|Date||5 January 1942|
|Title||Relief of wife's earned income under the British and Canadian income tax, and its application to the United States|
|Description||Staff memo, Division of Tax Research, Treasury Department|
|Location||Box 54; Married Couples; Records of the Office of Tax Analysis/Division of Tax Research; General Records of the Department of the Treasury, Record Group 56; National Archives, College Park, MD.|
January 5, 1942 Mr. Blough Miss Coyle
Subject: Relief of wife's earned income under the British and Canadian income tax, and application to the United States
Below is a summary statement respecting British and Canadian treatment of earned income of wives under the income tax, and possible adaptation of such treatment to mandatory joint returns in the United States. A more detailed statement is attached.
GREAT BRITAIN: In Great Britain, the income tax of a husband and wife is always computed on their joint income, even though each may choose to pay his own share of the total tax. If the wife has earned income, the couple is allowed up to 45 pounds sterling ($180) more personal exemption than other husbands and wives, since the ordinary married exemption of 180 pounds sterling ($560) is increased by nine-tenths of the wife's earnings up to this maximum addition (the other tenth of her earnings being deductible under the regular earned income credit).
Originally (from 1894-1931) the extra exemption granted on the basis of the wife's earned income sufficed to make the maximum exemption of a working couple equal to the combined exemption of two single people. In the past decade, however, the maximum exemption has been sometimes less and sometimes greater than that of two single people, because the Finance Acts have held to the 45 pounds sterling maximum addition while changing the ordinary exemption of a husband and wife.
The relief granted does not affect the surtax, which is imposed on income prior to deduction of exemptions and credits. Nonetheless, it has considerable tax value because the standard tax rate is so high (50 percent). Where husband and wife have $840 or more of joint taxable income after other exemptions and credits, the maximum additional exemption reduces their tax by $90. On lower incomes the tax reduction is less.
CANADA: Under the dominion income tax law there are no joint returns. Husbands and wives are taxed with respect to their separate incomes (though certain divisions of income designed to reduce the tax, like interspouse partnerships, employment, and property transfers, are not recognized). There is therefore no occasion to accord special relief to the earned income of working wives.
APPLICATION TO THE UNITED STATES: Since Canada does not have joint returns, only the British practice is applicable to the present problem of according special relief to earned income of working wives under mandatory joint returns in this country.
Outright adoption of the British system appears inadvisable, because under our graduated rate scale the tax value of any increase in the personal exemption rises with the size of the joint income, whether earned or unearned. Thus, if the personal exemption of working couples were increased to the extent of the wife's earnings up to perhaps $500, the tax value of the added exemption would range from 6 percent of the addition for the smallest incomes affected to 81 percent of the addition for the highest incomes (the added exemption being in effect deducted from the top bracket of the income).
To avoid this undesirable result, it is suggested that relief be granted in the form of a tax credit of 10 percent of the wife's earnings up to $500. This would limit the tax saving to $50.
A maximum reduction of $50 in the joint tax of husband and wife is considerably less than the $90 saving possible under the British system. It should be recalled, however, that our ordinary marital exemptions are far more liberal than the British both in absolute amount ($1,500 vs. $560) and in relation to the single exemption ($1,500 to $750 here vs. $560 to $320 there).
The application of the tax credit should be restricted to cases where the income is actually earned by the wife, excluding both community property income that is merely deemed earned and unearned income, such as dividends or interest, that may be deemed earned net income up to $3,000.
Earned income relief to husbands and wives in Great Britain and Canada
I. British treatment
1. EXISTING ALLOWANCE (FINANCE ACT OF 1941)
In Great Britain, the income tax of husband and wife living together is computed on their aggregate income. Separate returns and separate assessment, though permitted at the option of either spouse, do not alter their combined tax liability.
