CRS Summarizes Tax Deductions for Individuals

Every tax filer has the option to claim deductions when filing their income tax return. Deductions serve four main purposes in the tax code: (1) to account for large, unusual, and necessary personal expenditures, such as extraordinary medical expenses; (2) to encourage certain types of activities, such as homeownership and charitable contributions; (3) to ease the burden of taxes paid to state and local governments; and (4) to adjust for the expenses of earning income, such as unreimbursed employee expenses.

Some tax deductions can be taken by individuals even if they do not itemize. These deductions are commonly referred to as above-the-line deductions, because they reduce a tax filer's adjusted gross income (AGI, or the line). In contrast, itemized and standard deductions are referred to as below-the-line deductions, because they are applied after AGI is calculated to arrive at taxable income.

Tax filers have the option to claim either a standard deduction or to itemize certain deductions. The standard deduction, which is based on filing status, is, among other things, intended to reduce the complexity of paying taxes, as it requires no additional documentation. Alternatively, tax filers claiming itemized deductions must list each item separately on their tax return and be able to provide documentation that the expenditures being deducted have been made. Only tax filers with deductions that can be itemized in excess of the standard deduction find it worthwhile to itemize. Whichever deduction the tax filer claims -- standard or itemized -- the amount is subtracted from AGI.

Deductions differ from other tax provisions that can reduce a tax filer's final tax liability. Deductions reduce final tax liability by a percentage of the amount deducted, because deductions are calculated before applicable marginal income tax rates. In contrast, tax credits generally reduce an individual's tax liability directly, on a dollar-for-dollar basis, because they are incorporated into tax calculations after marginal tax rates are applied.

Some deductions can only be claimed if they meet or exceed minimum threshold amounts (usually a certain percentage of AGI) in order to simplify tax administration and compliance. In addition, some deductions are subject to a cap (also known as a ceiling) in benefits or eligibility. Caps are meant to reduce the extent that tax provisions can distort economic behavior, limit revenue losses, or reduce the availability of the deduction to higher-income tax filers.

Because some tax filers and policymakers may not have detailed knowledge of tax deductions, this report first describes what they are, how they vary in their effects on reducing taxable income, and how they differ from other provisions (e.g., exclusions or credits). Next, a discussion concerning the rationale for deductions as part of the tax code is provided. Because some deductions are classified as tax expenditures, or losses in federal revenue, they might be of interest to Congress from a budgetary perspective. The final section of this report includes tables that summarize each individual tax deduction, under current law. Many of these deductions are part of the permanent income tax code. The American Taxpayer and Relief Act of 2012 (P.L. 112-240) extended several temporary provisions through 2013. The Tax Extender Act of 2013 (S. 1859) would provide a one-year extension for most of the provisions that expired at the end of 2013, including all of the temporary, individual provisions discussed in this report.

This report will be updated, as necessary, to reflect changes in current law.

                            Contents

This report first describes what tax deductions are, how they vary in their effects on reducing taxable income, and how they differ from other provisions (e.g., exclusions or credits). Next, it discusses the rationale for deductions as part of the tax code. The final section includes tables that summarize each individual tax deduction, under current law.

This report focuses on the standard treatment of tax deductions for individuals under the individual income tax code. As such, the following are beyond the scope of this report:

• the different treatment of deductions under the alternative minimum tax for individuals,¹

• tax deductions for businesses under the individual income tax code,² and

• options for reforming itemized deductions.³

To understand what tax deductions are, it is helpful to first understand how a tax filer calculates individual income tax liability. Figure 1 provides an overview of how a tax filer calculates his or her federal tax liability.⁴ To calculate taxes owed (tax liability), tax filers first add up all of their forms of income (see step 1 in Figure 1) to calculate their gross income. Next, the tax filer subtracts any above-the-line deductions to calculate their adjusted gross income, or AGI (step 2). AGI is often referred to as "the line." Then, the tax filer subtracts personal exemptions, or fixed dollar amounts per spouse and dependent child (step 3). The tax filer then subtracts the greater of either the sum of all of their below-the-line, or itemized deductions, or the standard deduction, which is a fixed amount based on filing status, in order to arrive at taxable income (step 4). The marginal tax rates are applied to taxable income (step 5) to arrive at a preliminary tax liability. Finally, tax credits are subtracted from preliminary tax liability (step 6) to arrive at final tax liability. The provisions in Figure 1 surrounded by dotted lines are covered in this report.

 

Figure 1. Computation of Federal Personal

 

Income Tax Liability

 

 

 

What Are Tax Deductions?

