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Joint Committee Report JCS-7-79: General Explanation of the Revenue Act of 1978

MAR. 12, 1979


DATED MAR. 12, 1979
Citations: JCS-7-79





The Revenue Act of 1978 provided tax reductions to stimulate consumer and investment spending in order to increase economic growth. In addition, it contained many tax changes designed to improve the equity of the tax system and to simplify it.





Principal provisions



The principal provisions of the Revenue Act of 1978 are the following:
  • A reduction in individual income tax rates, a major element of an individual income tax reduction of approximately $12.8 billion for calendar year 1979.

  • A permanent tax rate reduction for corporations, amounting to $5.1 billion for calendar year 1979.

  • A major expansion of the earned income tax credit for the working poor, which will amount to $1 billion in 1979. In addition, the credit is simplified and will be reflected in an employee's paychecks, rather than being paid out in one lump sum as a tax refund.

  • An increase (beginning in 1979) in the zero bracket amount and the corresponding floor under itemized deductions (which had replaced the standard deduction) from $2,200 to $2,300 for single persons and heads of households, and from $3,200 to $3,400 for married couples.

  • An increase in the personal exemption from $750 to $1,000 (beginning in 1979) to replace the expiring general tax credit.

  • A doubling of the tax credit for political contributions and repeal of the itemized deduction for political contributions.

  • Repeal of the itemized deduction for nonbusiness State and local gasoline taxes.

  • A phaseout of the exclusion for unemployment compensation benefits at higher income levels.

  • Changes to limit certain tax shelters.

  • Rules for taxation of benefits under certain deferred compensation plans.

  • An increase from 50 percent to 60 percent in the portion of long-term capital gains deductible from income.

  • A once-in-a-lifetime election to exclude from taxable income the first $100,000 of gain from the sale of a principal residence by taxpayers who are age 55 or older.

  • Elimination of capital gains and adjusted itemized deductions from the list of tax preferences subject to the add-on minimum tax for individuals.

  • A new alternative minimum tax at rates up to 25 percent on taxable income increased by the capital gains deduction and certain adjusted itemized deductions (generally, certain itemized deductions in excess of 60 percent of adjusted gross income), which individuals will pay only if it exceeds their regular income tax. An exclusion for capital gain from the sale of a principal residence is provided.

  • Repeal of the 25-percent alternative income tax on the first $50,000 of long-term capital gain.

  • A capital gains tax rate reduction for corporations.

  • Deferral of carryover of basis at death until 1980.

  • Denial of business deductions for use of certain entertainment facilities, such as yachts and hunting lodges.

  • An expansion of the WIN-welfare tax credit to encourage both business and nonbusiness employers to hire WIN registrants and welfare recipients.

  • A targeted jobs tax credit, to replace the general jobs tax credit, designed to encourage people to hire needy youths and other categories of people who frequently have difficulty finding jobs.

  • A permanent 10-percent investment tax credit.

  • Liberalization of the investment tax credit by raising the amount of tax liability which the credit may offset from 50 percent to 90 percent by 1982, extending it to rehabilitation of existing industrial and commercial buildings, and extending the full credit to certain pollution control facilities for which 5-year amortization is elected.

  • Revised subchapter S rules.

  • Additional funding of $0.4 billion (a total of $2.9 billion) for social services under Title XX of the Social Security Act for fiscal year 1979.

  • A Congressional policy statement regarding the rate of growth in Federal outlays for fiscal years 1979-1983, and possible further income tax reduction.

Overall revenue effect



The Act provides new tax credits of $18.9 billion in calendar year 1979 and $22.5 billion in 1980. The budget effect in fiscal year 1979, including both the new tax cuts and the extensions of expiring tax cuts, is a revenue reduction of $19.3 billion.

Of the new tax cuts for 1979, $12.8 billion represents cuts in individual income tax liabilities, $3.7 billion represents business income tax cuts and $2.2 billion represents reductions in capital gains taxes for individuals and corporations.1 The remaining $2 billion in tax cuts for 1979 relate to certain excise and estate and gift tax changes.


Individual Income Taxes



The Revenue Act of 1978 provides three principal individual income tax cuts affecting virtually all taxpayers. The Act increases the personal exemption from $750 to $l,000 beginning in 1979. This increase in the exemption replaces the temporary general tax credit, which equaled the greater of $35 for each exemption or 2 percent of the first $9,000 of taxable income in excess of the zero bracket amount). The Act replaced the tax rate schedule, which had 25 brackets, with a new schedule with 15 wider brackets. Also, it increases the zero bracket amount and the corresponding floor under itemized deductions, which had replaced the old standard deduction, from $2,200 to $2,300 for single persons, and from $3,200 to $3,400 for married couples.

