TAX HISTORY

I couldn't come up with anything else to write about, so here is a "rerun" of a post from a few years back with an overview of the history of our federal income tax, updated for more recent developments.

 

1643: The colony of New Plymouth, Massachusetts levies the first recorded income tax in America.

1861: Congress passed the first income tax law as an emergency measure to fund the Civil War.

1872: Congress repeals the income tax law.

1894: As a response to complaints that excessive reliance on tariffs as a source of revenue resulted in an increase in the cost of imported goods, Congress again passed an income tax law.

1895: The US Supreme Court ruled that the income tax law was unconstitutional.

1913: In February the 16th Amendment, which states "Congress shall have the power to lay and collect tax on incomes, from whatever sources derived, without apportionment among the several states, and without regard to any census or enumeration", was ratified by the necessary 3/4 of the states. On October 3rd Congress passed the Revenue Act of 1913, which created the first permanent US income tax.

Under this act, the first $3000 of income for single persons and $4000 for married couples was exempt from taxation. A "normal" tax of 1% was applied to income above $3000 or $4000, and a "super" tax of from 1-6% was applied to income in excess of $20,000. Deductions were allowed for business expenses (including depreciation), interest paid on "personal indebtedness", all national, state, county, school and municipal taxes paid, casualty losses, and worthless debt. In the first year only 1 out of every 271 American citizens were taxed and $28 Million in revenue was raised.

1916: The Federal Estate Tax was enacted to help generate additional revenue to fund America's anticipated entry into the first World War.

1917: Congress raised tax rates in response to the increasing cost of the war and approved credit for dependents and deductions for charitable contributions.

1918: The maximum combined basic and super income tax rate reached 77%.

1922: For the first time preferential tax treatment was provided for capital gains.

1932: The tax law was amended to provide that US presidents were liable for federal income tax on their salaries. Franklin Roosevelt was the first president since Abraham Lincoln to pay federal income tax on his presidential salary.

1935: The Social Security tax, 1% on the first $3000 of wages, was enacted.

1941: Tax tables for low-income taxpayers were introduced, simplifying the calculation of tax liability.

1942-1945: New tax laws, in response to the cost of World War 2, created withholding on wages, more tax brackets for lower income taxpayers, the standard deduction, a personal exemption for dependents, a deduction for medical expenses, and increased tax rates. By the end of the war the maximum tax rate was 94%.

1953: The Bureau of Internal Revenue becomes the Internal Revenue Service. And Robert D Flach, who would eventually become the internet's WANDERING TAX PRO, is born.

1954: Congress completely revised the Tax Code, changing rates, redefining Adjusted Gross Income, and adding credits for retirement income and dividends and new itemized deductions.

1961: Taxpayers were required to provide their Social Security or other taxpayer identification number to banks and other financial institutions so they could report interest and dividend payments to the IRS.

1964: Tax rates were reduced from a range of from 20% to 94% to from 16% to 77%. The Income Averaging method of tax computation was introduced.

1970: Congress created a Minimum Tax so high-income individuals could not completely avoid paying taxes through the use of preferential tax shelters, loopholes and deductions.

1972: Robert D Flach, who would later become the internet's WANDERING TAX PRO, prepares his first Form 1040 as a paid preparer.

1974: Congress created the deductible Individual Retirement Account (IRA) for taxpayers not covered by employer pension plans.

1975: Low-income taxpayers were allowed to claim a refundable Earned Income Credit (EIC).

1979: Unemployment compensation was made partially taxable.

1981: Tax legislation reduced tax rates by 25% over 3 years, indexed tax brackets for inflation, and applied the same tax rates to earned and unearned income.

1984: For the first time recipients of Social Security and Railroad Retirement benefits were subject to tax on up to 50% of the benefits received, depending on the recipient's income.

1986: The largest revision of the Tax Code since 1954, the Tax Reform Act of 1986, was enacted. The law reduced the number of tax brackets from 14 to 2, decreased the maximum tax rate from 50% to 28%, repealed the dividend exclusion, Income Averaging, the itemized deduction for sales tax paid and the preferential treatment of long-term capital gains, introduced the passive activity rules, the Kiddie Tax, the deduction from gross income for health insurance premiums paid by self-employed individuals, and the 2% of AGI limitation on most miscellaneous itemized deductions, phased out the itemized deduction for personal (credit card, auto loan, etc.) interest, limited the deduction for business meals and entertainment to 80%, and replaced the additional personal exemption s for age 65 and blind with an increased standard deduction.

1987: For the first time taxpayers were required to list the Social Security number of dependent children, age 5 and over.

1990: The Revenue Reconciliation Act of 1990 added a third tax bracket (31%) and instituted the reduction of itemized deductions and phase-out of personal exemptions for high-income taxpayers.

1993: The Omnibus Budget Reconciliation Act added the 36% and 39.6% tax brackets, increased the maximum tax on Social Security benefits from 50% to 85%, and reduced the deduction for business meals and entertaining from 80% to 50%.

1998: In response to abusive treatment of taxpayers by the Internal Revenue Service, the IRS Reform and Restructuring Act of 1998 was enacted.

2001: Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001, the largest tax cut in over 20 years, with 85 major provisions. All provisions of this act will expire in 2011. And Robert D Flach begins publishing THE WANDERING TAX PRO blog.

2003: To stimulate the economy, Congress passed the Jobs and Growth Tax Relief Reconciliation Act of 2003, the third major tax bill in as many years, and the third largest tax cut in history.