If the wife has earned income, the marital exemption of $560 (140 pounds sterling) is increased by 90 percent of her earnings, but not by more than $180 (45 pounds sterling). The exemption can thus attain a maximum of $740 (185 pounds sterling). Only 90 percent of the wife's earnings is counted in this connection, because the other 10 percent is deducted under the regular earned income allowance accorded all individuals. /1/
This increase is the personal exemption is of no benefit so far as the surtax is concerned, since that is imposed on net income before allowances. It is of substantial benefit, however, as respects the standard tax, the maximum increase of $180 (45 pounds sterling) having a tax value ranging up to $90 (22 pounds sterling 1/2). /2/
2. HISTORICAL DEVELOPMENT
Prior to the Finance Act of 1894, no special relief was accorded to the earned income of working wives.
/1/ In Great Britain, the earned income credit is one-tenth of earned net income not to exceed $600 (150 pounds sterling).
/2/ The first $660 (165 pounds sterling) of income in excess of exemptions and credits is taxed at 32-1/2 percent, with some limitations applicable to very small incomes; and the amount of taxable income above the first $660 is taxed at 50 percent. At 32-1/2 percent, the maximum increase in the personal exemption, $180, would have a tax value of $58.50; and at 50 percent, a tax value of $90. The latter figure represents the tax reduction secured by husband and wife with joint taxable income of $840 or more prior to the increase of the exemption. On taxable incomes below $840, the value of the increased exemption would vary, depending upon the rates applicable to the top amount of income offset by the additional exemption.
END OF FOOTNOTES
From 1894-1895 to 1919-1920, when the ordinary exemption /1/ of a married couple did not differ from that of a single individual, two separate exemptions were allowed if the wife had earned income /2/, one being applicable only against her earnings and the other being applicable against the balance of the joint income. This relief was granted only if the joint income of husband and wife did not exceed 500 pounds sterling.
Toward the end of the period, the husband might also claim the "wife allowance" introduced by the Finance Act of 1918. In 1918-1919 and 1919-1920, therefore, working couples with joint income not in excess of 500 pounds sterling were granted two abatements or exemptions plus a wife allowance. /3/
The Finance Act of 1920 corrected this situation by merging the wife allowance with the marital exemption and limiting the increased exemption of working couples to an amount not in excess of the exemption accorded two single couple. It fixed the exemption of a single individual at 135 pounds sterling, the exemption of a husband and wife living together at 225 pounds sterling, and the maximum increase in the latter on account of earned income of the wife at 45 pounds sterling (yielding the working couple a maximum exemption of 270 pounds sterling). Up to the 45 pounds sterling limit, the increase consisted of all of the wife's earnings not offset by the regular earned income credit and thus comprised (then as now) 90 percent of her actual earnings up to 50 pounds sterling. This relief was accorded regardless of the size of the joint income.
/1/ To avoid confusion, it should be noted that in Great Britain the exemption limit below which an income is not liable to tax is generally higher than the personal exemption or allowance accorded to incomes that are liable to tax. Thus, under the Finance Act of 1941, the exemption limit or amount of income at or below which income tax does not apply is $440 (110 pounds sterling) whereas the personal allowance for single individuals liable to tax is only $320 (80 pounds sterling). The discussion above relates to the personal allowances or exemptions accorded to individuals liable to tax.
/2/ Under the 1894 Act, the "relief" did not extend to cases where the wife's income was earned in carrying on a trade as opposed to a profession or vocation ... Eventually a further concession was made in Section 5 of the Finance Act, 1897, which granted separate exemption or abatement to the wife's income from any business carried on by means of her own personal labour and unconnected with the business of her husband." (Royal Commission on the Income Tax: Appendices and Index to the Minutes of Evidence, page 58.)
/3/ In 1918 the amount of the wife allowance was the tax on 25 pounds sterling; this was increased in 1919 to the tax on 50 pounds sterling.
END OF FOOTNOTES
The arrangement introduced by the 1920 Act continued unchanged through the taxable year 1930-1931 (apart from changes in the percent of the wife's earnings taken into account consistent with changes in the regular earned income credit /1/).
