Individual Income Tax Returns, 1998 - Statistical Data Included

Taxpayers filed 124.8 million returns for Tax Year 1998, a 1.9-percent increase over the previous year. For 1998, adjusted gross income (less deficit) (AGI) rose 9.0 percent to more than $5.4 trillion, following a 9.6-percent increase for 1997. Total taxable income increased faster than AGI for 1998, with a percentage increase of 10.3 percent. Total income tax, however, increased by only 7.8 percent, and as a percentage of AGI decreased slightly to 14.6 percent from 14.7 percent for 1997. Net capital gains (less losses) increased 25.3 percent to $446.1 billion for 1998, the fourth consecutive year of double-digit growth. Unemployment compensation continued to decline for the sixth straight year, declining 2.4 percent to $16.8 billion.

Two of the largest components of AGI, salaries and wages and taxable pensions and annuities, increased 7.4 percent and 8.1 percent, respectively. Other components of AGI with sizable increases included taxable Individual Retirement Arrangement (IRA) distributions (34.3 percent, bolstered by the introduction of Roth IRA's), taxable Social Security benefits (11.6 percent), and partnership and S corporation net income (less loss) (11.3 percent). Total deductions increased by $73.4 billion, or 6.9 percent. Total standard deductions increased 4.0 percent for 1998, while total itemized deductions (after limitation) increased 9.0 percent to $676.5 billion. Charitable contributions increased 10.1 percent to $109.2 billion for 1998, which marks the third consecutive year of double-digit growth. Due to the implementation of the child tax credit and the tax credits for higher education, total tax credits (including only the portion of the earned income credit used to offset income tax before credits) increased 146.8 percent to $30.1 billion for 1998. Much of this growth can be attributed to the child tax credit (new for 1998) which was taken by 24.8 million taxpayers and totaled more than $15.1 billion. Also new for 1998, education credits totaled $3.4 billion. The total earned income credit grew 4.0 percent to $31.6 billion, the smallest percentage increase since 1986.

Adjusted Gross Income and Selected Sources of Income

As shown in Figure A, AGI increased 9.0 percent to more than $5.4 trillion for 1998. The growth rate of AGI was more than four times the annual inflation rate (2.1 percent as measured by the Consumer Price Index) for the same period [1]. The principal components of income and of the statutory adjustments to AGI are presented in Figure B and Table 1. The largest component of AGI, salaries and wages, increased $265.8 billion, or 7.4 percent, for 1998. Net capital gain (less losses) continued double-digit growth for the fourth consecutive year in 1998, rising 25.3 percent to $446.1 billion. Partnership and S corporation net income (less loss) and business or profession net income (less loss) increased 11.3 percent and 8.4 percent, respectively. Dividend income actually declined for 1998 by 1.7 percent. Taxable interest income remained relatively flat, with an increase of only 3.9 percent for 1998. Unemployment compensation benefits declined for the sixth consecutive year, dropping 2.4 percent for 1998 to $16.8 billion. Some of this decline may be attributed to the unemployment rate, which at 4.5 percent for 1998 was the lowest it had been since 1973 [2].

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Many forms of retirement income also showed significant increases for 1998. Taxable Individual Retirement Arrangement (IRA) distributions grew 34.3 percent for 1998, which can be partially attributable to the conversion of traditional IRA's to Roth IRA's. (See the Changes in Law section.) Taxable Social Security benefits increased 11.6 percent to $68.7 billion, and taxable pensions and annuities increased 8.1 percent to $280.7 billion for 1998.

Losses

Total negative income includes net negative income line items from individual tax returns [3]. Total negative income, i.e., net loss, included in AGI increased for 1998 by 4.0 percent to $191.9 billion (Figure C). Overtaking net operating loss as the largest component of total net losses, partnership and S corporation net loss increased 18.2 percent to $53.5 billion for 1998. Net operating loss, for 1998 the second largest component of the total, actually decreased 5.9 percent to $48.3 billion, while business or profession net loss declined by 0.4 percent to $23.7 billion [4]. Two of the smaller components of net loss showed large increases for 1998; other net loss and estate and trust net loss increased 23.9 percent and 17.0 percent, respectively.

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Statutory Adjustments

Statutory adjustments, which are subtracted from total income in the computation of AGI, increased 9.7 percent to $51.5 billion for 1998 (Figure D). Part of this increase was due to a new adjustment for student loan interest for 1998, which was taken by 3.8 million taxpayers and totaled more than $1.7 billion. (See the Changes in Law section.) The largest statutory adjustment was the self-employment tax deduction, representing 31.0 percent of the total. This adjustment increased 7.3 percent to $16.0 billion for 1998. Payments to self-employed retirement (Keogh) plans increased 7.8 percent to $11.0 billion. Self-employed health insurance deductions increased 21.3 percent to $4.7 billion. This is partially attributable to a change in the law that increased the maximum percentage of premiums that a taxpayer could deduct. (See the Changes in Law section of this article for an explanation of the self-employed health insurance deduction.) Alimony paid increased 9.0 percent to $6.9 billion. There were three statutory adjustments showing declines for 1998; moving expenses, forfeited interest penalty, and payments to individual retirement arrangements decreased 8.9 percent, 7.0 percent, and 5.5 percent, respectively.

