Tax Calculator Methodology Statement and Glossary

Methodology Statement

The Tax Policy Center (TPC) designed the tax calculator to help users understand how the Tax Cuts and Jobs Act (TCJA) would affect the income and payroll taxes we pay. The calculator considers most major individual income tax provisions in the plan. For practical reasons, however, it omits the corporate provisions and does not fully account for some less common types of income, expenses, and other factors. Although the calculator’s results may not fully represent all the plan’s details, they should give users a good sense of how the TCJA would affect their taxes.

However, it is not a tax preparation tool. For ease of use, many items that would be included on actual tax returns are omitted. Numbers generated cannot be applied to specific tax returns.

More information about the TCJA and related TPC analyses are available here.

Inputs – Income Sources

Long-term capital gains

Capital gains and losses are classified as long term if the asset was held for more than one year, and short term if held for a year or less. Taxpayers in the pre-TCJA 10 and 15 percent tax brackets pay no tax on long-term gains on most assets; taxpayers in the pre-TCJA 25-, 28-, 33-, or 35- percent income tax brackets face a 15 percent rate on long-term capital gains; and those in the pre-TCJA top 39.6 percent bracket pay a 20 percent rate. Short-term capital gains are taxed at the same rate as ordinary income and should be entered as "other income."

Other income

Income from all other taxable sources, including short-term capital gains, business income net of expenses, gambling winnings net of losses, and others. Include the value of nonqualified dividends in other income; the TPC tax calculator assumes all income included in "dividends" comes from qualified dividends and therefore faces the preferential long-term capital gains tax rate. Since 2013, the net investment income tax (defined below) has imposed a 3.8 percent tax on investment income for high-income taxpayers. Income subject to that tax includes interest, dividends, annuities, royalties, rents, income from passive businesses, and net capital gains. Income from those sources should be included in the taxable interest category to ensure the calculator includes it in calculating tax liability.

Pension and retirement

Regular payments during retirement from plans tied to previous employment. Pension income is generally taxable. If recipients contributed to their Regular payments during retirement from plans tied to previous employment, including taxable withdrawals from defined contribution retirement accounts (e.g., IRA, 401(k), etc.). Pension income is generally taxable. If recipients contributed to their pensions, however, their contributions are not taxable. Contributions are prorated over the expected duration of pension receipt, and that amount of each year's pension payment is exempt from tax.

Dividend

Dividends paid by corporations that are generally subject to federal income tax. Qualified dividends (which include most but not all dividends) face the same preferred tax rates as long-term capital gains. Nonqualified dividends are taxed at ordinary tax rates. The TPC tax calculator assumes all dividends are qualified and therefore face the preferential long-term capital gains tax rates. To include nonqualified dividends, add their value to "taxable interest."

Social Security Benefits

All benefits for retirees, survivors, and dependents. Only part of Social Security benefits is taxed; the percentage subject to income tax depends on the taxpayer's income.

Tax exempt interest

Interest on instruments such as municipal bonds that is exempt from the federal individual income tax. Interest on private-purpose municipal bonds, the funds from which support private activity, is generally taxable under the alternative minimum tax (AMT), even if it is tax exempt under the regular income tax.

Taxable interest

Interest paid on savings accounts and other financial investments, other than tax-exempt interest.

Wages and Salary

For the principal taxpayer, all income from paid employment, including tips, bonuses, and the like.

Wages and salary of spouse

For the spouse of the taxpayer, all income from paid employment, including tips, bonuses, and the like.

Employer-sponsored insurance (ESI) premiums

Health insurance premiums paid by employers or by employees with pre-tax dollars. These premiums are not subject to either income or payroll taxes.

Business income

Net income from a sole proprietorship, partnership, S corporation, limited liability company, or other business that is taxed on the owner's individual income tax return. The tax calculator will treat all of this income as qualified business income (QBI) for the purpose of the 20 percent deduction in the Tax Cuts and Jobs Act (unless subject to the limitation on professional services described below). Enter pass-through income not eligible for the deduction as other income.

Professional Services Business

Pass-through income earned in a "specified service trade or business" is not eligible for the qualified business income (QBI) deduction for single taxpayers with taxable income above $157,500 ($315,000 for married couples filing jointly). In the TCJA, specified service is defined as "any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees."

