Federal Income Tax 23.0

FederalTax simulates federal income tax liabilities following the procedures of the 1040 form as closely as possible. The income data on the CPS are supplemented with data on capital gains, deductible expenses, and IRA contributions obtained through a statistical match with the Internal Revenue Service’s Statistics of Income Public Use File (PUF). Child care expenses required for the simulation of the child and dependent care credit are imputed using the TRIM3 Child Care Expense module. The filing units for FederalTax are individuals or married couples. Persons in the household but outside a given tax filing unit may be counted as dependents of the unit, and a tax filing unit may be claimed as the dependent of another tax filing unit within the household. Units are classified as filing single, joint, or head of household returns. Tax units are simulated to pay any taxes that are owed, and all tax units that are eligible for a refundable credit are simulated to receive the credit.

Taxes are only computed for the "economic adults" on the CPS, since income is not reported on the records of children under 15. Presumably, a child's income is captured on a parent's record. Therefore, FederalTax implicitly taxes all income of children who are not economic adults at their parents' tax rate.

The documentation included here is current as of the 2005 tax year. Detailed documentation of the operation of the FederalTax module is presented in 14 sections:

Structure of Processing
Tax Units and Filing Status
Dependency Decision
Imputations of Income and Expenses
Gross Income
Adjustments to Income
Calculation of AGI
Itemized Deductions and Standard Deduction
Personal Exemptions for Taxpayers and Dependents
Taxable Income and Tax Computation
Tax Credits
Final Tax Computation
Aligning a Current Law FederalTax Simulation to Target Data
Prior Versions of FederalTax

1. Structure of Processing

The logic of the FederalTax simulation is contained in the C++ code, simulation "forms," and program rules. The FederalTax "forms" are short pieces of code that derive their name from the 1040 and other income tax forms used by tax units in calculating their taxes. However, the FederalTax forms do not exactly correspond to 1040 or other income tax forms, but more closely approximate a line and/or group of lines from an income tax form. For example, the form named "TaxableIncome" calls the "AdjustedGrossIncome" form in order to obtain AGI, and then subtracts exemptions and deductions, as obtained from the "Exemptions" and "Deductions" forms, in order to calculate the tax unit’s taxable income.

The C++ code controls the basic processing of the simulation and performs the tests necessary to identify tax units, dependents, and qualifying children for the EITC, child and dependent care credit, and child tax credit. For each tax unit, the C++ code makes a call to the main Tax "form" specified for the run. The Tax form in turn calls other forms in order to calculate the income taxes for the tax unit. The C++ code and forms reference the "program rule" values for the simulation, through which key values such as tax rates and tax brackets are specified.

Forms are specific to a given simulation run, and can be modified by the user in order to make changes to the calculation of federal income taxes. Extreme care should be taken in making such modifications, as modifying one form may have unintended consequences in other areas. Many routine changes can be handled in a straightforward manner through the program rules. For example, changes in tax brackets and tax rates are handled through program rules and do not require modification to the forms. Users who would like to modify the forms used in their simulation are advised to contact TRIM3 staff for advice before proceeding.

FederalTax computes taxes for all potential tax units. It does not attempt to simulate the fact that some units do not file, even though they either owe tax or are eligible for a refundable tax credit. After all tax units in a household have been processed, tax units that were simulated to be the dependents of other tax units are reprocessed. The reprocessing occurs because dependents are not allowed to claim the personal exemptions and may be limited in the amount of the standard deduction.

The age, marital status, and other demographic characteristics of persons on the CPS reflect the characteristics at the time of the CPS interview (February, March, or April), whereas the income data reflects income in the prior calendar year. Like other TRIM3 modules, FederalTax simulates the rules in effect for the calendar year represented by the CPS income data, and assumes that the household composition and demographic characteristics reported at the time of the CPS interview were in effect for the entire simulated year.

FederalTax calculates the tax liability incurred (or refundable credits earned) during the year being simulated. Therefore, a family’s annual after-tax income reflects the family’s income minus the taxes (or plus the credits) that arise from income received in that year, and does not reflect the fact that some of the taxes would not be paid (or refunds received) until taxes are filed in the subsequent calendar year.

2. Tax Units and Filing Status

All single individuals aged 15 and above and married couples are defined as tax units, regardless of whether or not they have taxable income. Some tax units may become dependents of other units. Note that you can identify a complete filing unit including dependents by refering to the result variable ExpandedUnitID. ExpandedUnitHead is the PersonID of the head of the filing unit.

FederalTax assigns tax units to one of three types of returns: joint, head of household, or single, and does not model any returns as married filing separately. A person is simulated to file a single return if he or she does not meet the criteria for a joint or head of household return (described below).

A. Joint Returns

Joint filers include persons who are "married, spouse present", "married spouse absent, military", and "married spouse absent, other". Because the CPS does not indicate how long a person has been widowed, FederalTax does not model the rule that allows recent widows to file joint returns. The CPS does not collect data on an absent spouse, so FederalTax implicitly treats the absent spouse as having no income. Persons who are "married, spouse absent, separated" are assumed to be legally separated and are simulated to file a single or head of household return.

B. Head of Household Returns

Under IRS rules, to file as head of household, a taxpayer must be unmarried or legally separated at the end of the tax year (with certain exceptions for married couples who live apart), have paid more than half the cost of keeping up a home for a year, and have a qualifying person living in the household for more than half the year (with exceptions for dependent parents, temporary absences such as school, and birth or death during the year). Effective with the 2005 tax year, a person (with certain exceptions) must be the taxpayer's dependent in order to qualify the taxpayer for head of household filing status. HeadOfHhldQualifyingPerson indicates which persons qualify the household reference person for head of household filing status.

FederalTax assumes that a widowed, unmarried, or separated person who is the household reference person meets the test for having paid more than half the cost of keeping up a home. Beginning from version 19.0, FederalTax assumes the same for the cohabiting partner of the household reference person, if they have a common child, and only the cohabiting partner has income. TRIM3 does not simulate the rule that prevents public assistance income from being counted as a person's contribution to keeping up a home. All persons present in the household at the time of the CPS interview are assumed to have been in the household for more than half the year. In addition, the household reference person’s marital status at the end of the tax year is assumed to be the same as his or her marital status at the time of the interview.

3. Dependency Decision

To calculate exemptions, FederalTax must first determine whether a tax unit has any dependents. To be a dependent, a person must pass the relationship test, married dependent test (if married), citizen/resident test, gross income test (with certain exceptions), and support test.