 

2010:  Congress passed the "Patient Protection and Affordable Care Act of 2010 and Health Care and Education Reconciliation Act of 2010", aka "Obamacare", which made the US Tax Code even more of a mucking fess and created more unnecessary work for tax preparers.

 

2013: Congress passed the "American Taxpayer Relief Act of 2012", which made permanent most of the expiring "Bush" tax cuts )from the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003), permanently "fixed" the dreaded Alternative Minimum Tax, and brought back PEP and Pease.

Click HERE for reports, information, and charts on major tax legislation over the years.  

TTFN

SUMMER RERUN - TAX HISTORY

Let me end a week of tax history with a brief overview -

1643: The colony of New Plymouth, Massachusetts levies the first recorded income tax in America.

1861: Congress passed the first income tax law as an emergency measure to fund the Civil War.

1872: Congress repeals the income tax law.

1894: As a response to complaints that excessive reliance on tariffs as a source of revenue resulted in an increase in the cost of imported goods, Congress again passed an income tax law.

1895: The US Supreme Court ruled that the income tax law was unconstitutional.

1913: In February the 16th Amendment was ratified by the necessary 3/4 of the states. On October 3rd Congress passed the Revenue Act of 1913, which created the first permanent US income tax.  In the first year only 1 out of every 271 American citizens were taxed and $28 Million in revenue was raised.

1916: The Federal Estate Tax was enacted to help generate additional revenue to fund America's anticipated entry into the first World War.

1917: Congress raised tax rates in response to the increasing cost of the war and approved credit for dependents and deductions for charitable contributions.

1918: The maximum combined basic and super income tax rate reached 77%.

1922: For the first time preferential tax treatment was provided for capital gains.

1932: The tax law was amended to provide that US presidents were liable for federal income tax on their salaries. Franklin Roosevelt was the first president since Abraham Lincoln to pay federal income tax on his presidential salary.

1935: The Social Security tax, 1% on the first $3000 of wages, was enacted.

1941: Tax tables for low-income taxpayers were introduced, simplifying the calculation of tax liability.

1942-1945: New tax laws, in response to the cost of World War 2, created withholding on wages, more tax brackets for lower income taxpayers, the standard deduction, a personal exemption for dependents, a deduction for medical expenses, and increased tax rates. By the end of the war the maximum tax rate was 94%.

1953: The Bureau of Internal Revenue becomes the Internal Revenue Service. And Robert D Flach, who would eventually become the internet's WANDERING TAX PRO, is born.

1954: Congress completely revised the Tax Code, changing rates, redefining Adjusted Gross Income, and adding credits for retirement income and dividends and new itemized deductions.

1961: Taxpayers were required to provide their Social Security or other taxpayer identification number to banks and other financial institutions so they could report interest and dividend payments to the IRS.

1964: Tax rates were reduced from a range of from 20% to 94% to from 16% to 77%. The Income Averaging method of tax computation was introduced.

1970: Congress created a Minimum Tax so high-income individuals could not completely avoid paying taxes through the use of preferential tax shelters, loopholes and deductions.

1972: Robert D Flach, who would later become the internet's WANDERING TAX PRO, prepares his first Form 1040 as a paid preparer.

1974: Congress created the deductible Individual Retirement Account (IRA) for taxpayers not covered by employer pension plans.

1975: Low-income taxpayers were allowed to claim a refundable Earned Income Credit (EIC).

1979: Unemployment compensation was made partially taxable.

1981: Tax legislation reduced tax rates by 25% over 3 years, indexed tax brackets for inflation, and applied the same tax rates to earned and unearned income.

1984: For the first time recipients of Social Security and Railroad Retirement benefits were subject to tax on up to 50% of the benefits received, depending on the recipient's income.

1986: The largest revision of the Tax Code since 1954, the Tax Reform Act of 1986, was enacted. The law reduced the number of tax brackets from 14 to 2, decreased the maximum tax rate from 50% to 28%, repealed the dividend exclusion, Income Averaging, the itemized deduction for sales tax paid and the preferential treatment of long-term capital gains, introduced the passive activity rules, the Kiddie Tax, the deduction from gross income for health insurance premiums paid by self-employed individuals, and the 2% of AGI limitation on most miscellaneous itemized deductions, phased out the itemized deduction for personal (credit card, auto loan, etc.) interest, limited the deduction for business meals and entertainment to 80%, and replaced the additional personal exemption s for age 65 and blind with an increased standard deduction.

1987: For the first time taxpayers were required to list the Social Security number of dependent children, age 5 and over.

1990: The Revenue Reconciliation Act of 1990 added a third tax bracket (31%) and instituted the reduction of itemized deductions and phase-out of personal exemptions for high-income taxpayers.

1993: The Omnibus Budget Reconciliation Act added the 36% and 39.6% tax brackets, increased the maximum tax on Social Security benefits from 50% to 85%, and reduced the deduction for business meals and entertaining from 80% to 50%.

1998: In response to abusive treatment of taxpayers by the Internal Revenue Service, the IRS Reform and Restructuring Act of 1998 was enacted.

2001: Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001, the largest tax cut in over 20 years, with 85 major provisions. All provisions of this act will expire in 2011. And Robert D Flach begins publishing THE WANDERING TAX PRO blog.

2003: To stimulate the economy, Congress passed the Jobs and Growth Tax Relief Reconciliation Act of 2003, the third major tax bill in as many years, and the third largest tax cut in history.

TTFN

SUMMER RERUN - THE FIRST 1040

I talked about my first 1040.  Now here is a post on the first 1040 –

In February of 1913 the 16th Amendment was ratified by the required three-fourths of the states. The amendment gave Congress the power to “lay and collect tax on incomes, from whatever sources derived, without apportionment among the several states, and without regard to any census or enumeration.” On October 3, 1913, Congress passed the Revenue Act of 1913, which created the first permanent federal income tax.