Since 1931, virtually the same scheme has applied; that is, if a wife has earned income, the ordinary married exemption has been increased by the percent of her earnings not offset by the regular earned income credit, up to a maximum increase of 45 pounds sterling. The only difference is that the former equality between the maximum exemption of the working couple and two single exemptions has not been maintained. Instead, the maximum exemption was a little lower than two single exemptions from 1931-1932 to 1934-1935 and since 1935 has been somewhat higher than two single exemptions. Under the Finance Act of 1941, for example, the maximum increase of $180 (45 pounds sterling) would bring the exemption of a working couple up to $740 (185 pounds sterling) as compared with $640 (160 pounds sterling or 80 pounds sterling apiece) allowed two single persons. This variation has resulted from changes in the amount of the ordinary exemption without corresponding change in the maximum amount of increase (45 pounds sterling) allowed a working couple.
From 1894-1931 the British system had the effect of granting a working couple the same personal exemption as two single individuals, to the extent permitted by the wife's earnings.
Since 1931, this equality has not been maintained, the maximum exemption of the working couple being in some years lower and in recent years higher than two single exemptions. The allowance which formerly achieved this equality, however, has been adhered to -- a maximum increase of 45 pounds sterling (now equivalent to $180) over the ordinary exemption of a married couple. In a sense this special relief takes cognizance of the wife's earnings up to 50 pounds sterling, by adding to the personal exemption the percent of such earnings not already deducted under the ordinary earned income credit.
/1/ A temporary discrepancy occurred in the years 1925-1926 to 1927-1928, when the regular earned income credit was increased from one-tenth to one-sixth of the earned income, and yet nine-tenths of the wife's earnings continued to be allowed as an addition to the personal exemption (up to the 45 pounds sterling maximum). In 1928 this discrepancy was corrected by allowing addition of only five-sixths of the wife's earnings. See historical table in Tolley's Income Tax Manual, 1940-1941, page 8.
END OF FOOTNOTE
4. APPLICATION TO THE AMERICAN SITUATION
Various bases appear for applying to mandatory joint returns in this country special earned income relief for working wives modeled on British practice.
a. A working couple might be given the same personal exemption as two single individuals. In this event, no special relief would be accorded, since the exemption allowed married couples already equals that of the two single individuals.
b. The exemption of the working couple might be increased equivalently with the maximum increase allowed in Great Britain (45 pounds sterling or $180). What is an equivalent increase, however, is not clear, since an allowance of $180 has a different tax value in Great Britain than here (the value varying, particularly in the United States, with the size of the income).
The maximum increase of 45 pounds sterling (representing actual earnings of 50 pounds sterling) approximates the dependent credit of 50 pounds sterling currently allowed in Great Britain. /1/ A similar proportion of the United States dependent credit would permit an increased exemption to working couples of $360.
c. The exemption of the working couple might be increased in the ratio of the maximum exemption under the British Finance Act of 1941 to the sum of two single exemptions; or in the ratio of the maximum exemption to the ordinary married exemption. These ratios are respectively 1.16 and 1.32 ($740 to $640 and $740 to $560). Corresponding percentage increases in the American exemption of $1,500 would amount to approximately $240 and $480.
The most liberal of the above increases based on the British system (0, $180, $360, $240, and $480) approaches $500. It might therefore be recommended that under mandatory joint returns in this country the personal exemption of the married couple be increased by the amount of the wife's earning /2/ up to a maximum increase of $500.
/1/ This approximation to the dependent credit did not obtain in 1920, however, when the 45 pounds sterling maximum increase was introduced. The dependent credit at that time was 36 pounds sterling for the first child and less for other dependents.
/2/ The percent of such earnings already deducted under the earned income credit is ignored, partly for simplicity and partly because the credit affects only the normal tax.
END OF FOOTNOTES
The tax value of such an additional allowance here, however, would increase with the size of the joint income, from 6 percent of the allowance on the smallest incomes affected to 81 percent of the allowance on the highest incomes (the tax value being determined by the applicable top bracket rates). /1/
Hence, IT IS RECOMMENDED that since the primary object in view is relief of small earned incomes, the relief be granted in the form of a tax credit equal to 10 percent of the wife's earned net income, the maximum credit not to exceed $50. The application of such credit should be restricted to cases where the income is actually earned by the wife, excluding both community property income that is merely deemed earned and unearned income, such as dividends or interest, that may be deemed earned net income up to $3,000.