Inputs – Deductions and Expenses

Charitible contributions

Contributions to qualified charities that taxpayers may itemize as deductions on their federal tax returns. The amount of contributions a taxpayer can deduct in a given year depends on the nature of the contributions and the taxpayer's income. Deducting contributions reduces taxable income and tax liability and therefore lowers the after-tax cost of donations. Because the tax reduction depends on the marginal tax rate, taxpayers in higher tax brackets incur lower net-of-tax costs of giving than taxpayers in lower tax brackets.

Childcare expenses

Total amount paid for care of children under age 13 while the taxpayer (and spouse, if any) works (or for one spouse to attend school while the other spouse works). Taxpayers may claim the child and dependent care tax credit for some or all of these expenses.

Medical Expenses

Qualifying medical expenses include out of pocket medical expenses on preventative care, treament, surgeries, and dental and vision care. Only medical expenses that exceed a certain percentage (10 percent under pre-TCJA law and 7.5 percent under the TCJA in tax year 2018) of adjusted gross income (AGI) are deductible.

Home mortgage interest deduction

Interest paid on home mortgages for a primary residence, qualifying second home or vacation property. Taxpayers may itemize such interest as deductions on their federal tax return, but the deduction of mortgage interest is limited based on the amount of debt. Under pre-TCJA law, interest on up to $1,000,000 of acqusition debt was eligible for the deduction. The TCJA lowered that limit to $750,000 for mortgages after 12/15/2017.

State and local property taxes

Taxpayers can claim either the income or sales tax payments they make to state and local governments as an itemized deduction on their federal tax returns. Under the TCJA, the combined deduction for state and local taxes is limited to $10,000 (single and joint filers). Taxpayers may not deduct these taxes in calculating their AMT.

College expenses

Total amount of tuition and fees expenses paid for all family members attending college.

Student loan interest

Interest paid on student loans.

Interest on home equity loan

Under pre-TCJA law, homeowners can deduct interest paid on up to $100,000 of home equity loans. Under the TCJA, such interest is no longer eligible for a deduction.

State and local income or sales taxes

Taxpayers can claim property tax payments to state and local governments as an itemized deduction on their federal tax returns. Under the TCJA, the combined deduction for state and local taxes is limited to $10,000 (single and joint filers). Taxpayers may not deduct these taxes in calculating their AMT.

Outputs – Taxable Income Calculation

Personal Exemptions

A fixed-dollar reduction in taxable income for each taxpayer and qualifying dependent. The personal exemption is indexed annually for inflation. In 2017, the exemption is $4,050. The personal exemption phaseout reduces personal exemptions by 2 percent for each $2,500 or part thereof over a threshold that depends on tax filing status. The TCJA repeals personal exemptions.

Itemized Deductions

A deduction that allows taxpayers to itemize allowed expenses and deduct the total value in lieu of claiming the standard deduction. Common deductible expenses include state and local income and property taxes (or sales taxes for residents of states with no income tax), mortgage interest, medical expenses (in excess of a certain percentage of AGI), and contributions to charitable organizations. Under pre-TCJA law, a limitation on itemized deductions (Pease) reduces itemized deductions by 3 percent of the amount by which AGI exceeds a threshold, but not by more than 80 percent. (Note: In some cases, a taxpayer subject to the AMT can reduce tax liability by itemizing deductions, even if total itemized deductions are less than the relevant standard deduction. This situation can occur because some itemized deductions can be claimed under the AMT but the standard deduction cannot.)

Standard Deduction

A deduction that each tax filer may claim that differs by filing status and is indexed annually for inflation. In 2017, the standard deduction is $6,350 for single filers and married people filing separately, $9,350 for heads of household, and $12,700 for married couples filing jointly. About 70 percent of tax returns filed for 2014 claimed the standard deduction. An additional standard deduction is allowed if the taxpayer and/or spouse are age 65 or older and if he or she is blind; in 2017, the additional deduction is $,1250 for married filers and $1,550 for individuals and heads of household. One additional deduction is allowed for each elderly taxpayer and for each blind taxpayer. Thus, a couple in which both spouses are over 65 and blind would get four additional deductions.