Congress had made two previous attempts at instituting a federal income tax. The first, in 1861, was an emergency measure to fund the Civil War and was repealed in 1872. In 1894, in response to complaints that excessive reliance on tariffs as a source of revenue caused the price of imported goods to rise, Congress again passed an income tax law, which the Supreme Court ruled unconstitutional in 1895.

Here are some facts about the very first Form 1040:

· The tax applied to salaries and wages, interest, dividends, rents, royalties, pensions and annuities, income from estates, trusts, sole proprietorships and partnerships, and gains from the sale of most types of property.

· The salaries and wages of state and local government employees were exempt from income tax.

· Interest from federal, as well as state and local, government bonds were exempt from income tax.

· Deductions were allowed for “personal” interest, federal excise taxes, taxes paid to state and local governments, casualty and theft losses, bad debts, business expenses, and depreciation of property used in business.

· There was an exemption of $3,000.00 for single persons and $4,000.00 for married couples.

· A “normal” tax of 1% was applied to the first $20,000.00 of taxable income. Dividends were exempt from this “normal” tax. An additional or “super” tax of from 1% to 6% was applied to income, including dividends, in excess of $20,000.00.

· The return was due “on or before the first day of March”.

· There was only one page of instructions!

Over the years the federal income tax has evolved into the complicated “mess” that it is today. According to former Treasury Secretary Paul O’Neill, “Our tax code is so complicated; we’ve made it nearly impossible for even the Internal Revenue Service to understand.”  

TTFN

SUMMER RERUN - MY FIRST 1040

The first Form 1040 that I did as a paid preparer was the 1971 model (I can actually tell you the name of the taxpayer on the very first 1040 I worked on). There have been tons of changes to the 1040 over the years.

On Page 1 of the 1971 Form 1040 one would indicate name, address and Social Security numbers of the filer(s). In the case of a return for a married couple the names were listed as “Richard and Mary Taxpayer” on one line instead of a separate line for the name of each spouse. The filing status was checked and exemptions were claimed. The taxpayer and spouse could each claim an additional exemption for being 65 or over and blind. The names, but not Social Security numbers, of dependent children were listed, with no indication of whether they “lived with you” or “did not live with you”. The names, but again not Social Security numbers, of “other” dependents were listed on Page 2 of the 1040.

Income was reported on Lines 12 through 18 on Page 1, with lines for wages, dividends (no designation of “qualified”), interest (taxable only – no reporting of tax-exempt interest), and “income other than wages, dividends and interest”, the sub-total, total “adjustments to income” and Adjusted Gross Income. The Line for dividends include (a) for gross dividends and (b) for an exclusion amount. If gross dividends and/or total interest exceeded $100 one would have to complete and attach Schedule B

The net tax liability was reported on Lines 19 through 23. Federal Income Tax withheld, Estimated Tax Payments, and “Other payments” were deducted and a balance due or refund was indicated.

Line 31 of the Form 1040, and not Schedule B, was where the taxpayer was asked about foreign accounts.

Page 2 of the Form 1040 consisted of Part I where other dependents were listed, along with relationship, months live in taxpayer’s home, did dependent have income of $675 or more, amount taxpayer furnished toward support, and amount furnished by all others, including the dependent, but not the dependent(s)’ Social Security number(s).

Specific items of income, adjustments to income, credits, other taxes, other payments, and the actual Tax Computation were reported on Lines 34 through 64 in Parts II through VII.

Social Security, Railroad Retirement, and Unemployment benefits were totally exempt from federal income tax. One could use the “3-year” rule for recovering employee contributions to determine the taxable portion of pensions and annuities. This was calculated on Part I of Schedule E.

Adjustments to income included –

* “sick pay”,

* Moving expense,

* Employee business expense, and

* Payments as a self-employed person to a retirement plan, etc.

The only credits indicated on the 1040 were –

* Retirement income credit,

* Investment credit, and

* Foreign tax credit.

The personal exemption amount was $675. Tax could be calculated by “using Tax Rate Schedule X, Y or Z, or if applicable, the alternative tax from Schedule D, income averaging from Schedule G, or maximum tax from Form 4726”. Other taxes included a line for “Minimum tax”, not yet alternative.

On Schedule A –

* medical and dental expenses were reduced by 3% of Adjusted Gross Income (this was the only item on the Form 1040 that was reduced based on AGI),

* taxes included state and local gasoline tax (from gas tax tables), general sales tax (from sales tax tables) and (not or) state and local income tax, with an additional deduction allowed for sales tax paid on “major purchases”,

* contributions were deductible pretty much as they are now, except there was no strict requirement for documentation,

* interest expense included not only home mortgage interest (fully deductible – no principle restrictions) but also interest on installment purchases and credit cards, and

* miscellaneous deductions were not reduced by a % of AGI; certain employee business expense, as mentioned earlier, were deductible as an “above-the-line” adjustment to income.

Schedule D allowed for a 50% deduction for net long-term capital gain – only half of such gains were included in AGI. So if net long-term capital gain (or net combined long-term and short-term gain if smaller) was $10,000, only $5,000 was reported as income on Page 2 of Form 1040. The maximum net capital loss deduction was $1,000.

The starting tax rate was 14% and the top was 70%, although the rate for “earned income” such as wages was capped at 50% - hence the “Maximum Tax” calculated on Form 4726.