If CohabParentChildAssignment is set to "children are never assigned to the parent who is not their family head", QualifyingChildRule indicates whether only one person can claim the same child for the dependency exemption, child tax credit, head of household filing status, child care credit, and Earned Income Tax credit. If QualifyingChildRule indicates that the same child could be claimed by different people for different tax purposes, then, in some cases, a child will be allowed to be the EITC qualifying child of one person and the dependent of another. If QualifyingChildRule indicates that only one person can claim the same child for these purposes, and TRIM3 has initially set the child to be the dependent of one person and the EITC qualifying child of another person, the child will be made the EITC qualifying child of the person of whom he or she is a dependent. Child care expenses are specified by the rule ChildCareExpenses.

If the CohabParentChildAssignment rule is set to any other option, the child will be made the EITC qualifying child of the person on whom he or she is dependent.

Beginning with the 2005 tax year, taxpayers are asked to determine whether a person is a "qualifying child", and if so, whether the "qualifying child" is a dependent. Children and other relatives who do not count as "qualifying children" may be claimed as dependents through the "qualifying relative" test. TRIM3 does not specifically distinguish between qualifying children and qualifying relatives when determining dependency. The net effect of the 2005 changes primarily involves the gross income test, and is captured through the program rule ExemptGrossIncomeTest (discussed in section D below). Although the support test changed in 2005, the method for approximating it in TRIM3 remained the same (see section E). For information concerning the effect of the "qualifying child" definition on eligibility for various credits, click here. The tests used to determine whether a person is a dependent are described below.

A. Relationship Test

Under IRS rules, a dependent must be a relative or someone else who lived in the home as a family member for the entire year, as long as the relationship "does not violate local law". In addition, many types of relatives living outside the household can be claimed as dependents.

Because the CPS does not include information about relatives living outside the household, TRIM3 does not capture dependents outside the household. Persons present in the household at the time of the CPS interview are assumed to have been present within the household for the entire prior calendar year.

All of a person’s relatives within the household are considered potential dependents. The only exception is that heads and spouses of related subfamilies can only be simulated to claim their own children as dependents (e.g., they would not be simulated to claim the household reference person as a dependent).

In addition to claiming relatives as dependents, TRIM3 allows the household reference person and spouse to claim foster children (of any age) as dependents, as well as unrelated individuals under the age of 15 who are not identified as foster children. Given the lack of data regarding relationships between non-relatives, TRIM3 does not allow any other type of non-relative to be claimed as a dependent.

Starting with version 13.0, two new program rules add more flexibility in setting the maximum age for dependent children. MaxAgeDepNonStudent specifies the maximum age for a dependent child that is not a student, and MaxAgeDepStudent specifies the maximum age for a dependent child that is a student.

B. Married Dependent

Under IRS rules, a married person cannot be claimed as a dependent if he or she files a joint return, unless the return was filed only to obtain a refund and neither spouse would have tax liability if they had filed separate returns.

If TRIM3 finds that a married person has no positive or negative federal income taxes, then the married person is claimed as a dependent (assuming other relevant tests are met).

C. Citizen or Resident Alien

Under IRS rules, a dependent must be a U.S. citizen or resident alien, a resident of Canada or Mexico, or an adopted child. Under the IRS definition, "resident alien" is not restricted to "permanent resident" (i.e., "Green Card") aliens, but also pertains to aliens who are "substantially present" in the United States. "Substantially Present" aliens have been in the United States for at least 31 days of the current year, and 183 days during the three-year period that includes the current year and the prior two years.

FederalTax treats all persons as meeting the citizen or resident alien test. While the TRIM3 immigrant and citizenship status imputations flag certain persons as illegal aliens and non-citizens temporarily in the United States, the total number who would fail the "substantially present" test is most likely quite small. Therefore, no attempts have been made to approximate this test within FederalTax.

D. Gross Income

A dependent's gross income (not including non-taxable income) must be less than the personal exemption amount for a taxpayer, unless the dependent is a child of the taxpayer who is under the age of 19, under the age of 24 and a full-time student, or (beginning in 2005) permanently and totally disabled. Effective with the 2005 tax year, "child" is defined as the taxpayer's child, stepchild, foster child, or sibling, or a descendant of any of them (for example, a grandchild or niece).

FederalTax approximates this rule as follows. If the potential dependent’s adjusted gross income (note that AGI is used instead of gross income) is less than the amount specified by the program rule DependencyTestGrossIncome, then the person passes the gross income test. The program rule ExemptGrossIncomeTest indicates the definition of "child" for the purpose of the gross income test. Click here for further details on the gross income test. Click here for information about how TRIM3 identifies full-time students. Click here for more information about how TRIM3 identifies disabled children.

E. Support Test

Beginning with the 2005 tax year, a potential dependent must not have provided more than half of his or her own support in order to be claimed as a dependent. For tax years prior to 2005, the taxpayer must have provided over half of the dependent's support during the tax year (with exceptions for children of divorced and separated parents and persons supported by two or more taxpayers). Support includes a place to live, clothing, food, gifts, etc.

FederalTax approximates the support test by assuming the head and spouse spend equal amounts of money on each person in their family and comparing that amount to the amount of income of the potential dependent. The income items included in the support test are specified through the program rule SupportTestIncome. Special rules pertaining to divorced parents or persons supported by two or more taxpayers are not captured. Due to a lack of detailed information on the CPS concerning sources of support for the child other than his or her own income and that of the head and spouse, TRIM3 uses the same assumptions to model the support test for both current and pre-2005 tax law. Details concerning the simulation of the support test are provided below.

For potential dependents of related and unrelated subfamilies:

The income of the head and spouse (if present) is summed and divided by the number of persons in their subfamily. If this amount is greater than or equal to the potential dependent’s income, then the head and spouse pass the "support test" for that person and can claim him or her as a dependent.

If the subfamily head and spouse (if present) are themselves claimed as dependents of the household reference person, then TRIM3 re-evaluates the subfamily’s dependents and potential dependents to see if they pass the support test for the household reference person.

For potential dependents of the household reference person and spouse:

The income of the household reference person and spouse (if present) is summed and divided by the number of persons in their family (related subfamilies included). If this amount is greater than or equal to the sum of the potential dependent’s income, then the household reference person and spouse pass the "support test" for that person and can claim him as a dependent.

If the potential dependent is married with spouse present, then FederalTax applies the support test to the sum of the potential dependent and dependent spouse’s income, divided by two.

For potential dependent children of cohabiting parents:

The income of the child's family head and his/her other parent, who is the cohabiting partner of the family head and member of a different family, is summed and divided by the number of persons in the child's family and the cohabiting partner's family. If the amount is greater than or equal to the sum of the potential dependent's income, then the cohabiting parents pass the "support test" for that person and can claim him/her as a dependent.