Outputs – Regular Tax Calculation

Child/Family tax credit (partially refundable)

A tax credit for taxpayers with eligible dependent children. Under pre-TCJA law, taxpayers may claim a tax credit equal to $1,000 for each dependent child under age 17. The credit phases out for high-income taxpayers, declining by 5 percent of AGI over a threshold $110,000 for married couples and $75,000 for single parents. The credit is only partially refundable; that is, only part of the credit can reduce total income tax liability below zero. The refundable portion equals 15 percent of earnings over $3,000. Under the TCJA, the child credit is increased to $2,000 and begins to phase out at $400,000 for married couples and $200,000 for single parents. The refundable portion equals 15 percent of earnings over $2,500 up to $1,400. The TCJA also provides a $500 non-refundable credit for other dependents that do not qualify for the child credit.

Child and Dependent Care Credit (not refundable)

A tax credit for taxpayers with eligible dependent children who pay for child care. Taxpayers who pay for care of children under age 13 or certain other dependents so they can work (or, for couples, so one spouse can attend school while the other spouse works) can claim up to 35 percent of allowed expenses up to $3,000 for one child or $6,000 for two or more children. The credit rate phases down to 20 percent as income rises between $15,000 and $43,000.

Education Credits (partially refundable)

Tax credits for taxpayers or dependents of taxpayers attending college or graduate school. Taxpayers who attend college or graduate school (or whose dependents do) can claim either the American opportunity tax credit (AOTC) or the lifetime learning tax credit (LLTC) for tuition, fees, and the cost of books (and can claim the AOTC for some students and the LLTC for others). Each student can get the AOTC, which equals 100 percent of the first $2,000 of eligible expenses and 25 percent of the next $2,000 (for a maximum credit of $2,500) for each of four years of postsecondary education. The credit is partially refundable: 40 percent of the credit can reduce tax liability below zero. The LLTC equals 20 percent of tuition and fees for any postsecondary education, up to a maximum annual credit of $2,000. The maximum applies to all students in the household claiming the credit, not to each student individually. It is not refundable: it can only offset positive tax liability.

Earned Income Tax Credit (fully refundable)

A tax credit for workers whose income and assets fall below specific limits. The earned income tax credit (EITC) equals a percentage of earnings (depending on the number of children in the tax unit) up to a maximum that depends on the number of children and the taxpayer's marital status. The credit remains at that maximum until income reaches a phaseout threshold, beyond which the credit falls at a fixed rate (again depending on the number of children). The credit is fully refundable; that is, taxpayers can get the full credit, even if it exceeds their positive tax liability. Under federal budget rules, the refundable portion of the EITC is considered an outlay (government spending) rather than negative revenue.

Total Refundable Credits

Tax credits that not only offset positive tax liability but also result in negative taxes, and hence payments from the federal government to the taxpayer. Refundable credits include the earned income tax credit and some of the child tax credit and the American opportunity tax credit. In general, refundable credits apply only after nonrefundable credits are applied; the order of application can result in lower tax liability for affected taxpayers.

Regular Income Tax After Credits

The amount of tax owed to the governmentor, if it is negative, the payment from the governmentunless the AMT applies. "Tax after credits" equals "tax before credits" minus all applicable credits. Nonrefundable credits can only reduce "tax after credits" to zero; any additional nonrefundable credits are lost. Refundable credits can result in negative "tax after credits," in which case the tax filer receives a net payment from the government.

Tax Before Credits

Income tax liability calculated by applying the tax rate schedule to taxable income, before subtracting allowed tax credits.

Total Non-refundable Credits

Tax credits (including the child and dependent care credit, the lifetime learning credit, and some of the child tax credit and the American opportunity tax credit) that offset positive tax liability. Nonrefundable tax credits cannot result in a net payment to the tax filer. For example, a taxpayer with a $1,000 tax liability before credits who would otherwise qualify for $2,000 of nonrefundable credits can use only $1,000 of those credits to erase the liability. The additional $1,000 of credits is lost. Nonrefundable credits are typically applied before refundable credits (which can result in negative tax liability).

Outputs – Alternative Minimum Tax Calculation

AMT adjustments

Additions to regular taxable income of deductions, exemptions, and exclusions not allowed under the AMT. Under pre-TCJA law, the most common additions are personal exemptions, itemized deductions for state and local taxes and for miscellaneous expenses, and tax-exempt interest on private-interest bonds. The tax calculator incorporates only three AMT adjustments: personal and dependent exemptions; the itemized deduction for state and local taxes; and the differential between regular and AMT itemized deductions for medical expenses.