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Deductions

The total standard deduction claimed on 1998 individual income tax returns, i.e., the basic standard deduction plus the additional standard deduction for age or blindness, increased 4.0 percent to $459.5 billion (Figure E). Total deductions, the sum of the total standard deduction and total itemized deductions (after limitation), equaled $1.1 trillion, an increase of 6.9 percent. (See the Changes in Law section of this article for an explanation of the itemized deduction limitation.)

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The number of returns claiming a standard deduction increased 0.9 percent for 1998, accounting for 68.6 percent of all returns filed. For 1998, the average standard deduction equaled $5,369, up $163 from the 1997 average. This increase was largely due to inflation-indexing of the standard deduction amounts. (See the Changes in Law section of this article for an explanation of the standard deduction.)

Statistics for returns with itemized deductions are presented in Figure E and Table 3. Itemized deductions were claimed on 30.6 percent of all returns filed and represented 59.6 percent of the total deductions amount [5]. The average total for itemized deductions (after limitation) equaled $17,715, up $764 from the average for 1997.

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Total itemized deductions (before limitation) increased for 1998, as did all of the component deductions. The largest itemized deduction (comprising 38.6 percent of the total), interest paid, increased 8.4 percent to $271.6 billion. Home mortgage interest accounted for 93.7 percent of total interest paid, with the remaining portion consisting of investment interest and deductible points paid on a mortgage. Taxes paid, the second largest itemized deduction (34.4 percent of the total), increased 9.6 percent to $241.8 billion. Charitable contributions, reported by 33.8 million taxpayers, increased 10.1 percent to $109.2 billion, the third consecutive year of double-digit growth. Among the other itemized deductions, medical and dental expenses increased 9.2 percent to $32.0 billion, and miscellaneous deductions after the AGI floor (such as employee business expenses, paid tax preparer expenses, etc.) increased 8.3 percent to $40.5 billion.

The AGI threshold for the limitation of itemized deductions increased to $124,500 ($62,250 if married filing separately) for 1998. Due to this limitation, nearly 4.9 million higher-income taxpayers were unable to deduct $26.9 billion in itemized deductions, an increase of 15.8 percent from the 1997 amount.

Taxable Income and Total Income Tax

Taxable income grew at a higher annual rate than AGI for 1998, 10.3 percent compared to 9.0 percent (Figure A). Since taxable income is the result of AGI less exemptions and deductions, smaller increases in deductions (6.9 percent) and exemption amounts deducted (3.6 percent) resulted in a larger percentage increase in taxable income. Taxable income totaled almost $3.8 trillion, and total income tax increased 7.8 percent to $788.5 billion. The difference in growth rates between taxable income and total income tax (10.3 percent and 7.8 percent) can be partially attributable to the child tax credit, and to a lesser extent the new education credits, which became effective for 1998. The alternative minimum tax rose 25.2 percent to $5.0 billion.

Average AGI reported on. 1998 individual income tax returns was $43,407, and average taxable income was $37,508 [6]. These amounts represent a growth of 6.9 percent and 8.6 percent, respectively, from the 1997 amounts of $40,597 (average AGI) and $34,528 (average taxable income).

Figure F shows that the average tax rate for 1998 (i.e., total income tax divided by AGI reported on all returns, taxable and nontaxable) was 14.6 percent, a slight decrease from 14.7 percent for 1997. In the statistics, all of the income-size classes had average tax rates that were either equal to, or lower than, those for 1997. The constant or lower average tax rates for the income-size classes for 1998 were mainly the result of inflation-indexing of the size of the standard deduction, the size of the deduction for personal exemptions, and the widths of the tax rate brackets. The slight decrease in the total average tax rate for 1998 is partially attributable to the introduction of the child tax credit and the education tax credits. Also, taxpayers who reported long-term capital gains were taxed at the new lower rates, which became effective midway through 1997, making 1998 the first full year at the new rates. Taxpayers, as a whole, earned more income for 1998 and, thus, shifted into higher income size-classes. This is depicted in the three highest income-size classes, each of which displays an appreciable increase in the number of taxpayers for 1998, ranging from a 14.6-percent increase for the "$200,000 under $500,000" class to a 19.4-percent increase for the "$1,000,000 or more" class. These two income-size classes showed corresponding increases in total AGI of 14.7 percent for the "$200,000 under $500,000" class and 26.0 percent for the "$1,000,000 or more" class.

