Before 2018, taxpayers could claim a personal exemption for themselves and each of their dependents. The amount would have been $4,150 for 2018, but the Tax Cuts and Jobs Act (TCJA) set the amount at zero for 2018 through 2025. TCJA increased the standard deduction and child tax credits to replace personal exemptions.
Personal exemptions have been part of the modern income tax since its inception in 1913. Congress originally set the personal exemption amount to $3,000 (worth more than $70,000 in today’s dollars), so that very few persons were expected to pay the income tax. While the amount was substantially lower both in real terms and relative to average incomes by 2017, the tax code has added other features since 1913, such as the standard deduction and various tax credits, that have partly offset the exemption’s decline in value.
In addition to helping ensure that very low-income households do not pay income tax (and alleviating the administrative burden of collecting the tax on small amounts of income), personal exemptions also link tax liability to household size. For instance, in 2017 when the personal exemption amount was $4,050 and the standard deduction for a married couple was $12,700, a married couple with three children and income of $92,950 (before subtracting five personal exemptions and the standard deduction) and a married couple without dependents and income of $80,800 (before subtracting two personal exemptions and the standard deduction) had the same taxable income—in this case, $60,000.
As with other deductions and exemptions, however, the tax benefit from personal exemptions depends upon a taxpayer’s marginal tax rate. For instance, a single taxpayer in the 12 percent tax bracket would save $498 of taxes with a personal exemption of $4,150, whereas a single taxpayer in the 32 percent tax bracket would save $1,328. Thus, under a progressive income tax, exemptions are worth more to high-income taxpayers than to low-income taxpayers. In contrast, tax credits can have the same value for all taxpayers. By replacing personal exemptions for dependents with expanded child tax credits, TCJA moved toward equalizing the tax benefit for children and other dependents across households with different incomes.
There were certain limits on personal exemptions under prior law. Since 1990, personal exemptions phased out at higher income levels. In 2017, the phaseout began at $261,500 for singles and $313,800 for married couples filing a joint return. Personal exemptions were completely phased out at $384,000 for singles and $436,300 for married couples.
In addition, the alternative minimum tax denied taxpayers the use of personal exemptions, making larger families more likely to owe the alternative minimum than smaller families.
Updated May 2020
I have a deep understanding of tax laws and their historical evolution, including the nuances of personal exemptions and their significance in the United States tax code. The Tax Cuts and Jobs Act of 2017 significantly altered the landscape by eliminating personal exemptions from 2018 through 2025 while concurrently adjusting standard deductions and child tax credits. This adjustment aimed to recalibrate the tax structure, replacing the traditional personal exemption system with a new framework to benefit taxpayers.
Let's break down the key concepts within the provided article:
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Personal Exemptions:
- Originating in 1913 with an initial amount set at $3,000, personal exemptions were intended to exempt a significant portion of the population from income tax.
- Over time, these exemptions declined in value but were balanced by other features like standard deductions and various tax credits.
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Tax Structure Changes:
- The Tax Cuts and Jobs Act (TCJA) set personal exemptions to zero from 2018 to 2025 but raised standard deductions and child tax credits to compensate.
- This shift aimed to eliminate disparities between households and equalize tax benefits across income brackets, particularly with the expanded child tax credits.
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Relationship with Household Size and Tax Liability:
- Personal exemptions were crucial in linking tax obligations to household sizes, ensuring that low-income households were exempt from income tax and reducing administrative burdens for small-income earners.
- They played a role in determining taxable income, illustrated by scenarios where households with different numbers of dependents could have similar taxable incomes.
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Effect on Taxpayers' Marginal Rates:
- The tax benefits from personal exemptions were dependent on an individual's marginal tax rate.
- Higher-income taxpayers derived more significant benefits from exemptions compared to lower-income earners due to the progressive nature of the income tax system.
- Tax credits, however, could offer equal value to taxpayers across income brackets.
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Limits and Phaseouts:
- Personal exemptions had limits, phasing out at higher income levels since 1990.
- In 2017, the phaseout for singles began at $261,500 and $313,800 for married couples, completely phasing out at $384,000 for singles and $436,300 for married couples.
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Alternative Minimum Tax (AMT):
- The AMT restricted the use of personal exemptions, making larger families more likely to fall into this category than smaller families.
Understanding these concepts helps grasp the evolution of the U.S. tax system and the role personal exemptions played in shaping tax liabilities based on household size and income levels.
