(The following a dress by Randolph E. Paul, General Counsel for the Treasury, before the Philadelphia Bar Association, at the Midday Club, is scheduled for delivery at 8:00 P.M. Eastern War Time, Monday, June 14, 1943.)
THE CURRENT TAX PAYMENT ACT
As you know, the Current Tax Payment Act, recently enacted by the Congress and signed by the President bids fair to revolutionize the methods of collection of the personal income tax in this country. It seems entirely fitting that you, as members of the Bar of Philadelphia, the birthplace of so many of the revolutionary ideas of the past, should desire to be among the first to become conversant with the new tax, legislation which will so soon become a part of our national structure.
You are aware of the policies and problems which dictated the change from our present delayed system of collection of income taxes to the new current collection plan. You are likewise no doubt aware in some measure of the problems involved in changing to the new system. Let me emphasize that it was only this transition situation which caused the smoke and fire which have been present on the congressional battle-grounds during the last few months. For the reason that these policies and problems are known to you and are now a matter of history, I shall devote myself on, this occasion to giving you something more of the how of current tax payment, omitting any of the arguments on the why side of the problem.
For the sake of discussion the Current Tax Payment Act of 1343 is divisible into four parts. First, there are the provisions relating to the current collection of income and victory taxes through deduction and withholding at the source on wages. Second, there is the part of the Act which deals with the permanent system of current payment of income tax liabilities not collected by the withholding process Third, there are the provisions applicable only to this year and necessary to achieve the transition from the delayed payment to the current payment system. And fourth, the Act includes various miscellaneous provisions among which are those giving special tax treatment to members of the armed forces.
You are all familiar with the technique of collection of taxes by withholding to the extent that this technique has been employed and is being employed in the collection of Social Security and Victory tax liability. As you know, withholding under the Victory tax was accomplished through a set of provisions specially enacted for that purpose, as part of Chapter 1 of the Internal Revenue Code. Our meager administrative experience with that tax has indicated the desirability of a more flexible system, which will have as its ultimate goal an integration between income tax collection at the source and Social Security collection procedure. Convenience for both employer and the Government will be served by the eventual achievement of this goal. For that reason, therefore, it was suggested by the Treasury, and agreed to by the Congress, that the income tax withholding provisions be removed from Chapter I of the Internal Revenue Code and be made a new subchapter under Chapter 9 of the Code relating to employment taxes.
The duty to withhold an amount for income and victory taxes is net imposed on all persons making payments of compensation for personal services rendered. First, there must exist, as in the Social Security tax, the employer-employee relationship, as distinguished from the relationship of independent contractors. Then even where this relationship exists, wage payments in certain enumerated types of occupations, are excepted from the withholding requirement. The three main peacetime groups to which this exception applies are (1) agricultural laborers, (2) domestic servants in private homes, college clubs or fraternities, and (3) casual laborers not engaged in the course of the employer's trade or business. In addition, the service pay of members of the military or naval forces is excluded from the withholding provisions. Services performed for a foreign government or instrumentality and services performed while outside of the United States, where a major part of the services for an employer during the calendar year is to be performed outside of the continental limits, are also excluded. In this regard, however, the law specifically states that services performed on or in connection with an American vessel, or as an employee of the War Shipping Administration, are not services performed outside the United States. A further exception, new to withholding, is made in the case of remuneration paid for Services performed by a minister of the gospel.
From the letters we have received at the Treasury while this Act was under consideration, I know that many persons, particularly in the lower wage levels, have been greatly alarmed at the prospect of having 20 percent of their salaries withheld from them. Much of this alarm arises from an inaccurate conception of the withholding provisions. For the most part theme persons fail to recognize that withholding does not result in the imposition of any new tax but is merely a convenient method of paying the tax liability which existing law imposes.