The Act significantly expands the earned income tax credit for the working poor. Previously, the credit was 10 percent of the first $4,000 of earnings and was phased out as income rose between $4,000 and $8,000. Under the Act, the credit is 10 percent of the first $5,000 of earnings (an increase in the maximum credit from $400 to $500), and the phaseout range is increased to between $6,000 and $10,000. The credit is also simplified so that it will be easier to compute. Finally, instead of being paid out as one lump sum upon filing a tax return for the taxable year, the credit will be reflected in employees' paychecks, making it a more effective work incentive and distributing the tax relief more evenly throughout the year. The credit is treated as earned income for purposes of determining eligibility for, and benefits under, certain Federal assistance programs. The tax cut and additional outlays from the increased earned income credit will amount to $1 billion for 1979.

The Act repeals the deduction for nonbusiness State and local gasoline taxes in order to simplify preparation of individual tax returns.

In addition, the Act doubles the tax credit for political contributions to encourage wider political participation and, to simplify the income tax return, it repeals the alternative itemized deduction for political contributions.


Business Taxes



Corporate tax rate



The Act provides a sizeable reduction in the corporate income tax rate. The top corporate tax rate is reduced from 48 percent to 46 percent, and a system of graduated tax rates is established for small businesses. In place of rates of 20 percent on the first $25,000 of taxable income, 22 percent on taxable income between $25,000 and $50,000, and 48 percent on taxable income in excess of $50,000, the new rate schedule is 17 percent on the first $25,000 of income, 20 percent on income between $25,000 and $50,000, 30 percent on income between $50,000 and $75,000, 40 percent on income between $75,000 and $100,000, and 46 percent on income above $100,000. This tax reduction, amounting to about $5 billion in 1979, is designed to increase business investment and encourage the formation and expansion of small businesses. About $1 billion of the tax cut will be received by businesses with incomes below $100,000.


Investment tax credit



The Act makes permanent the existing 10-percent investment tax credit, as well as the $100,000 limitation on the amount of used property eligible for the credit and extends for 3 years the extra investment credit for contributions to Tax Reduction Act employee stock ownership plans (TRASOPs). The availability of the credit is also liberalized by increasing the tax liability limitation from 50 percent to 90 percent on a phased-in basis. The credit is amended to clarify its application to single purpose agricultural structures. Also, the Act extended the investment credit to expenditures for rehabilitation of commercial and industrial buildings. The full investment credit is extended to pollution control facilities for which the taxpayer has elected 5-year amortization. (These facilities received only one-half the normal investment credit under prior law.) There are also a number of technical amendments to the provision giving an extra investment credit to employers who contribute to employee stock ownership plans.


Targeted jobs credit: WIN credit



In place of the general jobs tax credit, which expired at the end of 1978 the Act increased the rate of the existing WIN-welfare recipient tax credit and provided a new targeted jobs credit to encourage businesses to hire needy youths and others who often have difficulty finding jobs even when the economy is prosperous. For trade or business employers who hire welfare recipients and WIN registrants, the WIN-welfare tax credit is 50 percent of the first $6,000 of wages for the first year of employment and 25 percent for the second year. Businesses will not receive a deduction for wages equal to the amount of the credit. In addition, there is a 35-percent credit for the first year of employment for welfare recipients (limited to the first $6,000 of wages per employee and $12,000 total qualifying wages per employer) who are hired outside of a trade or business. The categories of people eligible for the new targeted jobs credit include needy youths, needy Vietnam-era veterans, SSI recipients, convicted felons, recipients of general assistance, certain handicapped individuals, and high school students in cooperative education programs. The credit is 50 percent of the first $6,000 of wages for the first year of employment and 25 percent of such wages for the second year of employment. The expanded earned income credit and WIN and welfare credits were designed to increase the employment of people who are now on welfare, and the new targeted jobs credit was designed to help alleviate the serious unemployment problems of the covered groups.


Entertainment facilities



The Act denies deduction for entertainment facilities, including yachts and hunting lodges, because generally these facilities are used mostly for personal reasons. Club dues are not covered under the new disallowance rules.


Capital Gains and Minimum and Maximum Tax Provisions



The Act contains a major reduction in the income tax on capital gains. This was designed to encourage greater investment in new and risky enterprises and to increase the mobility of capital by encouraging taxpayers to sell appreciated assets. Congress believed that these beneficial economic effects of the capital gains tax reduction would greatly reduce the revenue loss from the capital gains tax cut.