4. Imputations of Income and Expenses

Most of the variables required by FederalTax are taken directly from the CPS. However, capital gains income, child care expenses, IRA and Keogh contributions, and itemized deductions are not available on the CPS and must be either imputed or obtained through a statistical match with the PUF.

A. Statistical Match With The PUF

With the exception of child care expenses, all of the expense and income items not available on the CPS are obtained through a statistical match with the IRS Statistics of Income Public Use File (PUF). The statistical match is performed outside of TRIM3 during the creation of each year's baseline simulation, and the matched variables are then imported into the TRIM3 database. The statistical match procedure used beginning with the 2003 FederalTax baseline is an unconstrained nearest-neighbor match, whereas the statistical match procedure used in earlier years uses a modified approach to an expanding-cell match. For further details about the statistical match procedure used beginning with the 2003 baseline, click here. For details about the match procedure used in earlier years, click here.

B. Child Care Expenses

Beginning with the 1996 baseline, child care expenses are obtained from the TRIM3 Child Care Expense module.

5. Gross Income

FederalTax captures most kinds of taxable income. Total taxable income (excluding taxable social security) is summed in the TotalIncome form. The taxable amount of social security is calculated in the TaxableSocialSecurity form. With the exception of net capital gains, all income amounts are obtained from the CPS. Net capital gains are obtained through the statistical match with the PUF. FederalTax treats all interest and dividend income reported on the CPS as taxable. IRA distributions are captured to the extent they are reported as pension income.

A. Total Income

The FederalTax TotalIncome form sums all taxable income amounts except for the taxable amount of social security. The default composition is: wages and salaries, interest, dividends, alimony income, self-employment non-farm income, net capital gains, government and private pensions, rents and royalties, self-employment farm income, and unemployment compensation.

Taxable income components (as of the 2005 tax year) that are not captured by FederalTax include refunds of state and local income taxes and taxable "other" income. Refunds of state and local income taxes are not captured because they are not reported on the CPS and have not been incorporated into the statistical match with the PUF. Taxable other income is not captured because the CPS does not distinguish between the taxable and nontaxable components of "other income" and we suspect that the majority of "other income" reported on the CPS is nontaxable.

Three types of income that are available on the CPS, but are not subject to federal income taxes are veterans’ benefits, workers’ compensation, and welfare benefits. To simulate the taxation of one or more of these income types, they could simply be added to the list of incomes summed in the TotalIncome form.

B. Social Security Income

FederalTax captures the fact that social security income is not fully taxable, and is not taxable at all for low-income tax units. The taxable amount of social security income depends on the extent to which a tax unit’s other income, after adjustments, plus a portion of the tax unit’s social security income exceeds certain income thresholds. In addition, FederalTax captures the fact that higher income units may be taxed on a greater portion of their social security benefits.

The taxable amount of social security is calculated in the form TaxableSocialSecurity. The income thresholds and taxable percentages are specified through the program rules SocialSecurityMinAGI1Joint, SocialSecurityMinAGI1SingleHh, SocialSecurityMinAGI2Joint, SocialSecurityMinAGI2SingleHh, SocialSecurityTaxRateHigh, and SocialSecurityTaxRateLow.

6. Adjustments to Income

FederalTax simulates three of the "adjustments to income" that are currently allowed: the Individual Retirement Account (IRA) deduction, one-half the self-employment tax, and self-employed SEP, SIMPLE, and Qualified Plans. Other types of adjustments to income are not simulated. As of the 2005 tax year, these include: educator expenses, certain business expenses of reservists, performing artists, and fee-basis government officials, health savings account deduction, moving expenses, self-employed health insurance deduction, penalty on early withdrawal of savings, alimony paid, student loan interest deduction, tuition and fees deduction, and the domestic production activities deduction.

All adjustments except deductible IRA contributions are summed in the Adjustments form (for each person individually). Deductible IRA contributions are calculated in the IRAComputed form (at the tax unit level). The AdjustedGrossIncome form calls the Adjustments form for each person in the tax unit and subtracts total adjustments from the unit’s income (including taxable social security). The amount calculated in IRAComputed is then subtracted in order to calculate the tax unit’s AGI.

A. Deductible IRA Contributions

The amount of the IRA contribution is obtained through the statistical match with the PUF. FederalTax calculates the amount of the allowable deduction in the IRAComputed form. IRA deductions are computed for each spouse separately and then added together.

The program rule IRADeductionLimitPerWorker indicates the maximum amount an individual can deduct for contributions to his or her own IRA. If the individual is age 50 or older, the maximum deductible amount is obtained from IRADeductionLimitPerWorker50Plus. The deductible amount is capped at the individual's earnings, unless the program rule FullSpousalIRA indicates that non-working spouses are eligible for the full IRA deduction, in which case the combined IRA deduction for the head and spouse is not allowed to exceed the combined earnings for the couple. If FullSpousalIRA indicates that non-working spouses are not eligible for the full IRA deduction, then the maximum amount of the tax unit’s deduction is obtained from IRADeductionLimitWorkerSpouse.

Tax units that are not covered by a pension plan are eligible for the maximum amount of the deduction. Otherwise, the deduction is phased out above certain income thresholds (where income is defined as AGI excluding the IRA deduction). IRADeductAGICoupleMin specifies the income level at which the deduction begins to be phased out for joint returns in which the head and spouse are each covered by a pension plan. If only one spouse is covered by a pension plan, then the beginning of the phase out for the uncovered spouse’s IRA deduction is obtained from IRADeductAGICutoff1NoPen. IRADeductAGISingleMin specifies the income level at which the deduction begins to phase out for a single or head of household return where the taxpayer has pension coverage. The range over which the deduction is phased down to zero is specified through IRAPhaseOutRange (for single / head of household returns, or joint returns for a spouse not covered by a pension plan) or IRAPhaseOutRangeJoint (for joint returns, for a spouse covered by a pension plan).

B. One-Half the Self-Employment Tax

Self-employment taxes (for social security and Medicare) are calculated in the PayrollTax module. The form OneHalfSelfEmploymentTax reads in the total self-employment tax calculated in the PayrollTax module and multiplies the total by 50 percent. OneHalfSelfEmploymentTax is added to the Adjustments form.

C. Self-Employed SEP, SIMPLE, and Qualified Plans

The deduction for self-employed SEP, SIMPLE, and Qualified Plans enables self-employed persons to deduct contributions to a retirement plan. FederalTax obtains the amount of the deduction from the statistical match with the PUF and adds the amount to the Adjustments form.

7. Calculation of AGI

AGI is calculated in the AdjustedGrossIncome form. It is equal to gross income less adjustments. Gross income is equal to the sum of the amounts in the TotalIncome and TaxableSocialSecurity forms. Adjustments are the sum of the amounts in the Adjustments and IRAComputed forms. The result of this calculation may be negative.