In addition, these same people fail to realize that 20 percent withholding is applicable only to the balance of the wages over and above the family status withholding exemption of the particular employee. For a single person with no dependents, the annual family status with holding exemption is $624. For a married person or a head of the family, the family status withholding exemption is $1,248 and an additional $312 is added to the exemption for each dependent of the individual employee except the first dependent in the case of a head of a family. In the case of married persons where both spouses are employed, the exemption may be divided by each spouse claiming half of the exemption, or either the husband or the wife may claim the entire exemption and the other spouse claim none. It should be noted, however, that the manner of claiming the withholding exemption will have no binding effect when it comes to the division of personal exemption which the spouses may wish to adopt in filing their returns for the year.
You will readily see that these figures are not, the exact figures provided with respect to the personal exemption for income tax, but you will also readily discover that there is an arithmetical ratio between the figures which makes them particularly useful in applying the system of withholding. For instance, where accounting machinery is used, the sorting operations are considerably reduced by having the exemption for a married person claiming half the personal exemption for withholding but having no dependents the same as that for a single person, or. a married person claiming half the exemption but having two dependents the same as that of a married person claiming all of the exemption and having no dependents.
It must be recognized that the collection of income taxes at the source through withholding will, at best, only approximate the actual income tax liability of a particular taxpayer. Every taxpayer liable for income tax is subject to a 6 percent normal tax, and a 13 percent surtax, and a net 3 percent victory tax over the victory tax exemption. These percentages total 22 percent. Withholding, however, is required only at the rate of 20 percent. Thus a 2 percent leeway for average deductions of the taxpayer is taken into account. Further, the family status withholding exemptions for the most part are slightly larger than the income tax exemption applicable to the particular taxpayer.
There are some married individuals, however, who although not liable for income tax because they earn less than $1,200 in any year are nevertheless liable for victory tax on amounts earned over and above the annual victory tax exemption of $24. These persons have been subject to withholding at the rate of 5 percent above the victory tax exemption since January 1st of this year. Because the current credit available through debt repayment, payment of insurance premiums, and bond purchases will be claimed by most taxpayers, it seemed wiser to reduce the rate of victory tax withholding to 3 percent which will more nearly approximate the actual tax liability of these persons. Therefore, in the case of these married persons withholding will be required at the 3 percent rate but not at the 20 percent rate.
Beginning with the first payroll period commencing on or after July 1st of this year, it will be the duty of every employer to deduct and withhold the amount required under the new Act. The determination of the amount required to be deducted and withheld will be based upon the withholding exemption certificate which is required to be filed by each employee, with his employer, setting forth his family status and the amount of the withholding exemption which he claims. In the case of married persons, the withholding exemption nay be divided between the husband and the wife or may be claimed by either one. The Bureau of Internal Revenue has already prepared forms for theme certificates and has made them available to the public for use by employers either on the forms furnished through the Collectors' offices or on forms reproduced by the employer to fit his particular accounting machinery. Employers may rely upon the information furnished in the withholding exemption certificates and will be under no duty to question the correctness of the statements contained in the certificates. Penalties are imposed in the case of an employee who furnishes false or fraudulent information with respect to the withholding exemption, The law provides that employees shall file new certificates in the event of changes in status; it is desirable, in order that withholding in the case of an employee whose status changes will closely approximate his tax liability, for employers to give effect to these new certificates as soon as possible, and they may do so immediately. They are required, however, to give effect to these changes only twice a year, on January 1st or July 1st, Such a requirement is necessary in the case of many very large employers in order that their payroll systems will not be constantly, disrupted.
Employers are given the option to use tables somewhat similar to those employed in connection with the victory tax to determine the amount to be withheld, rather than computing by the precise method of subtraction of the exemption and multiplying by the percentage figure in the case of each employee. The withholding tables set out in the, law cover the common payroll periods used in business organizations, and a determination of the amount to be withheld can be quickly ascertained by finding the proper column and line on the applicable table for the employee with the. withholding exemption stated in the certificate filed by him. At the end of every year and even before that time, should an employee cease his employment with a particular employer, the employer is required to furnish to each employee a receipt showing the wages paid during the calendar year and the amount of tax withheld with respect to his wages. A duplicate of this receipt filed with the Commissioner will constitute the information return in lieu of the form 1099 now required to be filed by employers. Under the law, as passed by the Congress, the requirement of the employer to return and pay over the tax withhold is general in language and follows the provisions of the law with respect to Social Security taxes. For the present time, at least, it is contemplated that the Commissioner's regulations will call for return of the tax at quarterly intervals as in the case of Social Security taxes.