Simply stated, deductions reduce taxable income. Each deduction reduces tax liability by the amount of deduction times the tax filer's marginal tax rate. In contrast, a tax credit reduces tax liability on a dollar-for-dollar basis because it would be applied after the marginal tax rate schedule. An individual in a 35% tax bracket would receive a reduction in taxes of $35 for each $100 deduction while an individual in a 25% tax bracket would receive a reduction in taxes of $25 for each $100 deduction. Hence, the same deduction can be worth different amounts to different tax filers depending on their marginal tax bracket. The tax savings from deductions are generally equal to the tax filer's marginal tax rate times the amount of the deduction. So higher-income tax filers typically benefit more than lower-income tax filers from deductions.

Deductions serve four main purposes in the tax code.⁵ First, they can account for large, unusual, and necessary personal expenditures, such as the deduction for extraordinary medical expenses. Second, they are used to encourage certain types of activities, such as homeownership and charitable contributions. Third, they account for and ease the burden the burden of paying for non-federal forms of taxes, such as state and local taxes. Fourth, deductions adjust for the expenses of earning income, such as deductions for work-related employee expenses.

The following sections define each form of deduction and explain in greater detail how deductions are used in the calculation of an individual's tax liability.

Above-vs.-Below-the-Line Deductions

To arrive at final tax liability, all taxpayers may be able to claim above-the-line deductions whether they claim itemized deductions or the standard deduction. Each of these deductions has a specific line on the Form 1040 (e.g., line 34 for the deduction of student loan interest). Figure 2 shows how tax deductions appear on the IRS Form 1040.

 

Figure 2. Above- Versus Below-the-Line Deductions on

 

the IRS Form 1040

 

 

 

These deductions are commonly referred to as above-the-line deductions, because they reduce a tax filer's AGI (the line). Above-the-line deductions are sometimes also called adjustments to income, because they generally represent costs incurred to earn income. In contrast, itemized and standard deductions are sometimes referred to below-the-line deductions, because they are applied after AGI is calculated to arrive at taxable income.

Above-the-line deductions may provide additional benefits to some tax filers seeking to claim certain tax preferences. A number of tax provisions have a phaseout of benefits as income increases. The higher the AGI, the less likely the tax filer will be able to claim a larger value of the tax preference. Tax deductions that lower AGI increase the likelihood that the tax filer will be able to claim a larger value of the tax preference.

Itemized Versus Standard Deductions

As previously discussed, tax filers have the option to claim either a standard deduction or the sum of their itemized deductions. Whichever deduction the tax filer claims -- standard or itemized -- the deduction amount is subtracted from AGI to arrive at final tax liability.

Standard Deduction

The standard deduction is a fixed amount, based on filing status, available to all taxpayers. In contrast to those itemizing their deductions, tax filers do not have to provide additional documentation in order to claim the standard deduction.

The standard deduction was introduced into the federal tax code with the passage of the Individual Income Tax Act of 1944 (P.L. 78-315) primarily to simplify tax administration and compliance. At the time of passage, it was noted that taxpayers generally had little idea about what deductions were allowable and few taxpayers kept accurate records. Thus, the enactment of the standard deduction reduced excessive unsupportable claims of deductions, although at the same time it permitted many taxpayers to take a deduction in excess of what they would have been allowed if they had been required to itemized their deductions.

Today it is also viewed as performing a social welfare purpose. The social welfare purpose of the standard deduction was introduced with the minimum standard deduction in the Revenue Act of 1964 (P.L. 88-272). Under this minimum standard deduction provision, a taxpayer was assured a minimum amount of deductions from his or her income. The personal exemptions combined with the standard deduction amount are designed to remove low-income households from the tax rolls.

The calculation of the standard deduction has changed over time. In 1944, it was equal to 10% of AGI, up to a maximum of $1,000. In 1964, a minimum standard deduction was introduced as a fixed value of $200 plus $100 for each exemption with a ceiling of $1,000 if married filing jointly.⁶ The value of the standard deduction, including both the percent of AGI and the maximum value, was increased multiple times from 1969 to 1975. The minimum standard deduction and the deduction were merged in 1977 into a flat standard deduction of $2,200 (single) and $3,200 (married filing jointly).⁷ The Economic Recovery Tax Act of 1981 (P.L. 97-34) indexed standard deduction amounts for inflation, beginning in 1985.⁸ The standard deduction has been increased over time, such as with the Tax Reform Act of 1986 (TRA86; P.L. 99-514).

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA; P.L. 107-16) phased out part of the so-called marriage penalty associated with the federal tax code, where the standard deduction for joint filers was less than twice the single filer amount. EGTRRA increased the deduction for joint filers to 200% of singles. This provision, most recently extended by Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (P.L. 111-312), expired in 2012. Under current law, the standard deduction for married couples filing jointly will be equal to 167% of upper limit for singles for the 2013 tax year and beyond.⁹

The standard deduction amount varies depending on the filing status of the tax unit (i.e., single, married filing jointly, married filing separately, or head of household), whether the tax filer is over the age of 65, and whether the tax filer is blind.