The 1971 standard deduction was $1,050 for both a single person and a married couple. The standard deduction was originally 10% of AGI up to a maximum of $1,000. It wasn’t until 1975 that the standard deduction for married was more than that for single. Click here for a chart of historical standard deduction amounts for single persons and married couples.

Obviously the 1971 tax returns were prepared by hand. We didn’t even have photocopies back then (at least where I worked). The returns were written, or sometimes typed, on 3-copy carbonized forms purchased from Accountants Supply House in Valley Stream, New York State.

So tax rates were higher back then – but there were a lot more deductions allowed. And one could also use either Income Averaging or 10-Year Averaging to cut thousands off a large tax bill.

How do I remember all this? My memory is good – but not that good. I have a client, originally a client of my mentor Jim Gill, for whom I have a copy of every single Form 1040 filed since 1970 in the file.

So do you think the Tax Code is better now, or was it “more better” back then?

TTFN

THOSE WERE THE DAYS

Every now and then a tax-related blog post, article or news item will take me back to my early days in the tax business.

A recent post by Professor Jim Maule on Income Averaging, referenced in Saturday’s BUZZ installment, did just that.  So I thought I would rerun two posts from the past on the Golden Age of 1040s -

Those were the days, my friend -

* when a savvy tax preparer could "pull a rabbit out of a hat" and save a client literally thousands of dollars in federal income tax with "Income Averaging" or "10-Year Averaging" (and in doing so be assured a client for life),

* when credit card interest, auto loan interest and personal loan interest, as well as our tax preparation fees, were fully deductible,

* when "Employee Business Expenses" were an adjustment to income and not an itemized deduction subject to a 2% of AGI exclusion,

* when there was no such thing as an Adjusted Gross Income exclusion or threshold or the "phase-out" of a deduction or credit,

* before all the acronyms (PIG, PAL, ACRS, MACRS and so on),

* and when one-half of long-term capital gain just disappeared from the tax return.

I started my career in February of 1972, preparing 1971 tax returns, when a deduction was really worth something and everyone itemized. As we used to tell clients, "Uncle Sam will reimburse you for up to half of our fee!"

In 1971 the top tax rate was 70%. There was a "minimum tax", not yet alternative, and a "maximum tax" (i.e. the maximum tax on "earned income" was 50%). While we did prepare a few maximum tax forms, I do not recall ever preparing a minimum tax form. The Alternative Minimum Tax did not begin to affect out clients until the 2nd half of the 1990s.

I went to work for James P Gill, my uncle's tax preparer, during my first year of college, with no experience preparing tax returns. I had never prepared a tax return before, not even my own! My education consisted solely of the freshman semester of "Accounting 101".

I learned the business the absolute best way possible - by actually preparing returns. On my first day of work I was given a briefcase containing a client's current year "stuff" and a copy of the previous year's return and told to "jump in and swim". If I had a question I would ask Jim, blessed with the patience of a Saint (a trait I soon learned was essential for a tax preparer), who would stop what he was doing to explain the answer to me.

I worked in a true "storefront" office on the fringe of Journal Square, Jersey City's equivalent of Times Square (made famous in the "Jersey Bounce", which "started at Journal Square"), where we dealt with what Jim affectionately referred to as "the great unwashed masses" on a daily basis.

There were no computers in those days. During my first few years we did not even have a copy machine in the office. Returns were prepared by hand on 3-page carbonized forms purchased from Accountant's Supply House. To this day I still prepare all my 1040s manually - in 35 tax seasons I have never used tax preparation software to prepare a return.

As I started out in the tax preparation business the matching of 1099s to 1040s had just begun. I remember a client who came into the office during my first or second year with a humungous print-out from the IRS listing by source all the interest and dividends that he had failed to report on his previous year's 1040.

Back then a tax preparer was truly in many ways also a "father confessor". One day a widow came into the office dressed in her black mourning outfit and waited to see Jim. Once in the "inner sanctum" she confessed that while her husband was alive she filed a joint return with him, prepared by our office, claiming only his income, and she also filed a single return, elsewhere, under her own Social Security number to report a small pension she received in her maiden name. In those days only the Social Security number of the husband was required to be entered on the return - and not that of the spouse. After giving her "absolution" Jim commenced to fix the situation.

During my early years you were also not required to list the Social Security number for dependents claimed on your return. One year a married client, let's call him John and call his wife Mary, left his "stuff" off at the office, which included a handwritten sheet listing, among other deductions, "dependents" John, Mary, Paul and George. The college student who prepared the return that year (not me) listed as dependents John, Mary, Paul and George. The client received the refund requested on the return without question.

The next year John came in and stayed while I prepared the return. I asked if he was still claiming his four kids, John, Mary, Paul and George, and he told me that he only had two children - Paul and George! The John and Mary he had listed on the sheet the previous year was apparently he and his wife. It appears that the student who had prepared the earlier return had forgotten our first, and most important, rule of tax preparation - always review the prior year's return when preparing the current 1040.

At the recent IRS Tax Forum it was reported that in the first year you were required to list a Social Security number for all of your dependents about 5 Million dependents disappeared from tax returns.

Over the years, due to our proximity to New York City, we prepared the returns of some "semi-famous" taxpayers. One year in the late 1970s we prepared the 1040 for the then captain of the New York Giants football team, who was partner in a local restaurant with one of our long-time clients. This was well before the days when professional athletes all had multi-million dollar contracts, but I do recall being surprised that his W-2 was only $100,000+. FYI, this person was one of the rare clients, I can count them on the fingers of one hand, who "stiffed" Jim over the years.

