Fewer taxpayers would likely benefit from the mortgage interest and charitable contribution deductions if federal tax reform boosts the standard deduction -- a staple of the House Republican “Better Way” tax reform blueprint and several other recent Republican reform proposals.
“There will be a lot fewer itemizers,” said Eric Toder, co-director of the Urban-Brookings Tax Policy Center.
Toder’s organization estimated that of the 45 million taxpayers expected to itemize in 2017, 38 million (nearly 85 percent) would take the standard deduction if the blueprint was the law of the land.
The House GOP blueprint includes a proposal to eliminate all deductions except those for charitable contributions and mortgage interest. While the blueprint proposal would preserve some form of incentive for charitable giving and home ownership, the biggest “side effects” of the proposed standard deduction would be reduced use of the charitable and mortgage interest deductions, said Scott Greenberg, an analyst with the Tax Foundation. Wealthier taxpayers would be the remaining claimants of the charitable and mortgage deductions following implementation of the blueprint in its current form, he added.
The blueprint, released in 2016, calls for combining into one deduction the basic and additional standard deductions, as well as the personal exemptions for families and individuals. Married filers would receive $24,000, single filers with children would get $18,000, and other single filers would get $12,000. The blueprint also includes a provision to consolidate personal exemptions for dependents with the child credit by increasing the child credit to $1,500, the first $1,000 of which would still be refundable, and making non-child dependents eligible for a $500 nonrefundable credit. It also proposes eliminating the estate and alternative minimum taxes, lowering the top marginal individual rate to 33 percent, and consolidate the current seven brackets into three.
For 2016 the standard deduction for single taxpayers is $6,300. It is $12,600 for married taxpayers filing jointly or qualifying widowers with dependent children, and $9,300 for those filing as a head of household.
House Ways and Means Committee member Peter J. Roskam, R-Ill., described the standard deduction proposal as one that would lower the tax burden. “Any time that you lower a tax burden, by definition it makes a tax break less valuable,” Roskam, who chairs the Ways and Means Tax Policy Subcommittee, told Tax Analysts.
Jason Fichtner of the Mercatus Center at George Mason University said one key factor determines the value of deductions for taxpayers. “Generally speaking, the ‘value’ of the itemized deductions to me depends on my marginal tax rate,” he said.
The IRS Statistics of Income Division publishes statistics on taxpayers who itemize deductions, most recently for tax year 2014. Of the more than 20 income ranges listed, taxpayers in the four ranges from $60,000 to $500,000 claimed most of the deductions on home mortgage interest -- almost 23.7 million out of more than 32.7 million returns. Deductions claimed by taxpayers in those income ranges make up about $217.3 billion of the more than $286.7 billion total.
The single income group with the most claims of the deduction was that of the $100,000 to $200,000 range, at more than 11 million returns. Taxpayers with high adjusted gross incomes must limit their itemized deductions: those with AGIs of more than $259,400 for single filers, $311,300 for married couples filing jointly or as a qualifying widow(er), $155,650 for married couples filing separately, or $285,350 for those filing with the head of household filing status.
Many homeowners do not take advantage of the mortgage interest deduction because they don’t have enough interest to deduct, Fichtner said. Some might decide their amount of itemized deductions would be close, even potentially more, but would take the standard deduction for convenience's sake, he added.
The mortgage deduction is worth more in higher-priced areas because more interest is being claimed, but the impact of the blueprint provision could be less severe in those communities because there would still be larger numbers of people claiming the deduction, Greenberg said.
Fichtner said changing the standard deduction would have more of an impact on the charitable deduction than on the mortgage interest deduction because taxpayers with mortgage interest have to pay that interest regardless of whether they itemize.
Legislative language on the blueprint is pending, but if the standard deduction change is implemented as written, it would likely have an effect both on taxpayers and on organizations they donate money to. Cutting marginal rates, another provision in the blueprint, would likely have a larger negative impact on charitable giving, but boosting the standard deduction has important effects as well, said Alexander L. Reid, former legislative counsel with the Joint Committee on Taxation and now an attorney with Morgan, Lewis & Bockius LLP in Washington. He said those effects would likely “be felt strongest by organizations that receive a large number of small contributions from middle- and lower-income taxpayers, such as churches and many poverty relief organizations.” He noted that there are limits on taxpayer use of the charitable contribution deduction based on adjusted gross income.
For higher-income donors, tax policy can affect the structure and timing of large gifts, said Harold Hancock, formerly tax counsel with Ways and Means and now with McGuireWoods LLP. Other taxpayers might decide to give more so they can meet thresholds allowing them to itemize, he said.
If done by itself, the standard deduction boost would reduce federal revenue by $1.2 billion between 2017 and 2026 on a static basis, Greenberg told Tax Analysts. Kyle Pomerleau of the Tax Foundation clarified that estimate was based on a Tax Foundation analysis of the entire blueprint.
However, the Tax Foundation also projects that raising the standard deduction as called for in the Republican blueprint, while eliminating the personal exemption for nondependent filers, would boost federal revenue by $191 billion through 2026 on a static basis, Greenberg said.
“Apparently, when these two provisions are taken together, the magnitude of the tax increase on households that currently itemize is larger than the magnitude of the tax cut on households that do not itemize, which is why the provisions raise federal revenue,” he said.
Pomerleau added, “The standard deduction expansion is roughly half the size of the net revenue change in the blueprint” but about one-sixth of all the tax cuts.
Greenberg said that while there are “hundreds of possible pay-fors that can be used to finance any tax cut,” lawmakers have numerous options for funding a boost in the standard deduction. He said he believes the personal exemption repeal is an especially popular one because it operates in “a fairly similar way” to the standard deduction, in that it subtracts a fixed amount from taxable income.
Lawmakers don’t only have to think about the cost of the standard deduction boost. While the increase offers simplicity and other benefits, it raises potential trade-offs, including effects on the use of the charitable, mortgage, state, and local tax deductions that lawmakers are working through, Hancock said.
“Those are big questions,” he said. “In the blueprint, for example, it is noted that there is still going to be an incentive for charitable giving. It’s not clear what that incentive is.”
But boosting the standard deduction offers lawmakers a powerful concept to latch onto as tax reform talks continue, Hancock said. “I do think what attracts people in a bipartisan way to this is that it is such an incredible simplification for individuals and families filing their returns,” he said.
Simplification is one reason Republican lawmakers in particular like the idea, said Greenberg. The provision also benefits middle-income filers more than any other group, it may have positive economic effects, and it can be a way for lawmakers to reduce the effects of taking away other provisions, such as most itemized deductions, he said.
Fichtner said there is also a benefit to the IRS in boosting the standard deduction. “The more people that elect to use the standard deduction also makes it easier for the IRS to administer,” he said, because there would be fewer itemized deductions to verify.
At least five major tax plans since 2014, including the House GOP blueprint, have called for boosting the standard deduction, a fact that Greenberg cited in noting the importance of the provision in the House blueprint.
“It's obviously hard to say definitively if something is a consensus idea, but this is certainly a popular one,” he said.
Stephen K. Cooper contributed to this article.