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Tax Credits

Statistics for the earned income credit (EIC) and the other tax credits are shown in Tables 2 and 4. For 1998, total tax credits (excluding the "refundable" portion of the EIC and any EIC used to offset any other taxes) increased 146.8 percent to $30.1 billion (Figure G). The change in total tax credits was primarily the result of the introduction of the child tax credit and the education tax credits for 1998. The child tax credit immediately overtook the foreign tax credit as the largest credit, with over $15.1 billion claimed, which accounted for 50.4 percent of total tax credits. (See the Changes in Law section of this article for more details on the child tax credit and education credits.) The new education credits were taken by 4.7 million taxpayers and totaled more than $3.4 billion. The foreign tax credit and child care credit also increased for 1998, rising 14.8 percent and 8.0 percent, respectively. Some of the increase in the child care credit may be attributable to the elimination of alternative minimum tax calculations limiting personal tax credits for 1998. (See the Changes in Law section.) The portion of the earned income credit used to offset income tax before credits decreased 40.8 percent to $2.2 billion, and the general business credit decreased 11.4 percent to $0.7 billion. Much of the decrease in the earned income credit used to offset income tax before credits can be attributed to the use of the child tax credit, which reduced the need to use the earned income credit to offset taxes and increased the portion of the earned income credit that was refundable.

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Unlike other tax credits, with the exception of the additional child tax credit (see the Changes in Law section for details on additional child tax credit), the EIC may not only offset income tax before credits, but may also offset all other taxes and may even be refundable. The refundable portion, the largest segment of the EIC, was treated as a refund and paid directly to taxpayers who had no tax against which to apply the credit, or whose EIC exceeded income tax (and other income-related taxes). The refundable portion of the EIC totaled $27.0 billion for 1998, an increase of 10.7 percent from 1997 (Figure H). The third part of the EIC, the portion used to offset all other taxes besides income tax, was $2.4 billion for 1998.

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Over 19.7 million taxpayers claimed the earned income credit for 1998, an increase of 1.6 percent from 1997. The total earned income credit increased 4.0 percent to $31.6 billion. (See the Changes in Law section of this article for more details on the earned income credit.) Returns with no qualifying children accounted for the largest increase for 1998 returns claiming the EIC. The number of these EIC returns increased 5.2 percent, while the corresponding amount of EIC claimed increased 10.0 percent. The number of EIC returns with one qualifying child decreased 0.9 percent, while the amount of EIC claimed on these returns increased 3.5 percent. The number of EIC returns with two or more qualifying children and the amount of EIC claimed on these returns increased 2.6 percent and 4.1 percent, respectively.

The number of these returns claiming a refundable portion of the EIC increased 5.9 percent, while the refundable portion of the EIC reported on them increased 10.7 percent. Much of this growth can be found in those returns with qualifying children. The number of refundable EIC returns with one or more qualifying children, increased 5.8 percent for 1998. The amount of refundable EIC claimed on returns with one qualifying child increased 12.6 percent, while the amount on returns with two or more qualifying children increased 9.6 percent. Much of this growth can be attributed to the use of the child tax credit, which, by reducing the amount of total income tax due, shifted some of the EIC used previously to reduce tax liability to that portion that is refundable.

Historical Trends in Constant Dollars

As shown in Figure I, AGI, salaries and wages, and gross domestic product showed large increases in constant dollars for 1998. Both salaries and wages and AGI decreased (in constant dollars) beginning with 1980 and continued to decline until 1982. In contrast, real GDP increased for 1981. For 1983, real AGI increased and continued to increase through 1986. Between 1987 and 1993, constant-dollar AGI fluctuated within a narrow band before increasing substantially from 1994 through 1998. The 6.7-percent increase for 1998 was the second largest increase in constant dollar AGI since 1987, behind only the 7.1-percent increase in 1997. The trend for salaries and wages over this same period is comparable. GDP also went up every year except 1980, 1982, and 1991. For 1998, real GDP increased 4.4 percent to $8.2 trillion.

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Over the same period, total income tax and tax as a percentage of GDP fluctuated (Figure J). For 1980 and 1981, total income tax (in constant dollars) increased gradually, then declined sharply between 1981 and 1983, coinciding with the lower tax rates provided by the Economic Recovery Tax Act of 1981 (ERTA81). Although the ERTA81 tax reductions were still being phased in, total income tax increased for 1984 and continued to increase through 1986, as AGI began to climb steadily. Tax as a percentage of GDP followed this trend, increasing substantially for 1986. Both total income tax and tax as a percentage of GDP decreased for 1987, the first year under TRA86, as the maximum tax rate was reduced from 50 percent to 38.5 percent. For 1988, total income tax rebounded, even though the second part of the TRA86 statutory tax rate reduction was being implemented. Between 1988 and 1991, total income tax (in constant dollars) declined modestly each year, mirroring the gradual decline of AGI. For 1992, total income tax increased and continued to increase through 1998, reflecting higher AGI and higher tax rates for high income individuals (for 1993 and later years). The increase in tax as a percentage of GDP remained almost steady between 1991 and 1994. As opposed to the continued record growth of AGI, the 7.8-percent increase in total income tax for 1998 was a decrease from the growth rate of 8.6 percent for 1997. Tax as a percentage of GDP, at 5.6 percent for 1998, was the highest level since 1986, but still less than the 6.6 percent shown for 1981.