8. Itemized Deductions and Standard Deduction

FederalTax calculates the standard deduction and total itemized deduction for which the tax unit is eligible, and assigns the unit to claim the larger of the two.

A. Standard Deduction

The amount of the standard deduction varies by filing status, dependency, and aged status. For tax units that are not dependents of other units, the standard deduction is obtained from the program rule StandardDeductionAmount, which contains values for single, joint, and head of household returns. The standard deduction is increased by the amount specified in AdditionalDeductionAged for each head or spouse aged 65 and above.

If the tax unit is claimed as the dependent of another tax unit, then the amount of the standard deduction is equal to the greater of earned income and the amount specified by DependentStandardDeduction, capped at the amount specified by StandardDeductionAmount.

The additional deduction for the aged is also available to the blind. However, since the CPS does not identify whether or not a person is blind, this provision is not simulated.

B. Itemized Deductions

Itemized deductions are obtained through the statistical match with the PUF. The amount of the tax unit’s total potential itemized deduction is calculated in the form TotalItemizedDeductions, which sums up the unit’s medical expense deduction, state and local tax deduction, real estate taxes, mortgage interest deduction, charitable contribution deduction, casualty and theft loss deduction, and miscellaneous deductions. The medical expense deduction is equal to the amount of medical expenses exceeding the percent of AGI specified by the program rule MedicalExpensesAGIPercent. Casualty and theft loss and miscellaneous deductions cannot be distinguished from one another in the data obtained from the PUF, and so five percent of the total amount is assumed to be for casualty and theft losses. Deductions for "other taxes" are not available in the version of the PUF data used for the 2003 and later baselines and so are not captured in those years (although they are captured in prior years).

Itemized deductions other than for medical expenses and casualty and theft loss may be limited for higher income taxpayers. The tax unit’s itemized deductions, after any limitations, are calculated in the ItemizedDeductions form. The program rules ItemizedDeductionAGILimit, ItemizedDeductionAGIPercent, and ItemizedDeductionLimitMaxPct are referenced in determining the extent of the limitation. Tax units whose AGI is higher than the amount specified by ItemizedDeductionAGILimit have their itemized deductions (subject to limitation) reduced by the lesser of 1) ItemizedDeductionAGIPercent of AGI in excess of ItemizedDeductionAGILimit, and 2) ItemizedDeductionLimitMaxPct of itemized deductions subject to limitation.

9. Personal Exemptions for Taxpayers and Dependents

The FederalTax Exemptions form calculates the amount of personal exemptions that can be claimed by the tax unit on behalf of the head and spouse and any dependents, and phases out the exemption for high-income units. The per-person amount of the exemption is obtained from the program rule ExemptionAmount. FederalTax multiplies ExemptionAmount by the number of people in the tax unit plus the tax unit’s dependents. Tax units that are claimed as dependents of other tax units are not permitted to claim the personal exemption on their own return.

The program rule AGICutoffForExemptions specifies the AGI level above which the exemption amount begins to be phased out, by filing status. To calculate the amount by which exemptions are reduced, the amount of AGI in excess of AGICutoffForExemptions is divided by the amount specified by ExemptionPhaseOutIncrement. The result is rounded up to the next highest integer and is multiplied by the amount specified by ExemptionPhaseOutPercent. This is then subtracted from the tax unit’s total exemption amount in order to calculate the amount of allowed exemptions.

10. Taxable Income and Tax Computation

A. Taxable Income

Taxable income is computed in the FederalTax TaxableIncome form. Taxable income is equal to AGI, minus standard or itemized deductions, minus exemptions. If the result is less than zero, it is reset to zero.

B. Tax Computation

Taxes are determined in accordance with tax brackets and tax rates, which vary by filing status. Tax brackets are specified through the program rules TaxBracketHeadOfHousehold, TaxBracketJoint, and TaxBracketSingle. Tax rates are specified through the corresponding program rules: TaxRateHeadOfHousehold, TaxRateJoint, and TaxRateSingle. Taxes (before credits) are calculated in the form TaxBeforeCredits.

FederalTax captures the fact that income from taxable gains may be taxed at a lower rate. After taxes have been calculated in accordance with the tax brackets and tax rates as describe above, FederalTax calculates an alternative tax that reflects the lower rate on capital gains. The tax (before credits) is then set to the minimum of the original and alternative tax.

FederalTax allows for two different tax rates on capital gains, as specified by CapitalGainsTaxRate1 and CapitalGainsTaxRate2. CapitalGainsBreakpoint, which varies by filing status, shows the AGI level at which capital gains start being taxed at the higher rate specified by CapitalGainsTaxRate2.

TaxQualifDivLikeCapGains indicates whether qualified dividends are taxed at the same rate as capital gains. If qualified dividends are taxed at the same rate as capital gains, then FederalTax randomly selects which tax units with CPS-reported dividends have qualified dividends. If a tax unit has dividend income, and its random number is less than or equal to the percent specified by PctWithQualifiedDiv (for its AGI level), then all of the tax unit's dividends are treated as qualified dividends and are taxed at the rate that is applied to capital gains.

C. Alternative Minimum Tax

Once a tax unit's initial tax (before credits) has been calculated, FederalTax determines whether the tax unit is required to pay the alternative minimum tax (AMT). FederalTax models the exemption preferences of the alternative minimum tax (AMT) that are most likely to affect middle-income taxpayers:

disallowance of personal exemptions, the standard deduction, and some itemized deductions in calculating AMT taxable income
inclusion of the AMT exemption (phased out for higher income units)
AMT tax brackets and tax rates

However, FederalTax does not capture the deferral preferences of the AMT that mainly affect high-income taxpayers (i.e., the rules that limit the extent to which taxpayers can postpone regular income tax payments or shelter income by hastening deductions or delaying income recognition). FederalTax does not specifically model this type of tax deferral behavior and so does not impose limits on this behavior through the AMT.

The AMT is calculated by calculating income taxes using AMT taxable income, tax rates, and brackets, and then subtracting taxes (before credits) calculated under the regular income tax rules (as described in section B). The AMT is then added to the tax unit's total tax liability.

AMT taxable income is calculated by subtracting certain itemized deductions and the AMT exemption from AGI. Itemized deductions subtracted from AGI include: the medical expense deduction (less AMTMedicalExpenseAGIPct multiplied by AGI), mortgage interest, charitable contributions, and casualty or theft losses. There is no phase-out of itemized deductions for high-income units when calculating the AMT.

