Evaluating Proposed Deductions for the COVID-19 Pandemic

The Coronavirus Aid, Relief, and Economic Security Act (P.L. 116-136) was a historic $2 trillion stimulus package targeting the economic effects of the COVID-19 pandemic. By many indications, more legislation will be needed to blunt the impact of the coronavirus.¹

In a further effort to help taxpayers with the economic fallout of the pandemic, government leaders have made two proposals in recent weeks, both to undo different parts of the Tax Cuts and Jobs Act of 2017. House Speaker Nancy Pelosi, D-Calif., suggested lifting the $10,000 cap on the state and local tax deduction to help homeowners, while President Trump suggested reevaluating the business meal and entertainment deduction to help businesses.² This article examines these two proposals and makes further suggestions.

Undoing SALT Deduction Caps

In late 2017, Congress enacted the TCJA.³ It was the most major tax reform since 1986, making numerous changes to corporate taxation, individual income taxes, and the estate tax. For individuals, tax brackets were lowered and the standard deduction nearly doubled, meaning that fewer taxpayers would take the below-the-line deductions that include homeownership tax breaks.

The 2017 tax legislation also curtailed the tax advantages for homeownership through major cuts to both the mortgage interest and the SALT deductions. Taxpayers who would still be able to itemize could deduct the interest on the first $1.1 million of mortgage debt only on existing mortgages.⁴ Homes purchased after December 15, 2017, however, are limited to a mortgage interest deduction on only the first $750,000 of mortgage debt.⁵ Further, the deduction for home equity debt was eliminated. Mortgage debt on second homes now only qualifies for an interest deduction to the extent that the first mortgage does not exceed $750,000.⁶ When it comes to the SALT deduction, taxpayers are now limited to deducting only $10,000 of their state and local taxes.⁷

In the COVID-19 era, however, homeownership has run into major trouble. Over 4 million American mortgage borrowers have had their payments paused or reduced in May 2020.⁸ While mortgage forbearance has already been offered to some Americans, the same has not yet been true with tax breaks.

There are both drawbacks and benefits to supporting homeownership through the tax code. In terms of drawbacks, it has been argued that eliminating tax subsidies will lead to affordable housing because house prices will fall to offset the loss of tax incentives. In addition, the economics of homeownership may not make sense for all people, such as the transaction costs associated with a short period of homeownership. Tax subsidies for homeownership might also be economically inefficient. For example, the mortgage interest deduction does not emphasize the purchase decision, but the quantity decision, which helps contribute to urban sprawl. A mobile labor market that is not tied down by homeownership is also beneficial to the economy.

In terms of benefits, homeownership has been described as an important component of social, economic, mental, and financial well-being.⁹ Families do not move as much when they own rather than rent, avoiding school transfers for their children and enhancing their educational outcomes. There is also often pride in ownership, improving neighborhoods for residents.

Importantly, in a time when many American households do not have sufficient savings, homeownership is a form of forced savings, with benefits that include wealth generation and intergenerational wealth transfer, protection from inflation, and increased borrowing power.¹⁰ The mortgage payment forces people to contribute regular payments that usually produce a return when it comes time to sell. Not only do they retrieve the money they invested in the house, but they often also benefit from appreciation — all tax-free thanks to the exclusion of up to $500,000 of gain from the sale of a principal residence from a married couple’s income.

Historically, changes in tax law often have encouraged home ownership. For example, tax reform in 1986 created the housing credit to provide an incentive to the private sector to create and preserve affordable housing. The Housing and Economic Recovery Act of 2008 established a tax credit for first-time homebuyers that was worth up to $7,500. Yet, the TCJA reversed this trend by targeting the mortgage interest deduction and the property tax deduction inherent to the SALT deduction.

Thus, it is not surprising that legislators are now considering lifting the SALT deduction cap. However, the need for help during the COVID-19 pandemic may vary among homeowners, and more targeted relief would be cost-effective. Further, the need for homeownership relief may be similar to those who need help with their rents. Nonetheless, mortgage defaults partially contributed to the 2008 economic recession and thus housing policy deserves additional attention during any recession that follows the COVID-19 pandemic.

Reinstating the Entertainment Deductions

The TCJA did not significantly change the deductibility of many business meals.¹¹ For example, per IRC section 274(n)(1), business meals are still deductible up to 50 percent with limitations — the taxpayer (or an employee of the taxpayer) must be present and the business meals cannot be lavish.¹² This deduction recognizes that much business is done over business meals, which then helps the economy.

However, the TCJA eliminated the deductibility of entertainment expenses. Before this, businesses could deduct up to 50 percent of their entertainment expenses if directly related to the active conduct of a trade or business or associated with the active conduct of a trade or business if incurred immediately before or after a bona fide business discussion. The IRS has clarified that “food and beverages that are provided during entertainment events will not be considered entertainment if purchased separately from the event.”¹³

It is unclear how COVID-19 will impact entertainment. On the one hand, social distancing makes entertaining risky given that entertainment spaces were not originally set up for social distancing. On the other hand, with more people working from home, businesses may need space to congregate for meetings with employees and clients. Already some companies like Twitter have announced that employees can permanently work from home, which may make entertainment spaces one way employees can congregate.¹⁴ This would increase the role of entertainment facilities in the workplace, but likely not as long as the pandemic continues. Given the pandemic, it is more likely that entertainment will be dramatically decreased from previous years. Entertainment is likely among the last priorities for businesses in the COVID-19 pandemic. If they are reluctant to meet in the office due to social distancing, they will also not want to meet in other spaces.

While restaurants and other entertaining facilities are hit hard in the COVID-19 era, changing the deductibility of entertainment or business expenses from the 2017 tax reform will likely not provide significant relief as social distancing continues in the near future. It is thus more efficient to instead do programs like the Paycheck Protection Program for small businesses.¹⁵ In the event of an extended economic recession after the end of the pandemic, perhaps the relevant deductions could be reconsidered.

Conclusion

It is not surprising that legislators seek to undo many of the 2017 tax reform provisions as an increasing number of Americans need relief. Many of these provisions were controversial in the first place, but COVID-19 has only increased the economic impact of various tax policy choices on Americans. Thus, it is important to consider all the ways to offer relief, including potentially bringing back some familiar tax deductions.