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Net capital gain (less losses) is the sum of gains and losses from the sale of capital assets. Figure K shows that, in constant dollars, net capital gain (less losses) increased 22.7 percent for 1998. Capital gain distributions, experienced a constant -dollar increase of only 0.1 percent for 1998. Net capital gain (less losses) decreased 9.6 percent, 25.6 percent, and 13.7 percent for 1989, 1990, and 1991, respectively. The post-recession years of 1992 and 1993 were marked with double-digit growth in net capital gain (less losses), before 1994 saw a decline of 3.8 percent. During this period, there were important tax law changes affecting net capital gain (less losses). Beginning with Tax Year 1991, the maximum capital gain rate remained 28 percent, while the maximum rate for ordinary income increased to 31 percent. When two new tax brackets were added under OBRA93, the maximum differential between ordinary income and capital gain income increased from three percentage points to more than 11 percentage points (39.6 percent for ordinary income compared to 28 percent for capital gains). In 1997, this differential increased to 19.6 percentage points due to the reduction of the maximum tax rate on most capital gains by 8 percentage points to 20 percent, while the highest income tax bracket for ordinary income remained at 39.6 percent.

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The constant-dollar percentage changes in capital gain distributions for this same period were larger. After increasing 34.9 percent for 1989, these distributions declined 32.4 percent for 1990 and then rebounded by 14.6 percent the following year. Similar to net capital gain (less losses), 1992 and 1993 saw large increases in capital gain distributions (54.5 percent and 56.8 percent, respectively) before the decline reported for 1994. An upward trend began in 1995 that has almost tripled the amount of capital gain distributions from $9.4 billion in 1995 to $28.2 billion in 1998.

Figure L presents data for several income, deduction, and tax items (in constant dollars) over time. After increasing substantially between 1988 and 1989, real taxable interest declined each year between 1990 and 1994. For 1992 and 1993, these declines were substantial, 24.7 percent and 21.6 percent, respectively. The increases from 1995 to 1998 only brought the taxable interest amount to levels less than those reported for 1992, and almost 40 percent below the maximum amount reported for 1989. This change is at least partially attributable to the general decline in interest rates over this period. Dividends decreased for 1990 and continued to decline until 1994, when they showed a slight increase. Dividends continued to increase during years 1995 through 1997, when they posted the largest constant-d ollar increase of the decade, increasing 13 percent above the amount for 1996. However, for 1998, dividends decreased for the first time since 1993, by 3.7 percent

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For the first time since the 1980's, constant-dollar business or profession net income (less losses) increased for 3 years in a row, with a 6.1-percent increase for 1998. Taxable Individual Retirement Arrangement distributions showed substantial increases for recent years, with the 1998 amount almost five times the level shown for 1988. Taxable Social Security benefits increased each year since 1988. The large increase for 1994 reflected the change in law requiring up to 85 percent (from a maximum of 50 percent) of Social Security benefits to be included in taxable income for some beneficiaries. Taxable pensions and annuities increased annually since 1979, with double-digit growth for 1983 through 1987. Tax Year 1998 levels were over three times the amount reported for 1979. Total rent and royalty net income (less losses) and partnership and S corporation net income (less losses) both showed large increases and large decreases over time. For most of the 1980's, rent and royalty net income (less losses) decreased annually, and for many years, the total was negative. This trend changed with TRA86 and its passive loss rules [7]. For 1991, this item finally reached a level exceeding the amount reported for 1981, and continued to increase through 1997 to a level more than double the 1979 amount. For the first time since 1989, rent and royalty net income showed a decrease (1.8 percent) in 1998. Similarly, partnership and S corporation net income (less losses) was negative from 1981 through 1986. For 1987, this item reached a level higher than the amount reported for 1979. Partnership and S corporation net income (less losses) more than doubled between 1987 and 1988, and, except for a decline for 1991, steadily increased through 1998. The real Tax Year 1998 amount was more than five times the amount reported for 1979.

The inflation-adjusted amount of total itemized deductions increased from 1979 through 1986, then declined for the next 2 years because of provisions in TRA86. The amounts increased slightly for 1989 and 1990, but declined for 1991, when itemized deductions were limited for taxpayers with AGI above certain income thresholds. Total itemized deductions increased through years 1995 to 1998. During this same period, the real itemized deduction for charitable contributions increased each year until 1987, when provisions of TRA86 disallowed the limited deduction of charitable contributions for non-itemizers. Since 1987, this deduction showed only small variations until 1996 when constant-dollar charitable contributions increased 11.6-percent over the previous year, which was followed by a 12.5-percent increase for 1997, and a 7.8-percent increase for 1998. For these last 3 years, over half of this growth was due to the nearly 100-percent growth in other than cash contributions. In constant dollars, these grew from $8.9 billion in 1996 to $17.8 billion in 1998.