The maximum amount of the AMT exemption varies by filing status and is specified by AMTMaximumExemption. The AMT exemption begins to phase out at the point specified by AMTExemptionPhaseOutPoint (which also varies by filing status), and is reduced by AmtExemptionPhaseOutRate percent of income in excess of AmtExemptionPhaseOutPoint. The income used in the phase-out calculation is AGI less the itemized deductions that are subtracted from AGI under the AMT rules.

AMTTaxBracket and AMTTaxRate specify the tax brackets and tax rates applied to AMT taxable income. FederalTax captures the fact that income from taxable gains and qualified dividends may be taxed at a lower rate. After taxes have been calculated in accordance with AMTTaxBracket and AMTTaxRate, FederalTax calculates an alternative tax that reflects the lower rate on capital gains and qualified dividends. The tax is then set to the minimum of the amount calculated using AMTTaxBracket and AMTTaxRate and the alternative tax.

The final step in calculation of the AMT is to subtract taxes (before credits) calculated under the regular income tax rules (described in section B above) from the amount of taxes calculated under the AMT. If the result is less than or equal to zero, then the tax unit is not required to pay the AMT. A positive amount represents the AMT owed by the tax unit.

D. Taxes Not Simulated By TRIM3

The self-employment tax is simulated in TRIM3 by the PayrollTax module and so is not simulated in FederalTax.

Several other types of taxes are reported on the 1040 form, but are not captured in TRIM3. As of the 2005 tax year, these include: social security and Medicare tax on tip income not reported to employer; additional tax on IRAs, other qualified retirement plans, etx; and household employment taxes. Note, however, that to the extent that workers report all of their tip income on the CPS, PayrollTax will capture the full amount of social security and Medicare taxes owed.

When reconciling FederalTax results with published data, the analyst should take into account the fact that FederalTax does not simulate all the taxes that may be reflected in the published data.

11. Tax Credits

The tax computed on taxable income may be reduced by tax credits. FederalTax simulates the earned income tax credit (EITC), child care credit, elderly or disabled tax credit, child tax credit, and the additional child tax credit. If a tax credit is refundable, it can reduce taxes to below zero. When taxes are negative, the taxpayer receives a refund check from the government.

FederalTax assumes that taxpayers claim the EITC, child tax credit, and additional child tax credit when they are eligible for these credits. However, probabilities of participation are used to select which apparently eligible tax units claim the elderly or disabled tax credit and child care credit.

A. Credit for the Elderly and Disabled

The elderly or disabled tax credit is for low-income persons who are elderly or retired on disability. The elderly or disabled tax credit is calculated in the ElderlyOrDisabledCredit form. The elderly or disabled credit is not refundable and so is not allowed to exceed the amount of the tax unit's taxes before credits.

To simulate the elderly or disabled tax credit, FederalTax must first determine whether the head and/or spouse of the tax unit is elderly or disabled. Elderly is defined as age 65 and above. A person is considered disabled if she or he did not work at all during the calendar year due to illness or disability, and also reports receiving social security, SSI, or veterans’ benefits. Persons that are both elderly and disabled are classified as elderly.

To calculate the credit, FederalTax starts by establishing an "initial amount," specified by the program rule ElderlyDisabledCreditBase. ElderlyDisabledCreditBase varies by filing status (joint versus single or head of household) and the number of disabled or elderly persons in the tax unit.

If the tax unit contains a disabled person, then the initial amount is not allowed to exceed the unit’s taxable disability income. For units where one member is elderly and the other is non-elderly disabled, an additional amount specified by the program rule AdditionalDisabilityAmount is added to taxable disability income prior to the comparison.

After the initial amount has been capped at the amount of taxable disability income (for disabled units) non-taxable social security income is subtracted from the result. The result is further reduced by one-half of the amount by which the tax unit’s AGI exceeds the thresholds specified by ElderlyDisabledCreditCap. Finally, the resulting value is multiplied by the value specified by ElderlyDisabledCreditRate in order to calculate the amount of the credit for which the unit is eligible.

Because FederalTax has typically found many more units eligible for this credit than actually claim it according to published data, not all eligible units are simulated to take the credit. If a unit is found eligible for the credit, then FederalTax assigns the unit to claim the credit if the unit’s uniform random number is less than or equal to the value specified by ElderlyCreditParticipationRate.

B. Child and Dependent Care Tax Credit

The child and dependent care credit reduces taxes for families with work-related child care expenses for a child under the age of 13 and/or a spouse or dependent who is unable to care for him or herself. Due to a lack of imputed childcare expenses for disabled adults in TRIM3, FederalTax only captures the child care component of the credit. The rules governing the child and dependent care credit are summarized below, along with the TRIM3 methodology used to approximate them.

Qualifying Child

To qualify for the child care credit, the taxpayer must have a qualifying child. Under IRS rules, a qualifying child is a dependent under the age of thirteen at the time the care was provided. Beginning with the 2005 tax year, the dependent must also be a child that meets the definition of "qualifying child" used in the dependency determination. A dependent that is not a "qualifying child" for the dependency determination, but is a "qualifying relative" cannot be claimed for the child and dependent care credit. Special rules apply to children of separated and divorced parents.

FederalTax counts a person as a qualifying child if he or she meets to definition specified by ChildCareCreditQualifChild and is within the age range specified by the program rules ChildCareCreditMinAge and ChildCareCreditMaxAge. ChildCareCreditQualifChild indicates which types of dependent children can be claimed for the child and dependent care credit. If ChildCareCreditQualifChild is set to "qualifying children who can be claimed as dependents," then TRIM3 models the rules in effect as of the 2005 tax year. For TRIM3, the only difference between this option and the second option ("dependent children") is that unrelated individual children who are <=15 and are not identified as foster children cannot be claimed for the child and dependent care credit (because although these children can be claimed as dependents, they count as "qualifying relatives" rather than "qualifying children" in the dependency determination.) Note that the age of the dependent reflects his or her age at the time of the CPS survey. FederalTax does not simulate the special rules pertaining to the children of separated and divorced parents. The child is assumed to be the qualifying child of the resident parent.

YoungChildCareAGIBracket1, YoungChildCareAGIBracket2 and YoungChildCareAGIBracket3 provide AGI thresholds corresponding to rates in YoungChildCareExpenseRate1, YoungChildCareExpenseRate2 and YoungChildCareExpenseRate3. These program rules are used to limit the amount of the young child and dependent care credit based on earnings of the head and spouse of a tax unit. If AGI is higher than the threshold in YoungChildCareCreditAgiBracket1, it is then tested against the second threshold and finally the third threshold if AGI exceeds the second threshold. The credit rate is taken from the corresponding rate rule--YoungChildCareExpenseRate1, YoungChildCareExpenseRate2 or YoungChildCareExpenseRate3. The rate is multiplied by the unit's qualifying young child and dependent care expenses to determine the amount of the young child and dependent care credit.