When the drummer for the original off-Broadway production of ONE MO' TIME became sick and a local union musician, whose return we prepared, took his place we welcomed as new clients most of the members of the cast, who came up to New York from New Orleans where the show had originated. It was the first year we added the Louisiana state income tax return to our repertoire. I remember having complimentary tickets for the show upstairs at the Village Gate and going backstage after the performance to deliver finished returns. We also did the tax returns for the road company.

Our clients were extremely loyal. If they moved out of state they would continue to mail their tax returns to us. We had one client who had retired to the Netherlands and still had us prepare her 1040!

Some clients were also compulsively consistent, coming in to have their returns done on the same day each year. Back when Abe Lincoln had his own separate legal holiday February 12th was a busy day for us, especially with teachers. We also had our share of clients who would wait until the very last day of each tax season, generally April 15th, to come in. When we saw Wally Weinmann, usually the last person on the last day, we knew that it was over! We even had a tv repairman who was always a year and a day late - he would come in on April 16th of 1975, for example, to have his 1973, not 1974, tax return prepared!

Of course in the "good old days" we never filed an extension. We finished all the returns on April 15th - even if we had to stay up until 3 am to do so!

A lot has changed since those days. Reagan completely rewrote the tax code with the Tax Reform Act of 1986, doing away with a lot of the loopholes and deductions we had used to work magic. Jim decided to retire when he turned 75 and handed his practice and office over to me. He would come in to help during the last weeks of the season until he passed away three years later.

As you may know, I now work out of a home office and no longer take on new clients. While I do not miss dealing with the "great unwashed masses" I do miss the "good old days". Every now and then a long-time client, faced with a large balance due to "Sam", will ask if we can Income Average and I think back to the days when we could "pull a rabbit out of a hat".

And of course, most of all I miss the days when come April 15th it was truly over - and we didn't have to spend the next six months dealing with GD extensions!

Tomorrow I will tell you about MY FIRST 1040.

TTFN

CHECK IT OUT

Tomorrow, October 22^nd, is the 25^th anniversary of the date President Ronald Reagan signed into law the Tax Reform Act of 1986 - “the most sweeping revision in the history of tax law”.

TRA 86 was billed as “tax simplification”.  It did simplify some things – reducing the number of tax brackets from 14 to 2 and eliminating and limiting certain deductions and tax calculation methods - but it also instituted complicated passive activity rules and started the ball rolling on limitations based on an AGI income.

I wrote a guest post on the Act for Peter J Reilly, CPA, author of the, coincidently, PASSIVE ACTIVIES blog at FORBES.COM.

Click here to check out my guest post.

The guest post ends on the prospects for another major tax reform in the near future.  After writing the item I came across an excellent list of the ingredients for tax reform from former Senator Bill Bradley (click here for the source) -

“Tax reform requires presidential leadership, an empowered Treasury Secretary, enthusiastic chairs of congressional tax writing committees, and a ‘zealot’ to push it.”

None of these items are currently in place.

And as further commentary on the prospects let me repeat something that I recently referenced in a BUZZ installment.  It seems all of the idiots in Congress want to close “tax loopholes” and do away with “tax expenditures” – except, of course, for the ones they personally helped create (click here for source).

TAX HISTORY

While I am in Maryland visiting with my uncle here is a brief history of the US income tax:

1643: The colony of New Plymouth, Massachusetts levies the first recorded income tax in America.

1861: Congress passed the first income tax law as an emergency measure to fund the Civil War.

1872: Congress repeals the income tax law.

1894: As a response to complaints that excessive reliance on tariffs as a source of revenue resulted in an increase in the cost of imported goods, Congress again passed an income tax law.

1895: The US Supreme Court ruled that the income tax law was unconstitutional.

1913: In February the 16th Amendment, which states "Congress shall have the power to lay and collect tax on incomes, from whatever sources derived, without apportionment among the several states, and without regard to any census or enumeration", was ratified by the necessary 3/4 of the states. On October 3rd Congress passed the Revenue Act of 1913, which created the first permanent US income tax.

Under this act, the first $3000 of income for single persons and $4000 for married couples was exempt from taxation. A "normal" tax of 1% was applied to income above $3000 or $4000, and a "super" tax of from 1-6% was applied to income in excess of $20,000. Deductions were allowed for business expenses (including depreciation), interest paid on "personal indebtedness", all national, state, county, school and municipal taxes paid, casualty losses, and worthless debt. In the first year only 1 out of every 271 American citizens were taxed and $28 Million in revenue was raised.

1916: The Federal Estate Tax was enacted to help generate additional revenue to fund America's anticipated entry into the first World War.

1917: Congress raised tax rates in response to the increasing cost of the war and approved credit for dependents and deductions for charitable contributions.

1918: The maximum combined basic and super income tax rate reached 77%.

1922: For the first time preferential tax treatment was provided for capital gains.

1932: The tax law was amended to provide that US presidents were liable for federal income tax on their salaries. Franklin Roosevelt was the first president since Abraham Lincoln to pay federal income tax on his presidential salary.

1935: The Social Security tax, 1% on the first $3000 of wages, was enacted.

1941: Tax tables for low-income taxpayers were introduced, simplifying the calculation of tax liability.

1942-1945: New tax laws, in response to the cost of World War 2, created withholding on wages, more tax brackets for lower income taxpayers, the standard deduction, a personal exemption for dependents, a deduction for medical expenses, and increased tax rates. By the end of the war the maximum tax rate was 94%.

1953: The Bureau of Internal Revenue becomes the Internal Revenue Service. And Robert D Flach, who would eventually become the internet's WANDERING TAX PRO, is born.

