working Families Tax Relief Act increased the additional child tax credit refundability rate from 10 percent to 15 percent.
About 90.6 million, or 67.4 percent, of the 134.4 million individual returns filed for 2005 were classified as taxable returns. This was a 1.7-percent increase in the number of taxable returns from 2004. Total AGI reported on taxable returns increased 9.4 percent to $6,857 billion. Total income on taxable returns rose using the 1979 Income Concept as well, increasing 9.6 percent to $7,016 billion for 2005. Total income tax rose by almost $103 billion (12.4 percent) to $935 billion for 2005. Average AGI for taxable returns rose to $75,687 for 2005, a 7.6-percent increase from 2004. Average income tax also rose for 2005 by 10.5 percent to $10,319.
In order to analyze the average tax rate over time, it is necessary to use a more consistent measure of income than AGI because some tax law changes resulted in the definition of AGI changing from year to year. The 1979 Income Concept controls for much of this variation in tax law, and its use provides a more consistent estimate of the average tax rate across years. Under the 1979 Concept, the average tax rate for 2005 rose to 13.3 percent from 13.0 percent for the previous year.
As shown in Figure B, the average tax rate on all taxable returns as a percentage of AGI was 13.6 percent for 2005. The average tax rate for the AGI-size classes ranged from 2.5 percent for the "$1 under $10,000" AGI-size class to 23.9 percent for the "$500,000 under $1,000,000" AGI-size class. This latter rate was higher than the 23.0-percent average paid by those taxpayers in the "$1,000,000 or more" class. This was partially due to taxpayers in the "$1,000,000 or more" class receiving almost double the percentage of AGI in the form of capital gains and qualified dividends taxed at preferential tax rates than those in the "$500,000 under $1,000,000" AGI-size class. Taxpayers in the "$1,000,000 or more" class received 38.7 percent of their AGI through these capital gains and qualified dividends compared to 20.3 percent for the "$500,000 under $1,000,000" AGI-size class.
The average tax rate of 13.6 percent for 2005 for all income classes combined was an increase of approximately 0.4 percentage points from the 13.3 percent for 2004. The average tax rate for taxable returns fell or stayed the same in every AGI-size class except for the $1 under $10,000 class, which increased less than 0.1 percentage point from 2004 to 2.5 percent. The overall average rate increased despite this decline in each AGI class because individuals tended to move to higher income classes which, in turn, faced higher tax rates. For example, in 2005, the number of taxable returns in every positive AGI class under $50,000 or less decreased, while the number of taxable returns reporting an AGI of $1 million or more increased by 26.3 percent from 2004. For 2001 and 2002, many of the higher income tax returns had shifted to lower income brackets partially due to reductions in realized capital gain (less loss). This trend began to reverse for 2003 and continued through 2005.
Marginal Tax Rate Classifications
A return's marginal tax rate is the highest statutory tax rate bracket applicable to that tax return. Marginal tax rate statistics are presented in Figure C and Table 1. These statistics are based on individual income tax returns showing a positive taxable income amount based on "tax generated" and items of income that were subject to the regular income tax, generally those included in AGI. (2) Income and Tax Concepts explains the determination of the marginal tax rate bracket into which a return is assumed to fall. Table 2 contains additional data based on ordinary tax rates and presents statistics on the income and tax generated at each ordinary tax rate by size of AGI.
For 2005, the number of individual returns with modified taxable income rose 1.6 percent to 104.3 million. The amount of modified taxable income reported on these returns increased 10.0 percent to $5,136.9 billion. (3) The tax generated on taxable returns rose by 11.6 percent to $972.7 billion. Figure C presents the amounts and percentages of modified taxable income and income tax generated (before reduction by tax credits, including the earned income credit) by the marginal tax rate categories (defined in Income and Tax Concepts).
Returns with modified taxable income in the "15-percent" (ordinary income) marginal tax rate bracket contained the largest share of returns for 2005, at 39.1 percent. These returns reported 20.0 percent of modified taxable income for 2005 and 13.6 percent of income tax generated. Conversely, taxpayers in the "35-percent" (ordinary income) marginal rate, the least represented bracket, accounted for only 0.9 percent of returns, but reported 21.3 percent of modified taxable income and 32.4 percent of tax generated (the largest of any tax bracket). The "10-percent" (ordinary income) marginal rate bracket reported the second largest share of returns at 24.4 percent. However, it only accounted for 2.5 percent of modified income and 1.3 percent of tax generated. With a 20.7-percent share of returns, making it the third largest, the "25-percent" (ordinary income) marginal rate bracket reported 27.5 percent of modified taxable income and 24.4 percent of tax generated. Returns in the "28-percent" (ordinary income) marginal rate bracket represented 3.5 percent of the total share of returns and accounted for 9.8 percent of modified taxable income and 10.7 percent of tax generated. Returns in the "33-percent" (ordinary income) marginal rate bracket represented the second smallest share of ordinary tax rate returns at 1.4 percent. It also accounted for 7.5 percent of modified taxable income, as well as 9.5 percent of tax generated. Returns in the capital gain and dividends, 10-percent, 15-percent, 25-percent, and 28-percent tax brackets represented 8.5 percent of returns (with modified taxable income), and reported a total of 11.1 percent of modified taxable income and 7.9 percent of tax generated.