Keeping Up a Home

Propr to the 2005 tax year, the taxpayer (and spouse, if married) must have paid over half the cost of keeping up the home for the year. Beginning with the 2005 tax year, this restriction no longer applies.

SubfamilyEligForCDCTC indicates whether related and unrelated subfamilies are eligible for the child and dependent care tax credit. If SubfamilyEligForCDCTC = "no", then just the tax unit containing the household reference person is eligible to claim the credit. This approximates the rule that the tax unit is required to pay over half the cost of keeping up the home in order to claim the credit. If SubfamilyEligForCDCTC = "yes" then related and unrelated subfamilies may also be simulated as eligible for the credit.

Earned Income

Under IRS rules, the taxpayer (and spouse) must have earned income and have paid for child care in order to work or look for work. A nonworking spouse is treated as working and having earned income if he or she is a full-time student or unable to care for him or herself.

FederalTax treats a person as working and having earnings if the sum of the person’s earned income (wages and salaries, self-employment farm, and self-employment non-farm) is greater than zero. While either spouse could qualify as a "student," FederalTax only checks the status of the person identified as the "spouse" on the CPS. Click here for more information about how TRIM3 identifies student status. FederalTax does not capture the provision that allows a nonworking spouse to be considered to be working if he or she is unable to care for him or herself. All child care expenses are assumed to be work related.

Additional Requirements

Additional requirements not captured by FederalTax are that the child care expenses must be paid to someone other than a person who is the taxpayer’s dependent or child under age 19, and that the care provider must be identified on the tax return. Special rules apply to taxpayers who file as married filing separately. Since FederalTax does not simulate any returns to file as married filing separately, these rules are not applied.

For years in which child care expenses are imputed by the TRIM3 Child Care Expense module, there may be additional restrictions on what sorts of families are imputed to have expenses, and what the expenses are assumed to reflect. See the Child Care Expense module documentation for further information.

Work Related Expenses

The child care credit is equal to a percentage of work related child care expenses, subject to an earned income limit and a dollar limit.

FederalTax assumes that all child care expenses (imputed by the Child Care Expense module or obtained from the statistical match with the PUF) are work-related expenses. FederalTax does not simulate certain rules relating to expenses. It does not simulate the fact that if a portion of taxpayer's wages were set aside for child care purposes on a pre-tax basis through an employer-sponsored "expense account", qualifying expenses must be reduced by that amount.

Earned Income Limit

Under IRS rules, the work related child care expenses cannot exceed the lesser of the earned income of the taxpayer and spouse (if present). A student spouse is assumed to have earnings of at least $250 (if one qualifying child) and $500 (if two or more qualifying children) for each month in which the spouse is a student.

FederalTax approximates this rule as follows. Child care expenses are capped at the smaller of the earnings of the head and spouse. However, if the spouse is a student, then child care expenses are capped at the earnings of the head.

Dollar Limit

There is a dollar limit on the total work related child care expenses that can be claimed. Dependent care benefits that are received from an employer and not included in income must be subtracted from the dollar limit.

FederalTax calculates the dollar limit by capping the number of qualifying children at the value specified by ChildCareCreditMaxNumber, and multiplying the resulting number by the value specified by ChildCareCreditMaxExpenses. FederalTax does not capture the reduced dollar limit for dependent care benefits.

Amount of the Credit

The amount of the child and dependent care credit is equal to a fraction of work related child care expenses (after the earned income and dollar limit). The fraction varies with the tax unit’s AGI.

AGI thresholds are contained in program rules ChildCareCreditAGIBracket, ChildCareCreditAGIBracket2 and ChildCareCreditAGIBracket3, and the corresponding rates are specified by ChildCareCreditExpenseRate, ChildCareCreditExpenseRate2 and ChildCareCreditExpenseRate3. The credit is computed by multiplying the rate obtained from the rate rule that corresponds to a unit's AGI by the unit's work-related child care expenses (after the earned income and dollar limit).

For tax units filing joint returns, the programs rules JointChildCareCreditAGIBracket, JointChildCareCreditAGIBracket2, JointChildCareCreditAGIBracket3, JointChildCareCreditExpenseRate, JointChildCareCreditExpenseRate2 and JointChildCareCreditExpenseRate3 may be specified. If these rules are not specified--i.e., they default to -1--the rates and brackets do not vary by filing status, and the AGI limits and associated rates are obtained from the rules listed in the paragraph above. The child care and dependent care credit is not refundable; thus, it is not allowed to exceed the amount of the tax unit’s taxes before credits.

The young child and dependent care credit is an optional refundable credit that is independent of the regular child and dependent care credit. It is calculated using program rules YoungChildCareAGIBracket1, YoungChildCareAGIBracket2 and YoungChildCareAGIBracket3 to specify AGI thresholds, and YoungChildCareExpenseRate1, YoungChildCareExpenseRate2 and YoungChildCareExpenseRate3 to specify the corresponding rates for each threshold.

For units filing joint returns, the young child and dependent care credit is calculated using program rules JointYngChildCareAGIBracket1, JointYngChildCareAGIBracket2 and JointYngChildCareAGIBracket3 to specify AGI thresholds, and JointYngChildCareExpenseRate1, JointYngChildCareExpenseRate2 and JointYngChildCareExpenseRate3 to specify the corresponding rates for each threshold. If these rules are not specified--i.e., they default to -1--the rates and brackets do not vary by filing status, and the AGI limits and associated rates are obtained from the rules listed in the paragraph above.

Participation Rate

When the child and dependent care credit is simulated using child care expenses imputed by the TRIM3 Child Care Module, too many units are simulated to claim the credit. This is most likely due to the fact that FederalTax is unable to simulate certain key restrictions on use of the credit. For example, FederalTax does not know whether or not the tax unit received dependent care benefits from an employer or paid child care expenses to a qualified provider who would be named on a tax return. Therefore, a number of tax units to whom FederalTax assigns the credit may actually be ineligible for the credit. Others might be eligible, but do not complete the steps necessary to claim the credit.

To reduce the number of tax units claiming the child and dependent care credit to a more reasonable level, FederalTax randomly selects a percentage of units to claim the credit. The percentage varies by AGI level and is specified through the program rule ChildCreditParticipAdjust.