1954: Congress completely revised the Tax Code, changing rates, redefining Adjusted Gross Income, and adding credits for retirement income and dividends and new itemized deductions.

1961: Taxpayers were required to provide their Social Security or other taxpayer identification number to banks and other financial institutions so they could report interest and dividend payments to the IRS.

1964: Tax rates were reduced from a range of from 20% to 94% to from 16% to 77%. The Income Averaging method of tax computation was introduced.

1970: Congress created a Minimum Tax so high-income individuals could not completely avoid paying taxes through the use of preferential tax shelters, loopholes and deductions.

1972: Robert D Flach, who would later become the internet's WANDERING TAX PRO, prepares his first Form 1040 as a paid preparer.

1974: Congress created the deductible Individual Retirement Account (IRA) for taxpayers not covered by employer pension plans.

1975: Low-income taxpayers were allowed to claim a refundable Earned Income Credit (EIC).

1979: Unemployment compensation was made partially taxable.

1981: Tax legislation reduced tax rates by 25% over 3 years, indexed tax brackets for inflation, and applied the same tax rates to earned and unearned income.

1984: For the first time recipients of Social Security and Railroad Retirement benefits were subject to tax on up to 50% of the benefits received, depending on the recipient's income.

1986: The largest revision of the Tax Code since 1954, the Tax Reform Act of 1986, was enacted. The law reduced the number of tax brackets from 14 to 2, decreased the maximum tax rate from 50% to 28%, repealed the dividend exclusion, Income Averaging, the itemized deduction for sales tax paid and the preferential treatment of long-term capital gains, introduced the passive activity rules, the Kiddie Tax, the deduction from gross income for health insurance premiums paid by self-employed individuals, and the 2% of AGI limitation on most miscellaneous itemized deductions, phased out the itemized deduction for personal (credit card, auto loan, etc.) interest, limited the deduction for business meals and entertainment to 80%, and replaced the additional personal exemption s for age 65 and blind with an increased standard deduction.

1987: For the first time taxpayers were required to list the Social Security number of dependent children, age 5 and over.

1990: The Revenue Reconciliation Act of 1990 added a third tax bracket (31%) and instituted the reduction of itemized deductions and phase-out of personal exemptions for high-income taxpayers.

1993: The Omnibus Budget Reconciliation Act added the 36% and 39.6% tax brackets, increased the maximum tax on Social Security benefits from 50% to 85%, and reduced the deduction for business meals and entertaining from 80% to 50%.

1998: In response to abusive treatment of taxpayers by the Internal Revenue Service, the IRS Reform and Restructuring Act of 1998 was enacted.

2001: Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001, the largest tax cut in over 20 years, with 85 major provisions. All provisions of this act will expire in 2011. And Robert D Flach begins publishing THE WANDERING TAX PRO blog.

2003: To stimulate the economy, Congress passed the Jobs and Growth Tax Relief Reconciliation Act of 2003, the third major tax bill in as many years, and the third largest tax cut in history.

CLICK HERE TO DOWNLOAD A COPY OF THE 30-PAGE SPECIAL REPORT "SUMMARY OF MAJOR ENACTED TAX LEGISLATION FROM 1981-2006" BY THE TAX POLICY CENTER.

TTFN

A BELATED HAPPY BIRTHDAY TO THE FEDERAL INCOME TAX!

The federal income tax celebrated its 97th birthday on October 3rd?

In February of 1913 the 16th Amendment was ratified by the required 3/4 of the states. The amendment gave Congress the power to “lay and collect tax on incomes, from whatever sources derived, without apportionment among the several states, and without regard to any census or enumeration.” On October 3, 1913, Congress passed the Revenue Act of 1913, which created the first permanent federal income tax.

Here are some facts about the very first Form 1040:

• The tax applied to salaries and wages, interest, dividends, rents, royalties, pensions and annuities, income from estates, trusts, sole proprietorships and partnerships, and gains from the sale of most types of property.

• The salaries and wages of state and local government employees were exempt from income tax.

• Interest from federal, as well as state and local, government bonds were exempt from income tax.

• Deductions were allowed for “personal” interest, federal excise taxes, taxes paid to state and local governments, casualty and theft losses, bad debts, business expenses, and depreciation of property used in business.

• There was an exemption of $3,000.00 for single persons and $4,000.00 for married couples.

• A “normal” tax of 1% was applied to the first $20,000.00 of taxable income. Dividends were exempt from this “normal” tax. An additional or “super” tax of from 1% to 6% was applied to income, including dividends, in excess of $20,000.00.

• The return was due “on or before the first day of March”.

• There was only one page of instructions.

• In the first year of the income tax only 1 out of every 271 American citizens were taxed and $28 Million in revenue was raised.

Over the past 97 years the federal income tax evolved into the mess that it is today. The Tax Code, which was 400 pages long in 1913, has swollen to over 71,000. The instruction booklet for the 1040 now has 44 pages (it was only 14 pages in 1987). According to former Treasury Secretary Paul O’Neill, “Our tax code is so complicated; we’ve made it nearly impossible for even the Internal Revenue Service to understand.” Here are some of the landmarks of this evolution.

• A personal exemption allowance for dependents and a deduction for charitable contributions were added in 1917.

• Capital gains were singled out for preferential treatment in 1922, although profits on the sale of certain types of property received special tax treatment as early as 1918.

• A deduction for medical expenses was introduced in 1942.

• The Standard Deduction was added in 1944 as an alternative to requiring taxpayers to itemize qualified expenses.