Specifically, the Act increases the percentage of long-term capital gains deductible from gross income from 50 percent to 60 percent, effective for sales after October 31, 1978. To ensure that this tax cut does not result in high-income individuals paying very low effective rates of tax, the Act imposes an alternative minimum tax on taxable income increased by the capital gains deduction and certain adjusted itemized deductions, with rates up to 25 percent. Individuals will pay this alternative minimum tax only if it exceeds their tax computed the regular way. The l5-percent add-on minimum tax is continued from prior law except that it does not apply to capital gains deductions or adjusted itemized deductions. Neither the add-on nor alternative minimum tax applies with respect to a capital gain from the sale of a principal residence. Another significant capital gains tax change under the Act will allow an individual, who is at least age 55, to elect to exclude from income up to $100,000 of any gain realized on the sale of his or her principal residence. However, this exclusion may be elected only once in a lifetime. The present rollover provision for gains on a principal residence where the proceeds of the sale are reinvested in another principal residence remains in effect.

The Act also removes capital gains from the tax preferences which reduce the amount of personal service income eligible for the 50-percent maximum tax.

The 50-percent maximum tax on personal service income is also liberalized by expanding the definition of earned income for businesses in which both capital and labor are used to produce income.

The Act also reduces the alternative corporate capital gains tax rate from 30 to 28 percent.

The application of the provision for carryover of basis at death, enacted in 1976, is deferred through the end of 1979.


Tax-Exempt State and Local Government Bonds



The Act makes a number of changes in the provisions relating to tax-exempt bonds. The elective $5 million limit on small issues of industrial development bonds is raised to $10 million and the limit on the amount of capital expenditures for the project is raised to $20 million for urban development action grant facilities. The Act permits advance refundings for certain industrial development bonds used to finance certain public projects. The Act also includes a transitional rule to exempt certain bonds issued in connection with advanced refundings of certain exempt industrial development bonds. It exempts interest from industrial development bonds for certain water projects. The Act also contains provisions for the treatment of industrial development bonds issued in connection with the local furnishing of electric energy and advance refunding arbitrage profits where profits are donated to a public charity. The Act also provides judicial review for private letter rulings relating to the tax exempt status of proposed bond issues.


Small Business Provisions



In addition to the substantially lower corporate tax rates for the first $100,000 of taxable income, the Act contains several provisions relating to small businesses. The Act liberalizes the rules for eligibility for subchapter S corporation treatment, which generally provides for the passthrough of income and losses to shareholders without the incidence of taxation at the corporate level. Also, the Act simplifies and liberalizes the provision which permits ordinary loss treatment (i.e., full deductibility) for investments in common stock of certain small business corporations.


Employee Compensation and Retirement Plans



The Act allows employees and independent contractors who perform services for a State or local government to defer annually an amount equal to the lesser of $7,500 or 33-1/3 percent of their currently includible compensation. In addition, compensation deferred under unfunded deferred compensation plans maintained by taxable employers will be subject to the principles of law applying on February 1, 1978.

Under the Act, participants in nondiscriminatory "cafeteria" plans will not have taxable income to the extent they elect to receive nontaxable benefits. ("Cafeteria plans" are employee fringe benefit plans permitting participants to choose among fringe benefits they want purchased with employer contributions.)

Also, the Act provides rules under which participants in "cash or deferred" profit sharing plans can defer tax on amounts paid by their employers into the plan.

The Act provides for simplified pension plans.

The Act provides favorable treatment for a sale of an annuity contract by a life insurance company to a public employee retirement plan.

Under the Act, self-insured medical and accident reimbursement plans will be required not to discriminate in favor of officers, shareholders or highly compensated employees in order for those participants to obtain favorable tax treatment. In addition, if certain requirements are met, the value of educational assistance provided by employers under a nondiscriminatory plan would be excluded from an employee's income.


Tax Shelter and Partnership Provisions



The Act contains several changes designed to limit the use of tax shelters. The coverage of the provision limiting loss deductions to the amount a taxpayer is at risk (the at risk provision) is expanded from four specific activities (farming, oil and gas, motion pictures, and equipment leasing) to all activities except real estate. This provision is also extended to certain closely held corporations, and the separate partnership at risk provision is repealed.

The Act imposes civil penalties for failure to file and late filing of partnership tax returns. In addition, partners of partnerships subject to the registration and reporting requirements of the Securities and Exchange Commission will now be subject to a four-year statute of limitations with respect to partnership income, deductions and credits flowed through to the partners.


Other Tax Provisions



The Act exempts from corporate income tax State-chartered corporations set up as general stock ownership corporations (GSOCs) for the residents of any State. Under these plans, the shareholders of the corporation (i.e., all residents of the State) would be taxed currently on their pro rata share of the corporation's taxable income in a manner similar to shareholders of subchapter S corporations.