C. Earned Income Tax Credit

The earned income tax credit (EITC) is a refundable tax credit for low-income tax units with earned income. To be eligible for the credit, the tax unit must meet certain requirements:

The taxpayer, spouse, and qualifying children must have a valid Social Security Number.
The tax unit must not file as married filing separately.
The taxpayer must be a U.S. citizen or resident alien for the entire year.
The tax unit must not file forms 2555 or 2555-EZ (pertaining to foreign earned income).
In certain tax years, the tax unit must have investment income less than a given amount.
The tax unit must have earned income less than a certain amount.
The tax unit must have AGI (or modified AGI) less than a certain amount.
The taxpayer cannot be an EITC qualifying child for another tax unit.
Additional rules pertain depending on whether or not the tax unit has qualifying children (see below).

FederalTax assumes that the tax unit meets the first four requirements. FederalTax does not simulate any units as filing as married filing separately. See the discussion under "Dependency Decision" for information regarding the assumption concerning resident alien status. FederalTax simulates the remaining requirements as closely as possible given the data available on the CPS.

Investment Income Test

The program rule EITC_InvestmentIncomeLimit controls whether or not the investment income test is simulated. EITC_InvestmentIncomeLimit specifies the maximum amount of investment income the tax unit can receive and still remain eligible for the EITC. Investment income is calculated in the EITC_InvestIncome form and includes interest, dividends, capital gains, and rental income (excluding net capital losses and net rental losses).

Additional Rules for Units with Qualifying Children

Tax units with a qualifying child are eligible for a more generous credit than are tax units with the same income who do not have a qualifying child. Under IRS rules, a qualifying child must:

Be the taxpayer's child, adopted child, stepchild, or descendent of any of them; OR be the brother, sister, stepbrother, stepsister, or descendent of any of them whom the taxpayer cared for as his or her own child; OR be the taxpayer's foster child whom the taxpayer cared for as his or her own child.
Be under age 19, under age 24 and a full-time student at the end of the tax year, or any age and permanently and totally disabled.
Have lived with the taxpayer in the United States for more than half the year.

FederalTax captures the relationship test. EITCFosterKid specifies the definition of "foster child" for the purpose of the EITC. If EITCFosterKid indicates that a foster child is "any child cared for as own," then a foster child is a child who meets at least one of the following criteria: 1) is specifically identified as a foster child on the CPS; 2) is an unrelated individual under the age of 15; or 3) is a related child of the household reference person who is not claimed as the qualifying child of a related subfamily. If EITCFosterKid indicates that a foster child is a "sibling, descendent of sibling, or child placed by an authorized placement agency", then a child must meet criteria (1) or (3) above to be considered a qualifying foster child.

The age, student status, and disabled child tests are also captured. Click here for information about how full-time students are identified. Click here for information about how TRIM3 identifies disabled children. Starting with version 13, two new program rules provide more flexibility in setting the maximum age for EITC qualifying children, MaxChildAgeEITCNonStudent and MaxChildAgeEITCStudent.

FederalTax assumes that all persons present in the household at the time of the CPS survey were present in the household for the entire prior year.

FederalTax assigns a qualifying child to be the qualifying child of his or her parent, if present in the household, unless the parent is the qualifying child of the household reference person. If the household reference person claims the child's parent as a qualifying child, then the household reference person also claims the child as a qualifying child. FederalTax does not simulate the "AGI tiebreaker" rule, which, in tax years prior to 2002, required that a child who was the qualifying child of more than one tax unit be assigned to the tax unit with the highest AGI.

Additional Rules for Units Without Qualifying Children

To receive the EITC without a qualifying child, a taxpayer must be between the ages of 25 and 64 and not be a dependent or EITC qualifying child of another unit. FederalTax captures these requirements. The minimum and maximum age allowed for units without qualifying children are specified through the program rules ChildlessEITCMaxAge and ChildlessEITCMinAge. If either the head or the spouse meets the age requirement, then the unit meets the age requirement for the EITC. If the head or spouse of the tax unit is simulated to be a dependent of another unit or EITC qualifying child, then the tax unit is denied the EITC. If rule ChildlessEITCRestrictions is set to option #2, parents with a child (bio/adoptive/step) in the household who is an EITC-qualifying child FederalTax cannot take the childless EITC.

Earned Income and AGI/Modified AGI Test

To receive the EITC, the tax unit must have earned income and AGI less than a certain amount. The amount varies by whether there are 0, 1, or 2 or more qualifying children. This test is modeled implicitly through calculating the phase out of the EITC.

For tax years 1996 to 2001, the IRS required that modified AGI be used for phasing out the EITC. Under IRS rules, modified AGI added the following income amounts to AGI: tax-exempt interest, the nontaxable part of pension, annuity, or IRA distributions, net capital and rental losses, and a percentage of net self-employment losses.

The program rule EITC_UseModifiedAGI specifies whether or not AGI or modified AGI is to be used in calculating the phase out. FederalTax is unable to distinguish between taxable and tax-exempt interest and pension, annuity, and IRA distributions; so all income from these sources is already included in AGI. FederalTax calculates modified AGI by adding net capital and rental losses, and a percentage of net self-employment losses (specified by the program rule EITC_ModifiedAGISelfEmpPct) to AGI.

Computation of the EITC

The amount of the EITC for which a tax unit is eligible depends on the number of qualifying children (0, 1, or 2 or more), the unit's filing status (joint versus single or head of household), the amount of the tax unit’s earned income, and the amount of the tax unit’s AGI (or modified AGI). The program rules EITCMaxIncome, EITCPhaseDownPoint, EITCPhaseOutRate, and EITCRate provide the thresholds and rates necessary for the calculation. All of these program rules are indexed by number of qualifying children and filing status.

EITCRate specifies the credit rate for the EITC. The credit rate is multiplied by the tax unit's earned income (up to the amount specified by EITCMaxIncome) to calculate the unit's maximum potential credit. For units with AGI/modified AGI or earned income above the amount specified by EITCPhaseDownPoint, the amount of the credit is then reduced or eliminated through the phase out.

EITCPhaseOutRate specifies the rate at which the tax unit’s EITC is phased out. To calculate the amount of the phase out, FederalTax subtracts the phase out threshold (specified by EITCPhaseDownPoint) from the larger of the tax unit’s earned income and AGI/modified AGI. The result is then multiplied by EITCPhaseOutRate to determine the total amount by which the tax unit’s maximum potential credit is reduced. If the phase out amount is greater than the tax unit’s maximum potential credit, then the unit is not eligible for the EITC.

All tax units eligible for the EITC are simulated to claim it. Even so, FederalTax typically falls short of target for the number of returns claiming the EITC and the total amount of the credit. This is a typical finding for models that simulate the EITC using data from the CPS, and is most likely attributable to differences in how income and family relationships are captured on the CPS versus income tax returns, and on real world errors involving EITC claims.