Tentative AMT

AMT liability obtained by applying AMT tax rates to AMT taxable income. Taxpayers for whom this value exceeds regular tax liability before credits generally owe AMT, calculated as the difference between AMT and regular tax liability.

AMT exemption

An exemption for taxpayers who are required to recalculate their income tax liability under AMT rules. If that liability exceeds their regular tax liability, they pay the excess as AMT. In effect, taxpayers pay the larger of their regular tax and their AMT liability. The AMT calculation begins with a taxpayers regular taxable income, adds preference items (which include personal exemptions, some itemized deductions, and certain other income excluded from the regular tax calculation), and subtracts the AMT exemption (which phases out for high-income taxpayers) to get an adjusted minimum taxable income (AMTI). Under pre-TCJA law, the AMT exemption amount in 2018 is $55,400 and phases out at a 25 percent rate when AMTI exceeds $123,100 (the exemption is $86,200, and the phaseout starts at $164,100 for married couples filing jointly). Under the TCJA, the AMT exemption in 2018 is $70,300 ($109,400 for married couples filling jointly) and phases out above $500,000 ($1,000,000 for joint filers).

AMT Liability (in addition to regular tax liability)

AMT that taxpayers owe in addition to their regular tax liability. The sum of regular tax liability and AMT liability equals the tentative AMT described above less any applicable tax credits.

Taxable Income for AMT Purposes

Regular taxable income plus AMT adjustments minus the applicable AMT exemption. Applying AMT tax rates to AMT taxable income yields tentative AMT liability. If that liability exceeds regular income tax liability, the excess equals the taxpayer's AMT.

Taxable Income

Adjusted gross income minus personal exemptions and the standard or itemized deductions allowed under the regular income tax.

Outputs – Taxes

Payroll Tax Liability

Taxes paid both by workers and by their employers that finance Social Security and Medicare. The Federal Insurance Contributions Act (FICA) tax funds Social Security; the employee and the employer each pay 6.2 percent of earnings up to a cap that is indexed for national wage growth. The Medicare tax equals 1.45 percent of all earnings, again paid by both employees and employers. Economists believe that the employer`s share of the tax is actually borne by the worker in the form of lower wages, and therefore the tax calculator assigns both employer and employee shares of the tax to the worker. The calculator also adds the employer`s share of the taxes to the worker's wage and salary income, based on the argument that employees' pay would increase by the amount of tax if the employer didn't have to pay it.

Additional Medicare Tax

An additional tax to help fund Medicare, paid by high-income workers since 2013. This tax equals to 0.9 percent of a high-income workers wage, salary, and other equivalent income over specified thresholds: $200,000 for single individuals and heads of household, $250,000 (counting earnings of both spouses) for married couples filing joint tax returns, and $125,000 for married couples filing separately. The thresholds are not indexed for inflation.

Net Investment Income Tax

Tax created by the 2010 healthcare legislation that has been paid since 2013 by high-income taxpayers. The NIIT equals 3.8 percent of the smaller of either investment income or the amount by which AGI exceeds a threshold: $200,000 for single individuals and heads of household, $250,000 for married couples filing joint tax returns, and $125,000 for married couples filing separately. (The thresholds are not indexed for inflation.) For simplicity, the TPC tax calculator applies the net investment income tax only to dividends, interest, and capital gains income. The effect of this tax on other investment income can be measured by adding the amount of that other income to the amount of interest income received. (Other investment income is taxed the same as interest income.)

Adjusted gross income

Total income subject to tax after adjustment for exclusions and additions. In TPC's tax calculator, AGI equals cash income less employer share of payroll taxes, contributions to deductible retirement plans, some or all of Social Security benefits, and tax-exempt interest. The tax calculator does not incorporate other adjustments to income.

Average Income Tax Rate

Tax liability measured as a percentage of total cash income (not taxable income). The average tax rate measures the share of total income going to pay the federal individual income tax.

Cash income (includes employer's share of payroll tax)

Income from all sources plus the employer's share of the payroll taxes that fund Social Security and Medicare. Economists believe employees' cash wages are reduced by the employer's share of payroll taxes and therefore consider the latter to be effectively part of cash wages.

Income Tax Liability

Amount of income tax owed, net of any allowed credits. (This is the same as regular income tax after credits, defined in Regular Tax Calculation below.)