Much of the fluctuation in alternative minimum tax (AMT) liability shown for 1988 through 1998 reflects changes in law. The AMT showed high growth for 1991, coinciding with increase in the AMT rate from 21 percent to 24 percent. The double-digit growth returned for 1993 when the AMT rate increased again, from 24 percent to 26 percent, with a new rate of 28 percent applying to alternative minimum taxable income exceeding certain levels. In addition, the AMT exemption amounts increased for 1993, as did the corresponding levels at which the exemption amounts were phased out. The next substantial increase in AMT liability was for 1996 when, although no law changes were instituted, AMT increased 19.3 percent. In 1998 AMT increased by 22.6 percent. The size of the AMT exemptions and the AMT income level at which the rate increases from 26 percent to 28 percent have not been indexed for inflation annually, whereas the widths of regular income tax rate brackets and the sizes of personal exemptions have been inflation-adjusted. Thus, year-to-year inflation may cause more taxpayers to be affected by the AMT and increase the amount of AMT liability.

With the exception of 1985, the real value of the total earned income credit declined from 1980 through 1986. Tax Year 1987 showed the largest percentage increase in the EIC, 89.0 percent, primarily due to the increases in both the rate and the base of the credit. Since 1987, total EIC increased each year, exhibiting double-digit growth for many of these years. Beginning with Tax Year 1991, the EIC was comprised of three component credits, with the maximum amount of the credit for 1991 being more than twice the maximum for 1990. OBRA93 modified the EIC by expanding the eligibility requirements to allow taxpayers without children to qualify for the credit and eliminating the health insurance credit and extra credit components of the EIC. In addition, the income eligibility levels and the maximum amounts of the credit increased. The increase for 1998, at 1.8 percent along with the 3.1-percent increase from 1997, represent the smallest percent increases since the EIC actually declined in 1986.

Summary

Both AGI and taxable income grew more than four times as rapidly as the annual rate of inflation (2.1 percent) for 1998. AGI increased 9.0 percent, and taxable income increased 10.3 percent. Total income tax increased less (7.8 percent). As a result, the total average tax rate actually fell 0.1 percentage point to 14.6, while the average tax rates for every individual income-size class either remained the same or fell.

The largest components of AGI, salaries and wages and net capital gain (less losses), increased 7.4 percent and 25.3 percent, respectively. A number of other income items contributed to the substantial growth of AGI: taxable Individual Retirement Arrangement distributions increased 34.3 percent (partially due to the conversion to IRA's); partnership and S corporation net income (less losses) increased 11.3 percent; and taxable pensions and annuities increased 8.1 percent. Total tax credits increased 146.8 percent to $30.1 billion for 1998. Much of this growth can be attributed to the introduction of the child tax credit and education credits, which totaled more than $15.1 billion and $3.4 billion, respectively.

Changes in Law

The following is a summary of Federal tax law and Internal Revenue Service administrative changes that had a major bearing on the 1998 data presented in this article. In general, the definitions used in this article are the same as those in section 4 of Statistics of Income--Individual Income Tax Returns 1997--Publication 1304.

Child Tax Credits--Starting with Tax Year 1998, a new credit of $400 was allowed for each qualifying child under the age of 17. In order to be a qualifying child, the person had to be a son, daughter, grandchild, or qualifying foster child for whom the taxpayer claims a dependency exemption. For families with no more then two children, the credit was non-refundable. For families with more than two children the credit could be refundable. For 1998, the child credit was phased out by $50 for each $1,000 (or fraction thereof) that AGI exceeded: $110,000 for taxpayers filing jointly; $55,000 for married filing separately; and $75,000 for single filers. In addition to the child tax credit, individuals were also eligible to take the additional child tax credit. The taxpayer had to meet the general requirements and had to claim more then two children or (more then $800 for the child tax credit). For 1998, some 754,000 tax returns were filed with additional tax credits totaling over $509 million.

Earned Income Credit--Several changes were made to the earned income credit for 1998. The maximum amount of the earned income credit increased, as did the amounts of earned income and AGI an individual could have and still claim the credit. Starting in 1998, the definition of modified AGI changed. Modified AGI included tax-exempt interest plus the nontaxable part of a pension, annuity, or IRA distribution, except for any amount that is nontaxable due to trustee-to-trustee transfer or a rollover distribution. Also, in prior years, 50 percent of business losses had to be added back to AGI to figure modified AGI. In 1998, this amount increased from 50 percent to 75 percent. Taxpayers with more than $2,300 of investment income (up from $2,250 for 1997) were not eligible for the earned income credit. For most people, investment income included interest (taxable and tax-exempt), dividend income, and capital gain net income. The maximum credit for taxpayers with no qualifying children increased 2.7 percent for 1998, from $332 to $341. For these taxpayers, earned income and modified AGI had to be less than $10,030 (up from $9,770 for 1997). For taxpayers with one qualifying child, the maximum credit for 1998 increased 2.8 percent, from $2,210 to $2,271. For taxpayers with two or more qualifying children, the maximum credit increased $100 to $3,756 for 1998. To be eligible for the credit, a taxpayer's earned income and modified AGI had to be less than $26,473 for one qualifying child (up from $25,760 for 1997), or less than $30,095 for two or more qualifying children (up from $29,290 for 1997).