For the 2013 tax year (2014 filing season), the inflation-adjusted standard deductions are as follows:

• $12,200 for married filing jointly or surviving spouses,

• $6,100 for single tax filers and married filing separately, and

• $8,950 for tax filers who qualify as the head of a household.¹⁰

• $12,400 married filing jointly or surviving spouses,

• $6,200 for single tax filers and married filing separately, and

• $9,100 for tax filers who qualify as the head of a household.¹¹

The additional standard deductions for those aged 65 or older and those who are legally blind are increased by $1,500 if single or head of household and $1,500 if married filing jointly for tax year 2013 (2014 filing season).¹³ These increases apply per classification and are added above the base standard deduction amounts listed above. Thus, a 70-year-old blind and single tax filer would be eligible for a $3,000 increase ($1,500 for being 65 or older, and $1,500 for being blind) in his or her standard deduction for tax year 2013. These amounts are adjusted annually for inflation.

Itemized Deductions

Alternatively, tax filers claiming itemized deductions must list each item separately on their tax return and be able to provide documentation (i.e., in the event of an IRS audit) that the expenditures have been made.

Tax filers have been able to itemize their deductions since the Revenue Act of 1913 (P.L. 63-16), which created the first permanent federal income tax. Deductions for interest paid or unexpected casualty losses were early provisions in the federal income tax code because many businesses were sole proprietorships (i.e., pass-through entities) where the owner was personally liable for the costs of doing business. Itemized deductions have been reduced or limited in eligibility, most notably with TRA86. For example, TRA86 eliminated deductions for consumer interest and enacted more complex rules for deducting investment interest.¹⁴

Only individuals with aggregate itemized deductions greater than the standard deduction find it worthwhile to itemize. Itemized deductions are claimed on the IRS Schedule A form.¹⁵ Itemized deductions are allowed for a variety of purposes. A detailed summary of the requirements and limits for each of these provisions, and other itemized deductions, is included in Table 2, at the end of this report.

Some itemized deductions can only be claimed if they meet or exceed minimum threshold amounts (usually a certain percentage of AGI) in order to simplify tax administration and compliance. For example, a tax filer must meet a certain threshold (or a floor) to deduct a casualty, disaster, or theft loss.

Certain itemized deductions are treated as miscellaneous itemized deductions, which are allowed only to the extent that their total exceeds 2% of the individual tax filer's AGI. This floor makes it simpler for a tax filer to choose whether he or she would be better off itemizing the deductions or choosing to claim the standard deduction, and it helps to ensure that the IRS is only reviewing documentation of fewer, larger events rather than many, smaller events. Any restriction placed upon an itemized deduction generally applies prior to the 2% AGI floor.¹⁶ An example of an expense subject to the combined 2% of AGI floor for miscellaneous deductions is the 50% reduction for unreimbursed meals while traveling away from home on business.

In addition, some deductions are subject to a cap (also known as a ceiling ) in benefits or eligibility. Caps are meant to reduce the extent that tax provisions can distort economic behavior, limit revenue losses, or reduce the availability of the deduction to higher-income tax filers. For example, the home mortgage interest itemized deduction is limited to mortgage debt in the amount of up to $1 million for married couples filing jointly ($500,000 for individuals or married filing separate).¹⁷ This ceiling is intended to limit incentives for higher-income tax filers to finance their home purchases with deductible interest.

Pease Limit on Itemized Deductions for Higher-Income Tax Filers

There is a limitation on the value ofitemized deductions that certain, higher-income tax filers can claim. The limitation on itemized deductions was initially included in the Omnibus Budget Reconciliation Act of 1990 (P.L. 101-508), drafted by Representative Donald Pease of Ohio. Commonly referred to as "Pease" by tax analysts, it effectively increases taxes on high-income tax filers without explicitly increasing tax rates.

Pease's limitations are triggered by an AGI threshold.¹⁸ The number or total amount of itemized deductions claimed by a tax filer does not determine whether he or she is subject to Pease. Pease affects tax filers above the inflation-adjusted AGI thresholds who itemize deductions. For these tax filers, the total of certain itemized deductions is reduced by 3% of the amount of AGI exceeding the threshold.¹⁹ The total reduction, however, cannot be greater than 80% of the deductions (and the tax filer always has the option of taking the standard deduction). Consequently, the effective marginal tax rate for these tax filers will be 3% higher than their statutory marginal tax rate.²⁰

Pease was in effect from 1991 to 2009, and was fully repealed from 2010 to 2012.²¹ The Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L. 107-16) included the phased-in repeal of Pease between 2006 and 2009. Pease was scheduled to be reinstituted beginning with the 2011 tax year, but the reintroduction was postponed until the 2013 tax year by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (P.L. 111-312).