A new feature is one under which the Secretary of the Treasury may authorize depositories and financial agents of the United States to accept deposits of taxes withheld from employees from time to time and may prescribe the conditions under which the receipt of much taxes by authorized depositors shall be treated as payment of the taxes by the collectors. This provision is a very necessary and helpful one both to the Government and to employers. Large employers whose collection of taxes withheld. at the source from their employees would run into millions of dollars each quarter of the year are reluctant to accept the risk of holding these funds for the quarterly period at the end of which returns are ordinarily filed. By a system of current monthly or more frequent deposit of funds in United States depositories not only does the risk of loss become transferred from the employer to the Government but also the Treasury is more quickly able to utilize the funds flowing in from collection at the source. The instructions to employers which have already been prepared and are now being distributed carry the statement that it will be the duty of every employer who withheld more than $100 during the month to pay the withheld amounts to a depository within ten days after the close of each month, except for the last month of the quarter for which the return will be filed. The amounts collected in this last month will be remitted to the Collector with the return.
These are the highlights of the details of the new withholding technique which, it is contemplated, will in itself make some 70 percent of the taxpayers of the country substantially fully current in their income tax liabilities to the Government. These taxpayers will have only minor year-end adjustments by way of tax payment or refund to be made at the time of filing their annual returns. In developing this technique, the Treasury and the Congress were able to utilize many helpful suggestions which cane from employers and their representatives upon whom the burden of collection at the source is necessarily cast. These suggestions were principally useful to reduce the complications of the withholding system which takes into account the individual employee's family status. The splendid cooperative spirit exemplified by these businessmen constitutes a fine example of the American enthusiasm for getting large tasks accomplished.
3. CURRENT PAYMENT OF TAX NOT COLLECTED AT SOURCE
Since withholding applies only to wages and not to all types of wages and since there is collected through withholding only the normal tax, the surtax at the first bracket rate and the net victory tax, additional changes in our tax collection system are necessary to insure that all taxpayers are completely current. What I am about to describe to you is the system devised under the Current Tax Payment Act for persons whose wages exceed the first surtax bracket and for persons who are in the situation of most of you, that is, those who are individual entrepreneurs, professional men and the like, with respect to whose income the system of collection of taxes by withholding has no application. I am going to describe this system of current tax payment, first in its setting as a permanent feature of our income tax law. The special provisions with respect to the year 1943 in which the transition is made, I will discuss later.
As a year-in, year-out system, it is contemplated that each individual income taxpayer (other than an estate, trust, or non- resident alien whose wages are not subject to withholding) who fulfills the requirements for the filing of declarations will file at the time of filing his income tax return for the preceding taxable year, a declaration showing the amount of his estimated total tax liability for the current year, the amount of tax which he estimates will be withheld at the source and the difference between these two amounts. This difference will constitute his estimated tax for the year. At the time of filing these declarations, one-fourth of the estimated tax shown on the declaration twill be paid and in the event that circumstances occurring later in the year do not operate to make the original estimate incorrect, an additional one-fourth of the estimated tax will be paid on or before the fifteenth day of the last month of the remaining quarters of the taxable year. Where later circumstances show the original estimates to be inaccurate, be it either too high or too low once in each quarter of the taxable year.