Education Credits--Beginning in 1998, the Hope Scholarship Credit and the Lifetime Learning Credit for post-secondary educational expenses were available. Based on eligibility, a taxpayer could claim only one of the credits with respect to a certain student for a certain year. If the student made a tax-free withdrawal from an educational IRA, neither credit could be claimed. The credits would be phased out for AGI above $40,000 ($80,000 for married filing jointly) and terminated for AGI over $50,000 ($100,000 for married filing jointly).

The Hope Scholarship Credit allowed a maximum credit per student of 100 percent of the first $1,000 of qualified tuition and related expenses and a 50 percent credit for the next $1,000 of eligible expenses for enrollment in undergraduate programs. Also, the credit only applied for the first 2 years of post-secondary education. A total of 2.6 million taxpayers reported the Hope Scholarship Credit for 1998.

Unlike the Hope Scholarship Credit, the Lifetime Learning Credit could be used for Qualified tuition and expenses for undergraduate, graduate, and professional degree courses. The credit could be used for an unlimited number of years, as long as the taxpayer or dependents were enrolled in post-secondary education. This credit applied to expenses paid after June 30, 1998, and a maximum Lifetime Learning Credit of $1,000 could be claimed per tax return. There were 2.3 million taxpayers who reported Lifetime Learning Credit for 1998. Approximately 77-percent of the total of $3.4 billion in education credits was for the Hope Scholarship Credit and the rest for Lifetime Learning Credit.

Education IRA--Beginning in 1998, taxpayers could have made nondeductible contributions up to $500 annually to an educational IRA for a child under age 18. The earnings and withdrawals were tax-free to the extent that withdrawals did not exceed the beneficiary's qualified higher education expenses for the year. The educational IRA contribution was phased out for modified AGI between $95,000 and $110,000 (between $150,000 and $160,000 for married taxpayers filing jointly)

Exemption Amount--Indexing for inflation allowed most taxpayers to claim a $2,700 deduction for each exemption to which he or she was entitled for 1998, a $50 increase over the amount allowed for 1997. The AGI threshold for the reduction of exemption amounts was also indexed for inflation, from $121,200 to $124,500 for single filers; $181,800 to $186,800 for married persons filing jointly and surviving spouses; $151,500 to $155,650 for heads of household; and $90,900 to $93,400 for married persons filing separately.

IRA Deduction Restored for Certain Taxpayers Covered by Retirement Plans--Beginning in 1998, the phaseout ranges for deductible IRA's were increased. For a taxpayer to have been eligible to take the IRA deduction, he or she must have had taxable compensation and his or her modified AGI had to have met certain criteria. If the taxpayer was single, head of household, or married filing separately and lived apart from his or her spouses for all of 1998, his or her modified AGI had to be less than $40,000. If the taxpayer was married filing jointly or a qualified widow(er), his or her modified AGI had to be less than $60,000. In addition, an individual who was not an active participant, but was married to someone who was, could make a fully deductible IRA contribution, as long as their combined AGI was not more then $150,000. The maximum deductible amount for Tax Year 1998 was $2,000 per taxpayer.

Itemized Deductions--If a taxpayer's AGI was greater than $124,500 ($62,250 if married filing separately), some types of his or her itemized deductions were limited; this threshold increased from $121,200 ($60,600) for 1997 as a result of indexing for inflation. The limitation did not apply to deductions for medical and dental expenses, investment interest expenses, casualty or theft losses, and gambling losses; all other deductions were subject to the limitation. To arrive at allowable itemized deductions, total itemized deductions were reduced by the smaller of: (1) 80 percent of the "non-limited" deductions or (2) 3 percent of AGI in excess of the limitation threshold.

Personal Tax Credits--Beginning in 1998, personal tax credits were no longer limited by alternative minimum tax computations. The personal tax credits include: credit for child and dependent care expenses, credit for the elderly or the disabled, child tax credit, education credits, adoption credit, and mortgage interest credit.

Roth IRA-- Beginning in 1998, taxpayers were able to create Roth IRA's. Unlike traditional IRA's, contributions to a Roth IRA were not deductible. However, qualified distributions from the earnings of a Roth IRA were tax-exempt. The contribution limit for Roth IRA's was the lesser of $2,000 or the individual's taxable compensation unless the taxpayer contributed to both Roth IRA's and traditional IRA's. In this case, the contribution limit for Roth IRA's was reduced by all contributions (other than employer contributions) to traditional IRA's for the taxable year. The eligibility for Roth IRA's was phased out for joint filers with modified AGI between $150,000 and $160,000, married taxpayers filing separately and living with their spouses with modified AGI between $0 and $10,000, and all other filers (single, head of household, and married filing separately and not living with their spouses at any time during the year) with modified AGI between $95,000 and $110,000. Contributions to Roth IRA's could be made after the taxpayer reached the age of 70 1/2. Also, the minimum distribution rules did not apply to living taxpayers as they did for traditional IRA's.