• An Income Averaging method of tax computation was initiated in 1964, to be taken away by the Tax Reform Act of 1986.

• A “minimum” tax on specified “tax preference” items first appeared in 1970, and was replaced by the dreaded Alternative Minimum Tax (AMT) in 1979.

• An Individual Retirement Account for taxpayers not covered by an employer pension plan was introduced in 1974.

• The refundable Earned Income Credit for low wage earners with dependent children was created in 1975.

• Unemployment compensation was made partially taxable in 1979, and was eventually made fully taxable. I remember saying at the time, “The next thing you know they will be taxing Social Security”.

• Social Security and Railroad Retirement benefits became partially taxable in 1984.

• Taxpayers were required to list the Social Security number of dependent children, age 5 and over, for the first time in 1987. Eventually Social Security numbers were required of all dependent children, and are now applied for at birth.

By the way, if you who think taxes are too high today, from the end of World War II through the early 1960s the top tax rate was more than 90%!

TTFN

A BELATED HAPPY BIRTHDAY!

We missed it! Did you know the federal income tax celebrated its 96th birthday on October 3rd?

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In February of 1913 the 16th Amendment was ratified by the required three-fourths of the states. The amendment gave Congress the power to “lay and collect tax on incomes, from whatever sources derived, without apportionment among the several states, and without regard to any census or enumeration.” On October 3, 1913, Congress passed the Revenue Act of 1913, which created the first permanent federal income tax.

Congress had made two previous attempts at instituting a federal income tax. The first, in 1861, was an emergency measure to fund the Civil War and was repealed in 1872. In 1894, in response to com-plaints that excessive reliance on tariffs as a source of revenue caused the price of imported goods to rise, Congress again passed an income tax law, which the Supreme Court ruled unconstitutional in 1895.

In celebration of this special occasion, here are some facts about the very first Form 1040:

• The tax applied to salaries and wages, interest, dividends, rents, royalties, pensions and annuities, in-come from estates, trusts, sole proprietorships and partnerships, and gains from the sale of most types of property.

• The salaries and wages of state and local government employees were exempt from income tax.

• Interest from federal, as well as state and local, government bonds were exempt from income tax.

• Deductions were allowed for “personal” interest, federal excise taxes, taxes paid to state and local governments, casualty and theft losses, bad debts, business expenses, and depreciation of property used in business.

• There was an exemption of $3,000.00 for single persons and $4,000.00 for married couples.

• A “normal” tax of 1% was applied to the first $20,000.00 of taxable income. Dividends were exempt from this “normal” tax. An additional or “super” tax of from 1% to 6% was applied to income, including dividends, in excess of $20,000.00.

• The return was due “on or before the first day of March” (Oi vey! Thank God that was changed!).

• There was only one page of instructions!

• In the first year of the income tax only 1 out of every 271 American citizens were taxed and $28 Million in revenue was raised.

Over the years the federal income tax has evolved into the mucking fess that it is today. According to former Treasury Secretary Paul O’Neill, “Our tax code is so complicated; we’ve made it nearly impossible for even the Internal Revenue Service to understand.” Here are some of the landmarks of this evolution.

• A personal exemption allowance for dependents and a deduction for charitable contributions were added in 1917.

• Capital gains were singled out for preferential treatment in 1922, although profits on the sale of certain types of property received special tax treatment as early as 1918.

• A deduction for medical expenses was introduced in 1942.

• The Standard Deduction was added in 1944 as an alternative to requiring taxpayers to itemize qualified expenses.

• An Income Averaging method of tax computation was initiated in 1964, to be taken away by the Tax Reform Act of 1986.

• A “minimum” tax on specified “tax preference” items first appeared in 1970, and was replaced by the dreaded Alternative Minimum Tax (AMT) in 1979.

• An Individual Retirement Account for taxpayers not covered by an employer pension plan was introduced in 1974.

• The refundable Earned Income Credit for low wage earners with dependent children was created in 1975.

• Unemployment compensation was made partially taxable in 1979, and was eventually made fully taxable. I remember saying at the time, “The next thing you know they will be taxing Social Security”.

• Social Security and Railroad Retirement benefits became partially taxable in 1984.

By the way, if you who think taxes are too high today, from the end of World War II through the early 1960s the top tax rate was more than 90%!

TTFN

I FOUND IT!

I knew it had existed, although only briefly, but thought it was from the mid to late 1970s. It actually was in effect for tax years 1982 through 1986.
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What am I talking about? Why IRS Schedule W – “Deduction for a Married Couple When Both Work”. It was created to provide relief from the “marriage penalty”.
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I had first mentioned the Schedule W in last Saturday’s BUZZ post when commenting on the new IRS Schedule L.
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According to the instructions for the 1983 Schedule W “Complete this schedule and attach it to your 1040 if you take the deduction for a married couple when both work.” The deduction, an “Adjustment to Income” (above-the-line), was available if both husband and wife “work and have ‘qualified earned income’ {i.e. - W-2 or self-employment income less adjustments to income for employee business expenses and IRA and Keogh contributions - rdf}” and “file a joint return”.
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I rediscovered this deduction going through the Tax Analyst’s “1040 Achieve”, where you can download the federal Form 1040 from the original 1913 version through 2006. Upon finding it in 1982 I went to my client files and pulled out the folder for a client whose 1040 I have been preparing since 1981.
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While I am only required by law to keep copies of the current and three previous years’ returns, I actually have copies of all returns I have filed for as long as a person/couple/surviving spouse remains a client. There is one file, originally a client of my mentor, which has copies back to the late 1960s!
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To calculate the deduction you would first determine the individual net “Qualified Earned Income” for each spouse. The deduction was 10% (5% for 1982) of the lesser of the lower net qualified earned income or $30,000.
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The 1983 Schedule W for my client showed that the husband had W-2 earnings of $37,226 and the wife had a W-2 for $16,800. Neither had any applicable adjustments to income, so the deduction was $1,680 – 10% of the wife’s $16,800 Form W-2. If the wife’s W-2 had been for $33,600 the deduction would be limited to $3,000 – 10% of $30,000.
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The Schedule W discussed above should not be confused with George W's Schedule W - click here.