As to how to make an accurate estimate of your tax liability on March 15th of any year, I imagine that you may well be turning over in your minds the idea of asking me whether I have any recommendation as to the particular type of crystal ball which you can use. I concede that the problem may, in some cases, be a difficult one, especially for persons in your situation but there are a few suggestions which may be of help to you. Perhaps your experience over a number of years will indicate to you that your prior years' income adjusted for any special circumstances which you may be able to foresee will form a foundation for your estimate. Also, you will recognize the fact that making a conscientious attempt to estimate as nearly accurately as possible, you may obviate the necessity of making amended declarations in the course of the year and finding yourselves required to make extra heavy payments later in the year. But if that unexpected fee should come in later in the year, you have until December 15th to revise your original estimate of income and consequent tax liability. The law provides that, whenever an amended declaration is filed, the quarterly payment of estimated tax which accompanies the amended declaration and any subsequent payments not yet due shall be adjusted in amount to reflect the change in the amount of estimated tax.
The law gives special recognition to the farmer in connection with this requirement for filing of a declaration and paying estimated tax. A person who comes within the definition of farmer -- that is, a person who "derives at least 80 percent of his gross income from farming -- is given the option of filing his declaration on or before the fifteenth day of the twelfth month of the taxable year. At this time he is required to pay the total amount of the estimated tax shown on the declaration.
Let me point out that it will not be necessary for all taxpayers to file a declaration. Persons who are principally wage earners earning less than $27O0 per year in the case of a single person and $3500 in the case of a married person and his spouse will have most of their income tax liabilities completely paid through the withholding process. To eliminate unnecessary paperwork for such persons, therefore, the law prescribes in the case of a person having a gross income of $100 or less from sources not subject to withholding, he will have to file a declaration only if he either had in the prior year, or expects to have in the current year, wages. In excess of $2700 or $3500 depending on whether he is single or married. Thus instead of requiring declarations from all of the estimated forty-four million taxpayers of the country, declarations will be required from only fourteen million.
For persons whose income from sources other than wages subject to withholding exceeds $100, declarations are required only from those whose gross income was sufficient for the preceding taxable year, or is expected to be sufficient for the current taxable year, to require the filing of an income tax return. The privilege is extended to husbands and wives to make a joint declaration but an election to do so will not be binding for the purposes of filing the annual returns of the spouses and any payments on account of estimated tax made by husband or wife in a joint declaration may be treated as payments on account of the tax liability of either the husband or the wife or may be divided between them in any manner they see fit.
Of course, no system of income tax collection would be found workable if there were no sanctions for its enforcement. Accordingly, as you would expect, there are sanctions which will insure that individual income taxpayers will make a diligent effort to estimate their tax and to pay it during the taxable year as their income is earned. The law provides that where the estimated tax of a taxpayer together with the amounts actually withheld at the source falls short of 80 percent of his actual gross tax liability -- that is, his total income and victory tax liability before credit for amounts withheld at the source -- there shall be added to the tax for which he is liable an amount equal to 6 percent of the difference between the actual gross tax liability and the estimated tax plus withholding credit or the amount by which 80 percent of his gross tax liability exceeds the estimated-tax plus withholding credits, whichever is the lesser. In the case of farmers exercising the option to file year-end declarations, the tolerance limit for accurate estimation of the total tax liability is 66-2/3 percent.
For example, a salaried person estimates that his total tax liability for the year will amount to $800. He estimates that there will be withheld from him $600 and he files a declaration showing an estimated tax of $200, paying $50 on each quarterly installment. His actual gross tax liability, however, comes to $1200, and he actually has withheld from him $700. He would pay on his return filed after the close of the taxable year in addition to the $300, by which his estimated tax and payments by withholding during the taxable year fell short of his actual tax liability, the sum of $18 that being 6 percent of the S300 difference. There are, of course, additional sanctions for the failure to file a declaration and for failure to pay any installment of estimated tax.
At the time of filing returns after the close of the taxable year any balance of tax liability not paid currently during the taxable year must be paid in full and the installment privilege no longer is available to individual taxpayers. In some cases, of course, there will have been paid during the taxable year more than an individual's total tax liability. In a case of this sort where the return filed indicates such an overpayment, a new provision of the law allows the taxpayer to use as a credit to discharge his liability for estimated tax shown on the declaration filed at the same time as the return, the amount of the overpayment.