In relation to the additional exemption on which based (wife's earnings up to $500) such an allowance appears more liberal than the additional British exemption (wife's earnings up to $180). In terms of tax reduction, however, the suggested allowance is in general less liberal than the British, the maximum reduction being limited to $50 as against $90 in Great Britain.
POSSIBLE MODIFICATION: It may be noted that under present exemptions and deductions the relief recommended above may completely exempt from tax working husbands and wives without dependents having joint income up to approximately $2,100, and may result in a very large percentage reduction of tax for higher joint incomes, whether or not all earned. These results could be prevented by further limiting the tax credit to a selected percent (possibly 50 percent) of the tax.
II. Canadian treatment
1. FILING REQUIREMENTS: Under the dominion income tax law in Canada, husbands and wives with separate incomes are required, if liable to tax, to file separate returns. If only one spouse is liable to tax; (i.e., has net income in excess of the various exemptions and deductions) only that spouse is required to file a return, and only with respect to his own income.
2. PERSONAL EXEMPTION AND DEPENDENT CREDITS. /2/ The exemption of a married person is $1,500, but where a husband and wife have each a separate income in excess of $750, whether taxable or not, each receives an exemption of $750 (the same amount as is accorded a single individual). Apparently therefore if the wife's separate income is less than $750, the husband secures the full exemption of $1,500, though he reports only his own income.
/1/ 1941 rate scales. The 6 percent is applicable to incomes exempt from normal tax by reason of the earned income credit and the 81 percent is applicable to incomes in excess of $5,000,000 after deduction of credits.
/2/ The stated exemptions and credits are those allowed under the Income War Tax Act, 1941.
END OF FOOTNOTES
The credit of $400 for any dependent child may be taken by either parent under arrangement between themselves, but in case of dispute is allowed to the father. Dependent credit for other relatives (the amount actually expended for support, not exceeding $400) goes to the taxpayer furnishing the support.
3. EARNED INCOME ALLOWANCE: /1/ No earned income credit is granted in connection with the graduated income tax, but the surtax of 4 percent is levied only with respect to investment or unearned income (in excess either of $1,500 or of the personal exemption and dependent credit combined, whichever is greater). The exemption from surtax appears similar in effect, therefore, to the exemption of earned income from normal tax in the United States. In Canada, however, earned income is not limited to a maximum of $14,000 nor is the first $3,000 of net income considered earned whether or not actually earned.
4. PROVISIONS AGAINST TAX AVOIDANCE AND EVASION BY HUSBAND AND WIFE:
INTERSPOUSE TRANSFERS OF PROPERTY: Where a husband transfers property to his wife, or vice versa, the income from such property or from property substituted therefore, is taxed to the transferor.
HUSBAND AND WIFE PARTNERSHIPS: Where a husband and wife are partners in any business, the total income from the business may in the discretion of the Minister of Finance be treated as income of the husband or the wife and taxed accordingly.
EMPLOYMENT BY SPOUSE OR BY SPOUSE'S PARTNERSHIP: If one spouse is employed by the other, the remuneration paid cannot be deducted as an expense in determining the net profit of the business. Similarly, if one spouse is employed by the other's partnership, the portion of the remuneration paid equivalent to the proportion of the partner spouse's interest in the business must be added to the income of the partner spouse.
5. THE NATIONAL DEFENCE TAX: As respects separate liability of husband and wife and allocation of personal exemption, the provisions of the national defence tax appear similar to those of the income tax. The level of the exemptions is different, however, being $1,200 for a married person, and $660 apiece if husband and wife each have a separate income in excess of $660.
6. APPLICATION TO THE UNITED STATES: The Canadian system is not analogous to that proposed for the United States, since separate returns rather than joint returns are mandatory in Canada. As noted above (section II2) it appears that in Canada a special tax advantage under SEPARATE returns may accrue to families in which the wife has an income not exceeding $750 whether earned or unearned; but the grant of an additional tax reduction under separate returns in the United States is not in prospect.
/1/ The stated exemptions and credits are those allowed under the Income War Tax Act, 1941.
END OF FOOTNOTE