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BTW – in my search of 1040s of the 1970s I came across a credit available on the 1975 return only for “Purchase of New Personal Residence” claimed on Form 5405 (the same form number currently used for the First-Time Homebuyer Credit). So it is true that "everything old is new again"!
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TTFN

MY FIRST 1040

The first Form 1040 that I did as a paid preparer was the 1971 model (I can actually tell you the name of the taxpayer on the very first 1040 I worked on). There have been tons of changes to the 1040 over the years.

On Page 1 of the 1971 Form 1040 one would indicate name, address and Social Security numbers of the filer(s). In the case of a return for a married couple the names were listed as “Richard and Mary Taxpayer” on one line instead of a separate line for the name of each spouse. The filing status was checked and exemptions were claimed. The taxpayer and spouse could each claim an additional exemption for being 65 or over and blind. The names, but not Social Security numbers, of dependent children were listed, with no indication of whether they “lived with you” or “did not live with you”. The names, but again not Social Security numbers, of “other” dependents were listed on Page 2 of the 1040.

Income was reported on Lines 12 through 18 on Page 1, with lines for wages, dividends (no designation of “qualified”), interest (taxable only – no reporting of tax-exempt interest), and “income other than wages, dividends and interest”, the sub-total, total “adjustments to income” and Adjusted Gross Income. The Line for dividends include (a) for gross dividends and (b) for an exclusion amount. If gross dividends and/or total interest exceeded $100 one would have to complete and attach Schedule B

The net tax liability was reported on Lines 19 through 23. Federal Income Tax withheld, Estimated Tax Payments, and “Other payments” were deducted and a balance due or refund was indicated.

Line 31 of the Form 1040, and not Schedule B, was where the taxpayer was asked about foreign accounts.

Page 2 of the Form 1040 consisted of Part I where other dependents were listed, along with relationship, months live in taxpayer’s home, did dependent have income of $675 or more, amount taxpayer furnished toward support, and amount furnished by all others, including the dependent, but not the dependent(s)’ Social Security number(s).

Specific items of income, adjustments to income, credits, other taxes, other payments, and the actual Tax Computation were reported on Lines 34 through 64 in Parts II through VII.

Social Security, Railroad Retirement, and Unemployment benefits were totally exempt from federal income tax. One could use the “3-year” rule for recovering employee contributions to determine the taxable portion of pensions and annuities. This was calculated on Part I of Schedule E.

Adjustments to income included –

* “sick pay”,
* Moving expense,
* Employee business expense, and
* Payments as a self-employed person to a retirement plan, etc.

The only credits indicated on the 1040 were –

* Retirement income credit,
* Investment credit, and
* Foreign tax credit.

The personal exemption amount was $675. Tax could be calculated by “using Tax Rate Schedule X, Y or Z, or if applicable, the alternative tax from Schedule D, income averaging from Schedule G, or maximum tax from Form 4726”. Other taxes included a line for “Minimum tax”, not yet alternative.

On Schedule A –

* medical and dental expenses were reduced by 3% of Adjusted Gross Income (this was the only item on the Form 1040 that was reduced based on AGI),

* taxes included state and local gasoline tax (from gas tax tables), general sales tax (from sales tax tables) and (not or) state and local income tax, with an additional deduction allowed for sales tax paid on “major purchases”,

* contributions were deductible pretty much as they are now, except there was no strict requirement for documentation,

* interest expense included not only home mortgage interest (fully deductible – no principle restrictions) but also interest on installment purchases and credit cards, and

* miscellaneous deductions were not reduced by a % of AGI; certain employee business expense, as mentioned earlier, were deductible as an “above-the-line” adjustment to income.

Schedule D allowed for a 50% deduction for net long-term capital gain – only half of such gains were included in AGI. So if net long-term capital gain (or net combined long-term and short-term gain if smaller) was $10,000, only $5,000 was reported as income on Page 2 of Form 1040. The maximum net capital loss deduction was $1,000.

The starting tax rate was 14% and the top was 70%, although the rate for “earned income” such as wages was capped at 50% - hence the “Maximum Tax” calculated on Form 4726.

The 1971 standard deduction was $1,050 for both a single person and a married couple. The standard deduction was originally 10% of AGI up to a maximum of $1,000. It wasn’t until 1975 that the standard deduction for married was more than that for single. Click here for a chart of historical standard deduction amounts for single persons and married couples.

Obviously the 1971 tax returns were prepared by hand. We didn’t even have photocopies back then (at least where I worked). The returns were written, or sometimes typed, on 3-copy carbonized forms purchased from Accountants Supply House in Valley Stream, New York State.

So tax rates were higher back then – but there were a lot more deductions allowed. And one could also use either Income Averaging or 10-Year Averaging to cut thousands off a large tax bill.

How do I remember all this? My memory is good – but not that good. I have a client, originally a client of my mentor Jim Gill, for whom I have a copy of every single Form 1040 filed since 1970 in the file.

So do you think the Tax Code is better now, or was it “more better” back then?

TTFN