The Act provides a deficiency dividend procedure for mutual funds similar to that provided for real estate investment trusts.

Under the Act, contributions in aid of construction to regulated gas and electric utilities are treated as nontaxable contributions to capital (the same treatment previously given to water and sewer utilities).

Current law regarding employer reporting of tip income is extended.

The 4-percent excise tax on in investment income of private foundations is reduced to 2 percent. The existing excise tax credit for State taxes paid on coin operated slot machines is increased from 80 percent to 95 percent for 1979 and 1980, and the Federal tax is repealed entirely thereafter.

The Act extends the exclusion for amounts received by participants in the Armed Forces health professions scholarship program and the Public Health Service/National Health Service Corps scholarship program, pending a study of these issues.

Also, the Act extends through 1982 the moratorium on taxation of certain student loan cancellations.

The Act postpones for two years the effective date of the rules adopted in the Tax Reform Act of 1976 relating to trafficking in net operating loss carryovers.

The Act extends for 3 years the 5-year amortization of expenditures for rehabilitation of low-income housing.

The Act provides relief through 1979 for taxpayers involved in controversies with the IRS about employment tax status reclassifications of workers whom the taxpayers had not considered to be their employees.

It expands the exception to the source rules for interest on deposits in foreign branches of U.S commercial banks to interest on deposits with Puerto Rican branches of U.S. savings and loan associations.

The Act provides a safe harbor rule for real estate investment trusts from the tax on prohibited transactions.

The Act extends the family corporation exception to the rules requiring the accrual method of accounting and capitalization of pre-productive period expenses by farm corporations to certain two- and three-family corporations. In addition, there are changes in accounting rules for sod farms, florists, nurseries and certain other farmers.

The estate tax rules are changed to exclude a portion of the value of jointly owned property from a decedent's gross estate in recognition of the participation by a surviving spouse in the joint operation of a farm or other business.

There is an exemption from time investment credit recapture rules for the bankrupt railroads which transferred property to ConRail and there are changes in the net operating loss carryover rules as they apply to transferors of property to ConRail.

The Act provides for Treasury Department studies of the tax treatment of foreign owners of U.S. real estate, of the appropriate depreciation or amortization of equipment required by occupational health and safety (OSHA) or mine safety (MSHA) regulations, and of simplification of income tax returns for individuals.

The Act also expands the volunteer income tax assistance program of the Internal Revenue Service by authorizing the IRS to enter into training and technical assistance agreements with nonprofit agencies to prepare volunteers to provide tax counseling to elderly individuals.

Further, the Act includes various technical, clerical, and conforming amendments to the Tax Reform Act of 1976.


Amendments Relating to the Social Security Act



Grants to States for social services



The Act extends the temporary $200 million additional amount available to States for social services under title XX of the Social Security Act for one more year--through fiscal year 1979. As was the case in fiscal years 1977 and 1978, this $200 million is to be available only for child care and requires no non-Federal matching; this amount is to be allocated on a population basis. The Act also provides a further $200 million increase in the ceiling for fiscal 1979 which is available for social services generally and subject to the ordinary matching requirements of title XX.

The net effect of this provision is to raise the ceiling on Federal funding for title XX social services to $2.9 billion for fiscal year 1979. After fiscal year 1979, the ceiling will revert to its permanent level of $2.5 billion in the absence of further legislation.


Public assistance matching for Puerto Rico, the Virgin Islands, and Guam in fiscal year 1979



The Act increases the matching rate and ceilings in fiscal 1979 for public assistance programs for Puerto Rico, the Virgin Islands, and Guam. The matching rate is increased from 50 percent to 75 percent, up to a maximum amount of Federal funding for the fiscal year of $72 million in Puerto Rico, $2.4 million in the Virgin Islands, and $3.3 million in Guam. In the absence of further legislation, the matching rate and limitations will revert to their permanent-law levels after fiscal year 1979.


Policy with Respect to Additional Tax Reductions



The Act also contains the following congressional policy statement regarding Federal outlays and possible future tax reductions:


"As a matter of national policy the rate of growth in Federal outlays, adjusted for inflation, should not exceed 1 percent per year between fiscal year 1979 and fiscal year 1983; Federal outlays as a percentage of gross national product should decline to below 21 percent in fiscal year 1980, 20.5 percent in fiscal year 1981, 20 percent in fiscal year 1982 and 19.5 percent in fiscal year 1983; and the Federal budget should be balanced in fiscal years 1982 and 1983. If these conditions are met, it is the intention that the tax-writing committees of Congress will report legislation providing significant tax reductions for individuals to the extent that these tax reductions are justified in the light of prevailing and expected economic conditions."
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