The EITC is a refundable credit. Therefore, if a tax unit has no tax liability, or if the EITC reduces the tax liability to zero, any remaining EITC is received as a payment from the federal government.

D. Child Tax Credit

The child tax credit is a nonrefundable credit that reduces the amount of taxes owed by a fixed amount per qualifying child. The credit is phased out for higher income units. Some low-income units whose potential credit exceeds their income tax liability may be eligible for the refundable additional child tax credit.

Qualifying Child

A qualifying child for purpose of the child tax credit must be:

Under the age of 17 at the end of the tax year.
A citizen or resident of the United States.
The taxpayer's child, stepchild, foster child, or sibling, or a descendant of any of them (for example, a grandchild or niece).

Prior to the 2005 tax year, the child was also required to be the taxpayer's dependent. Beginning in 2005, there are two circumstances in which a person meeting the qualifying child criteria would not be a dependent: (1) if the child is not a dependent because the taxpayer is claimed as a dependent (and so cannot claim dependents); and (2) if the child cannot be claimed as a dependent because he or she is married and required to file a tax return.

FederalTax simulates the ChildTaxCredit as follows. Program rules ChildTaxCreditMinAge and ChildTaxCreditMaxAge specify the age range for children to qualify for the child tax credit. The child’s age at the time of the CPS interview is used in determining if the child qualifies. FederalTax assumes that all persons are citizens or residents of the United States (see the discussion under Dependency Decision),and checks to see that the child is the taxpayer's dependent. Corresponding rules--YoungChildTaxCreditMinAge and YoungChildTaxCreditMaxAge specify the age range for children to qualify for the young child tax credit.

ChildCreditFosterKid specifies the definition of "foster child" for the purpose of the child tax credit. If ChildCreditFosterKid indicates that a foster child is "any child cared for as own," then a foster child is a child who meets at least one of the following criteria: 1) is specifically identified as a foster child on the CPS; 2) is an unrelated individual under the age of 15; or 3) is a related child of the household reference person who is not claimed as the qualifying child of a related subfamily. If ChildCreditFosterKid indicates that a foster child is a "sibling, descendent of sibling, or child placed by an authorized placement agency", then a child must meet criteria (1) or (3) above to be considered a qualifying foster child.

FederalTax does not model the exceptions (beginning in 2005) that would allow certain children who are not dependents to be qualifying children for the child tax credit. If the taxpayer is claimed as a dependent (and so cannot claim dependents), then the taxpayer's children are simulated as the qualifying children of the household reference person. Few, if any, CPS families meet the second exception (where the child is not claimed as a dependent because he or she is married and required to file a tax return) because it is rare for children under the age of 17 to be married with non-zero tax liability.

Calculation of Child Tax Credit

The maximum potential child tax credit for the unit is calculated by multiplying the number of qualifying children by the amount specified in the program rule ChildTaxCreditAmount. The maximum amount is phased out for higher-income tax units. The program rule ChildTaxCreditBeginPhaseOut specifies the AGI level (by filing status) at which the credit begins to be phased out. Subtracting ChildTaxCreditBeginPhaseOut from AGI, dividing by 1000, rounding up to the nearest integer, and multiplying by 50, calculates the amount by which the maximum child tax credit is reduced.

The amount of the child tax credit that can be claimed is limited by the amount of the tax unit’s tax liability, after subtracting the elderly or disabled credit and child and dependent care credit.

Additional Child Tax Credit

Certain low-income tax units who are unable to receive the full child tax credit because the credit exceeds their tax liability may be able to claim the refundable additional child tax credit. AdditionalChildTaxElig indicates whether no additional child tax credit is simulated, whether tax units with any number of qualifying children are eligible, or whether only tax units with three or more qualifying children are eligible.

If only tax units with three or more qualifying children are eligible, then the additional child tax credit is initially set equal to the amount of child tax credit that is unclaimed because it exceeds the unit's tax liability. It is then capped by the amount by which the tax unit's social security and Medicare payroll taxes (including one half of the self-employment tax) exceed the unit's Earned Income Tax Credit.

If tax units with any number of qualifying children are eligible, then tax units with one or two qualifying children are simulated to receive a refundable credit that is equal to RefundCTCRate multiplied by the unit's earned income in excess of MinIncEligRefCTC. The amount of the refundable credit is capped at the amount of the child tax credit that is unclaimed because it exceeds the unit's tax liability. Tax units with three or more children are assigned the refundable credit calculated under this formula if it exceeds the amount calculated under the formula for three or more qualifying children described above.

E. Credits Not Simulated By FederalTax

Several tax credits are not captured in FederalTax. As of the 2005 tax year, these include the foreign tax credit, education credits, retirement savings contributions credit, adoption credit, mortgage interest credit, credit for prior year minimum tax, qualified electrical vehicle credit, general business credit, empowerment zone and renewal community employment credit, District of Columbia first-time home buyer credit, credit for alcohol used as fuel, renewable electricity, refined coal, and Indian coal production credit, New York Liberty Zone business employee credit, nonconventional source fuel credit, and Qualified Zone academy bond credit.

When reconciling FederalTax results with published tax data, the analyst should take into account the fact that FederalTax does not simulate all the tax credits that may be reflected in the published figures.

12. Final Tax Computation

The tax unit’s final tax liability (after nonrefundable and refundable credits) is calculated by the FederalIncomeTaxLiability form. The FederalIncomeTaxLiability form subtracts the values calculated in the EarnedIncomeTaxCredit form and the AddtionalChildTaxCredit form from the amount calculated by the TaxAfterCredits form.

TaxAfterCredits calculates the amount of tax liability remaining after nonrefundable credits, but before refundable credits. The amount calculated in the Credits form (the sum of the child and dependent care credit, elderly or disabled credit, and child tax credit) is subtracted from the unit’s TaxBeforeCredits, which is calculated as described in section 10 above.

13. Aligning a Current-Law FederalTax Simulation to Target Data

Alignment of a current-law FederalTax simulation is restricted to two types of changes: (1) modifications to income and expenditure amounts statistically matched from the PUF, and (2) changes to participation rates for the elderly or disabled tax credit and the child and dependent care credit. During the annual baseline process, the statistical match with the PUF is run iteratively, with adjustments being made such that the resulting amounts are reasonably close to target. Similarly, FederalTax is run iteratively, with adjustments being made to the participation rates in order to bring the elderly or disabled tax credit and the child and dependent care credit close to target.

14. Prior Versions of FederalTax

This documentation reflects the FederalTax module's capabilities effective with the version of "forms" used in the forthcoming 2005 FederalTax baseline FT2005). For a history of changes to the FederalTax module, click here.