Some taxpayers were also eligible to make taxable rollovers of traditional IRA's to Roth IRA's without paying the 10-percent tax on early withdrawals. Taxpayers had to have a modified AGI of $100,000 or less to be able to roll over a traditional IRA to a Roth IRA. When taxpayers converted an amount from the traditional IRA to a Roth IRA, they were required to include in gross income the amount that they would have reported in income if they had made a withdrawal from this IRA. The taxpayer did not include in gross income any part of the conversion that was a nondeductible contribution in a traditional IRA. Taxpayers then generally had the option of including this taxable amount from the conversion in income either for the current year or including it in equal parts over the next 4 years. Married taxpayers filing separately could not take advantage of this rollover provision. For 1998, taxpayers filing a total of 1.4 million returns converted $39.3 billion from traditional to Roth IRA's, resulting in $9.4 billion in taxable income.

Sale of a Home--Taxpayers who sold their primary residences after May 6, 1997, were generally able to exclude from income up to $250,000 ($500,000 for married couples filing a joint tax return) of the gain on the sale of their homes.

Self-Employed Health Insurance Deduction--Included in the Health Insurance and Portability and Accountability Act of 1996 was a provision to increase the maximum percentage of self-employed health insurance premiums that a taxpayer could deduct as an adjustment, from 40 percent in 1997 to 45 percent for 1998.

Self-Employment Tax--The ceiling on taxable "self-employment income" was increased for 1998 due to indexing. The maximum amount of net earnings applied to the Social Security portion of self-employment tax increased to $68,400 from $65,400 for 1997.

Standard Deduction--The basic standard deduction and additional standard deduction for age or blindness increased for 1998 as a result of inflation indexing. For single filers, the basic standard deduction rose from $4,150 to $4,250; for married persons filing jointly or surviving spouses, from $6,900 to $7,100; for married persons filing separately, from $3,450 to $3,550; and for heads of household, from $6,050 to $6,250. The basic standard deduction claimed by filers who were dependents of other taxpayers increased to a minimum of $700 (up from $650 for 1997). New for 1998, the amount of the standard deduction for a dependent could be greater than $700 and equal to the dependent's earned income plus $250 (but not more than the regular standard deduction amount). The additional standard deduction for people age 65 or older or blind rose to $1,050 for single filers and heads of households, and $850 for married persons filing jointly, surviving spouses, and married persons filing separately.

Student Loan Interest Deduction--Beginning in 1998, a deduction allowed eligible taxpayers to deduct up to $1,000 for interest paid on qualified higher educational loans. These loans must have gone towards qualified expenses of either the taxpayer, taxpayer's spouse, or any dependent of the taxpayer at the time the debt was incurred. The phase out for a taxpayer claiming the educational interest deduction began with a modified AGI of $40,000 to $50,000 ($60,000 to $75,000, joint returns) These income ranges will be indexed for inflation in 2003.

Tax Brackets--To counterbalance the effects of inflation, the boundaries for the tax brackets were widened. The 15-percent bracket applied to taxable income equal to or below $25,350 ($24,650 for 1997) for single filers; $42,350 ($41,200 for 1997) for joint filers or surviving spouses; $21,175 ($20,600 for 1997) for married persons filing separately; and $33,950 ($33,050 for 1997) for heads of household. The 28-percent tax bracket applied to taxable income in excess of the 15-percent bracket ceiling and equal to or below $61,400 ($59,750 for 1997) for single filers; $102,300 ($99,600 for 1997) for joint filers or surviving spouses; $51,150 ($49,800 for 1997) for married persons filing separately; and $87,700 ($85,350 for 1997) for heads of household. The 31-percent tax bracket applied to taxable income in excess of the 28-percent bracket ceiling and equal to or below $128,100 ($124,650 for 1997) for single filers; $155,950 ($151,750 for 1997) for joint filers or surviving spouses; $77,975 ($75,875 for 1997) for married persons filing separately; and $142,000 ($138,200 for 1997) for heads of households. The 36-percent tax bracket applied to taxable income in excess of the 31-percent bracket ceiling and equal to or below $278,450 ($271,050 for 1997) for single filers, joint filers or surviving spouses, and heads of households and $139,225 ($135,525 for 1997) for married persons filing separately. The 39.6-percent tax rate applied to taxable income in excess of the upper boundary for the 36-percent tax bracket.