As shown in Table 2, the total tax generated for 2005 at the 15-percent rate was more than at any other rate. The 33.5 percent of income taxed at this rate was reported by 73.9 percent of returns with modified taxable income, producing 26.5 percent of tax generated. The 35-percent rate generated the next largest amount of income tax liability. Tax in that bracket was reported on only 0.9 percent of returns. However, 11.0 percent of all income was taxed at this rate, producing 20.3 percent of tax generated. The 25-percent rate had the third largest amount of income. Tax in that bracket was reported on 26.9 percent of returns with 14.0 percent of all income taxed at this rate, producing 18.5 percent of tax generated.
Components of Total Income Tax
Regular Tax
Regular tax is generally tax determined from a taxpayer's taxable income based on statutory tax rates. It does not include the "alternative minimum tax" (AMT) nor does it exclude allowable tax credits. Figure D illustrates the derivation of the aggregate tax generated for 2005 returns. Table 1 includes two tax amounts: "tax generated" and "income tax after credits." Tables 5 through 8 and Figures A and B include an additional measure of tax, "total income tax," which also includes distributed tax on trust accumulations.
As shown (Figure D and column 5 of Table 1), the tax generated by applying statutory ordinary income and capital gain tax rates to modified taxable income was $972.7 billion, an 11.6-percent increase from 2004. (4) For most taxpayers, tax generated was equal to income tax before credits. However, for some taxpayers, income tax before credits included the alternative minimum tax (AMT) and/or special taxes on lump-sum distributions from qualified retirement plans (when a 10-year averaging method was used). (5) The AMT increased sharply by 33.7 percent to $17.4 billion for 2005. Income tax before credits was $990.2 billion for 2005, up from $884.3 billion, representing a 12.0-percent increase from 2004. Taxpayers used $55.3 billion of tax credits to reduce their income tax before credits. The earned income credit (EIC) is included in this computation to the extent that its application did not reduce income tax before credits below zero. Any portion of the EIC that is refundable to the taxpayer because it exceeds the taxpayer's liability and any portion of the EIC used to reduce taxes other than income taxes are excluded from the computation of income tax after credits. (6) Income tax after credits (Figure D) totaled $934.8 billion as did total income tax (the sum of income tax after credits and tax on trust accumulation distributions). These taxes both represented a 12.4-percent increase from 2004.
Table 4 provides estimates of income tax before credits by the type of tax computation for returns with modified taxable income. For 2005, the number of returns with the Schedule D and qualified dividend tax computation increased 6.4 percent from 20.4 million to 21.7 million. Along with this was an increase in the income tax before credits and tax generated at these lower rates. These taxpayers paid $91.7 billion (column 8) less in tentative taxes than they would have if they had not received the benefits of the lower capital gain and qualified dividend tax rates. This was up from the $65.6 billion in savings from using these rates for 2004 (column 4). The average tax savings for those who had these capital gains rose from $3,219 per return for 2004 to $4,228 for 2005. Tax Year 2005 saw an increase of only 83.7 thousand returns that calculated taxes with a regular tax computation only. For 2005, the number of returns filed by children under age 14 with Form 8615 for reporting investment income over $1,600 increased 26.9 percent to a little under 142 thousand. Using Form 8615 to compute their tax (as if their incomes were treated as the marginal incomes of their parents or guardians), these children generated just over $419.4 million (column 7) of tax revenue which is $24.4 million (column 8) less than the $443.8 million (column 6) of tax that would have been generated using ordinary tax computations, in previous years, this provision in the tax law caused these taxpayer's to pay additional taxes in comparison to the regular tax rate, such as the $3.8 million for Tax Year 2004. However, this anomaly probably occurred for 2005 because the higher rates on Form 8615 were offset by the preferential rates given to investment income for these children's long-term capital gains and qualified dividends.
Alternative Minimum Tax
The Revenue Act of 1978 established the alternative minimum tax to ensure that a minimum amount of income tax was paid by taxpayers who might otherwise be able to legally reduce, or totally eliminate, their tax burdens. The AMT provisions may recapture some of the tax reductions under the ordinary income tax. Form 625 I, Alternative Minimum Tax--Individuals, is used to calculate AMT. (See Computation of Alternative Minimum Taxable Income for an explanation of the computation of income for AMT purposes.)
Figure E presents statistics, by size of AGI, on the AMT reported by taxpayers filing Form 6251 with their returns. Some taxpayers included Form 6251 even though their tax liability was not increased due to the AMT. The tabulations in Figure E include such forms. For 2005, AMT liability rose 33.7 percent to $17.4 billion from $13.0 billion in 2004. This rise in AMT coincided with a large increase in the number of returns that were subject to paying the AMT. The number of returns subject to paying the AMT increased 29.3 percent from 2004 to 4.0 million returns for 2005, and the Alternative Minimum Taxable Income (AMTI) increased 27.0 percent from 2004. In addition, limiting certain business tax credits, the AMT increases the tax liability for some taxpayers who do not have any AMT liability.
Figure F shows the number of taxpayers with AMT liability and the amount of that liability for each of the years 1986 through 2005. Much of the variation in the number of taxpayers affected by the AMT and in the amount of AMT liability during the mid-to-late 1980s and early 1990s was attributable to tax law changes such as TRA86, RRA90 (Revenue Reconciliation Act of 1990), and OBRA93, which altered the AMT. Since then, the impact of the AMT has increased partially because the AMT exemptions have not been automatically indexed annually for the effects of inflation, whereas various parameters of the ordinary income tax (such as tax brackets, exemptions, etc.) have been indexed annually for inflation. In both EGTRRA in 2001 and JGTRRA in 2003, AMT exemptions were increased, while ordinary tax rates declined. For 2003, 2004, and 2005, AMT levels rose to $9.5 billion, $13.0 billion, and $17.4 billion, respectively. The amount in 2005 set the all-time high paid by individual taxpayers, surpassing the previous high set last year. This marks the fourth year in a row of increases in AMT levels. Since 2001, the AMT liability has increased a total of 157.8 percent. Also, during this same time, the number of returns paying AMT has more than tripled from 1.1 million to 4.0 million.
Income and Tax Shares
Historical statistics from 1986 through 2005 on income and tax by cumulative percentiles (based on numbers of returns) are presented in Tables 5 through 8. Distributions of AGI, as defined for each year and tax or income item, by descending and ascending cumulative percentiles of returns, are presented in Tables 5 and 6. These tables can be used to make comparisons across cumulative percentile classes within each year, among years within the ERTA81 period (i.e., Tax Years 1982 through 1986), and among years within the post-TRA86 period (i.e., Tax Years 1987 through 2005). Since TRA86 redefined AGI, Tables 5 and 6 are not as useful for comparisons between pre- and post-TRA86 years. Thus, Tables 7 and 8, which are based on a consistent definition of income (i.e., the 1979 Income Concept), are included to facilitate such comparisons.
Tables 5 and 7 are based on percentiles of returns cumulated downward from the highest income returns. The data in Tables 5 and 7 are shown for the top 1 percent, 5 percent, 10 percent, 25 percent, and 50 percent of returns. Tables 6 and 8 are based on returns cumulated upward from the lowest income returns. Data are shown for the bottom 50 percent, 75 percent, 90 percent, 95 percent, and 99 percent of all returns.
Consider, for example, the data in Table 5 for the 132.6 million returns filed for 2005 with positive AGI. (7) The average tax rate for these returns was 12.4 percent, a 0.3-percentage point increase from 2004. (A sizable portion of returns with positive AGI are nontaxable, accounting for the difference in the computation of this particular average tax rate versus the 13.6-percent average tax rate for taxable returns only--Figure A.) The average tax rate increased for second year in a row after having fallen for 3 previous years, bottoming out at 11.9 percent in 2003. Despite the overall increase, the average tax rate on the top 1 percent decreased, while the rates paid by the top 5 percent, 10 percent, 25 percent, and 50 percent all increased from 2004. The top I percent, 5 percent, 10 percent, 25 percent, and 50 percent all also recorded a larger share of the income tax burden than their respective shares of AGI. For 2005, the returns in the top 1 percent reported 21.2 percent of total AGI and 39.4 percent of income tax. The amount of AGI needed for inclusion in this percentile group (i.e., the AGI floor) was $364,657. For 2004, the returns in this percentile group (i.e., those with at least $328,049 in AGI) reported 19.0 percent of total AGI and 36.9 percent of total income tax.