Data Sources and Limitations

These statistics are based on a sample of individual income tax returns (Forms 1040, 1040A, 1040EZ, and 1040PC, including electronically-filed returns) filed during Calendar Year 1998. Returns in the sample were stratified based on: (1) the larger of positive income or negative income; (2) the size of business and farm receipts; (3) the presence or absence of specific forms or schedules; and (4) the usefulness of returns for tax policy modeling purposes [8]. Returns were then selected at rates ranging from 0.05 percent to 100 percent. The 1998 data are based on a sample of 164,340 returns and an estimated final population of 125,037,636 returns. The corresponding sample and population for the 1997 data were 124,768 and 122,421,991 returns, respectively.

Since the data presented here are estimates based on a sample of returns filed, they are subject to sampling error. To properly use the statistical data provided, the magnitude of the potential sampling error must be known; coefficients of variation (CV's) are used to measure that magnitude. Figure M shows estimated CV's for the numbers of returns and money amounts for selected income items. The reliability of estimates based on samples, and the use of coefficients of variation for evaluating the precision of estimates based on samples, are discussed in the appendix to this issue of the Bulletin.

[Figure M ILLUSTRATION OMITTED]

Notes and References

[1] U.S. Department of Labor, Bureau of Labor Statistics, Monthly Labor Review. The Consumer Price Index (CPI-U) for each year represents an annual average of monthly indices. CPI-U approximates the prices of goods and services purchased by typical urban consumers (1982-84=100):

Year   CPI-U   Year   CPI-U

1998   163.9   1988   118.3
1997   160.5   1987   113.6
1996   156.9   1986   109.6
1995   152.4   1985   107.6
1994   148.2   1984   103.9
1993   144.5   1983    99.6
1992   140.3   1982    96.5
1991   136.2   1981    90.9
1990   130.7   1980    82.4
1989   124.0   1979    72.6

[2] U.S. Department of Labor, Bureau of Labor Statistics, Household Data-Annual Averages. The unemployment rate is calculated as the percent of the labor force that is unemployed. For 1998, the rate of 4.5 percent was a decline from the 1997 rate of 4.9 percent.

[3] For purposes of this article, total negative income is a compilation of all income items on individual income tax returns (Forms 1040, 1040A, 1040EZ, 1040PC, and electronically-filed returns) for which a net loss for an income category was reported by the taxpayer. The Form 1040 income tax return entry for Schedule E, Supplemental Income and Loss (From rental real estate, royalties, partnerships, S corporations, estates, trusts, REMIC's, etc.), was separated into the following components: rent and royalty net loss, partnership and S corporation net loss, and estate and trust net loss. When any of these components was negative on a return, the corresponding loss (rather than the netted total amount from Schedule E) was included in the statistics for total net loss. For example, if a return showed estate and trust net income of $20,000 and rent and royalty net loss of $12,000, total net loss would include the $12,000 of rent and royalty net loss, rather than the $8,000 netted total of both sources of supplemental income.

[4] Net operating loss is a carryover of the loss from a business when AGI for a prior year was less than zero. The loss could be applied to the AGI for the current year and carried forward for up to 15 years. Net operating loss is included in other income on individual tax returns but edited separately for Statistics of Income purposes.

[5] The remaining 0.8 percent of the returns did not claim either a standard deduction or itemized deductions because no AGI was reported.

[6] Average AGI is defined as the amount of AGI divided by the number of returns filed. Average taxable income is defined as the amount of taxable income divided by the number of returns with taxable income. Average total income tax is defined as the amount of total income tax divided by the number of taxable returns. Taxable returns are defined as returns with "total income tax" (the sum of income tax after credits, the alternative minimum tax, and tax on Form 4970, Tax on Accumulation Distribution of Trusts) present. Tax on Form 4970 (not in the statistical tables) was $14.5 million for 1998. This tax, previously part of income tax after credits, was included in "other taxes" for 1998.

[7] Losses generated by any "flow-through" business activity (i.e., such as partnerships or S corporations for which profits and certain other amounts are passed through to the owners for taxation) in which the taxpayer did not "materially participate" (i.e., was not involved regularly and substantially in the operations of the activity) are categorized as passive activity losses. TRA86 gradually eliminated the use of passive losses as offsets to nonpassive income, such as salaries and wages. TRA86 provided for a 5-year phase-in (ending in 1991) of the limitations on passive losses for investments made prior to 1987; since Tax Year 1991, the restrictions applied to all passive losses. However, exceptions up to $25,000 were made for certain real estate losses. Under prior law, passive losses were fully deductible.

[8] Returns in the sample were stratified based on the presence or absence of one or more of the following forms or schedules: Form 2555, Foreign Earned Income; Form 1116, Foreign Tax Credit (Individual, Fiduciary, or Nonresident Alien Individual); Schedule C, Profit or Loss from Business (Sole Proprietorship); and Schedule F, Profit or Loss From Farming.

David Campbell, Michael Parisi, and Brian Balkovic are economists with the Individual Returns Analysis Section. This article was prepared under the direction of Jeff Hartzok, Chief.

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