For 2005, the returns in the top 5-percent group (returns reporting AGI of $145,283 or more) reported 35.7 percent of total AGI and 59.7 percent of income tax, compared to 33.5 percent and 57.1 percent, respectively, for 2004 (when the AGI floor was $137,056). For 2005, returns in the top 10-percent group (returns with AGI of at least $103,912) earned 46.4 percent of AGI and paid 70.3 percent of income tax. For 2004, the returns in this percentile group (with AGI of $99,112 or more) reported 44.4 percent of total AGI and 68.2 percent of income tax. The top 50-percent group (earning $30,881 or more) accounted for 87.2 percent of income and paid almost all (96.9 percent) of the income tax for 2005.
The statistics by percentile in Tables 5 and 6 for years prior to 1991 and in Tables 7 and 8 for years prior to 1994 were estimated, using a mathematical technique called "osculatory interpolation," applied to aggregated data tabulated by income-size classes, in order to distribute the tax returns within each class. (8) For 1991 and later years, the statistics by percentiles in Tables 5 and 6, and Tables 7 and 8 for 1994 through 2005 were computed based on an actual ranking of the returns in the statistical sample that served as the basis for Individual Statistics of Income estimates. The differences under the two methods were judged to be minor enough so that the pre- 1991 and post-1990 data are believed to be comparable.
Explanation of Selected Terms
This appendix provides brief explanations of the major tax concepts discussed. For more extensive definitions, see Individual Income Tax Returns 2005, Statistics of Income Division, Internal Revenue Service, Publication 1304.
Adjusted Gross Income--Adjusted gross income is "total income," as defined by the Tax Code, less "statutory adjustments" (primarily business, investment, or certain other deductions, such as payments to a Keogh self-employed retirement plan, certain deductible contributions to an Individual Retirement Arrangement (IRA), self-employed health insurance deductions, and one-half of Social Security taxes for the self-employed). Total income includes, for example, salaries and wages, taxable interest, dividends, alimony, and net amounts from such sources as business income, rents and royalties, and sales of capital assets.
Difference Due to Special Tax Computation--For this article, the tax difference is the amount of tax resulting from using provisions of one of the special tax computations (Form 8615 or Schedule D and qualified dividends) less the amount of tax that would have resulted from not having used any of these provisions (regular tax computation).
Dividends--Ordinary dividend income consisted of distributions of money, stock, or other property received by taxpayers from domestic and foreign corporations, either directly or passed through estates, trusts, partnerships, or regulated investment companies. Ordinary dividends also included distributions from money market mutual funds.
Ordinary dividends did not include nontaxable distributions of stock or stock rights, returns of capital, capital gains, or liquidation distributions. Taxpayers were also instructed to exclude amounts paid on deposits or withdrawable accounts in banks, mutual savings banks, cooperative banks, savings and loan associations, and credit unions, which were treated as interest income.
Qualified dividends are the ordinary dividends received in tax years beginning after 2002 that met certain conditions. These conditions include: the dividend must have been paid by a U.S. corporation or a "qualified" foreign corporation; the stock ownership must have met certain holding period requirements; the dividends were not from certain institutions, such as mutual savings banks, cooperative banks, credit unions, tax-exempt organizations, or farmer cooperatives; and the dividends were not for any share of stock which was part of an employee stock ownership plan (ESOP). The maximum tax rate for qualified dividends was 15 percent generally (or 5 percent for amounts that would otherwise have been taxed at the 10-percent or 15-percent regular income rate).
Form 8615 Tax Computation--Form 8615 was used to compute the tax on investment income of children under age 14 who had investment income of more than $1,600. Generally, such income was taxed as the marginal income of the parents.
Income Tax Before Credits--This amount consisted of the tax liability on taxable income, computed by using the tax tables, tax rate schedules, Schedule D Tax worksheet, Schedule J, or Form 8615, plus Form (s) 8814, any additional taxes from Form 4972, and the alternative minimum tax.
Income Tax Before Credits (Regular Tax Computation)--This amount consisted of the tax liability on ordinary income, computed by using the tax table or applying the rates from one of the four tax rate schedules, plus any additional tax (tax on lump-sum distributions from qualified retirement plans). When Form 8615 tax was payable on investment income of children, for this concept, all the income was taxed at the child's rate rather than at the rate...
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More articles from Statistics of Income. SOI Bulletin
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SOI sampling methodology and data limitations., January 01, 2008
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