The American Taxpayer and Relief Act of 2012 (ATRA; P.L. 112-240) restored Pease for tax years 2013 and beyond. Prior to the enactment of ATRA, Pease's income thresholds would have been triggered at $177,550 for single filers for 2013.²² After the enactment of ATRA, Pease applies to tax filers for the 2013 tax year (2014 filing season) with an AGI of

• $250,000, if single and not married;

• $275,000, if head of household;

• $300,000, if married filing jointly or a surviving spouse; or

• $150,000, if married, filing separately.²³

• $254,200, if single and not married;

• $279,650, if head of household;

• $305,050, if married filing jointly or a surviving spouse; or

• $152,525, if married, filing separately.²⁴

Table 1 and Table 2 provide a summary of above- and below-the-line tax deductions, respectively.²⁵ The first column provides a reference to where the provision can be found on the Form 1040 (if an above-the-line deduction) or on the Schedule A form (if a below-the-line, itemized tax deduction). The provision column contains a reference to where the provision can be found in the Internal Revenue Code (IRC), which is Title 26 of the U.S. Code. A brief summary of the provision follows in the adjacent column. When applicable, annual limits (whether they are floors or ceilings) and income limits and phaseouts are provided.²⁶ The last column provides the tax expenditure amount for FY2013 and FY2014.²⁷

Tax expenditures are defined under the Congressional Budget and Impoundment Control Act of 1974 (P.L. 93-344) as "revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of tax liability."²⁸ Tax expenditure estimates are based on current law, which does not assume extensions of temporary provisions that are subject to expire within the time period observed. Not all tax deductions have JCT tax expenditure estimates, as some provisions are estimated to result in revenue losses less than $50 million per fiscal year (JCT's de minimus level). In addition, some tax deductions are not considered tax expenditures for various, other reasons.²⁹ For example, the deduction for uncompensated employee expenses is considered an appropriate measure to adjust a tax filer's AGI.

^b Tax expenditures estimates are for individuals only, not corporations. Estimates below JCT's de-minimus amount of $50 million, as per its February 2013 estimates, are denoted by [dm]. Provisions without a JCT tax expenditure amount are denoted by NA.

^c For more information on ATRA's changes to the tax treatment of IRAs, see CRS Report R42894, An Overview of the Tax Provisions in the American Taxpayer Relief Act of 2012, by Margot L. Crandall-Hollick.

^b Tax expenditures estimates are for individuals only, not corporations. Estimates below JCT's de-minimus amount of $50 million, as per its February 2013 estimates, are denoted by [dm]. Provisions without a JCT tax expenditure amount are denoted by NA.

^c This estimate is the sum of the three different categories of charitable giving included in JCT's tax expenditures estimates that were conducted in 2013.

^d JCT did not provide a tax expenditure estimate for this provision, as it is considered to be a negative tax expenditure (i.e., revenue net-gain).

² Some of the deductions reported on the Internal Revenue Service Form 1040 relate to business expenses, as some business are organized as pass-through entities. Pass-through entities get their name from the fact that the business's income passes-through to the owner, as opposed to being claimed separately by the business. However, the tax treatment of business income through the individual tax code is beyond the scope of this report. For more information on pass-through entities, see CRS Report R40748, Business Organizational Choices: Taxation and Responses to Legislative Changes, by Mark P. Keightley.

³ For example, see CRS Report R42435, The Challenge of Individual Income Tax Reform: An Economic Analysis of Tax Base Broadening, by Jane G. Gravelle and Thomas L. Hungerford; and CRS Report RL33755, Federal Income Tax Treatment of the Family, by Jane G. Gravelle.

⁴ For a more detailed description of each of these tax terms, see CRS Report RL30110, Federal Individual Income Tax Terms: An Explanation , by Mark P. Keightley. For a general explanation of the federal tax system, see CRS Report RL32808, Overview of the Federal Tax System, by Molly F. Sherlock and Donald J. Marples.

⁵ Joseph A. Pechman, Federal Tax Policy, 3^rd ed. (Washington, DC: Brookings Institution Press, 1977), pp. 85-88.

⁶ CRS Report 80-31, Historical Summary of Selected Features of the Individual Income Tax, by George J. Leibowitz and Jane G. Gravelle. This archived report, last updated by Cheryl Savage Newton in 1980, is available upon request.

⁷ Ibid.

⁸ Jon Bakija and Eugene Steuerle, "Individual Income Taxation Since 1948," National Tax Journal, vol. 44, no. 4 (December 1991), p. 453.

⁹ See CRS Report R42485, An Overview of Tax Provisions Expiring in 2012, by Margot L. Crandall-Hollick.

¹⁰ See U.S. Congress, Joint Committee on Taxation, Overview of the Federal Tax System As in Effect for 2013, committee print, 113^th Cong., 1^st sess., January 8, 2013, JCX-2-13R (Washington: GPO, 2013), p. 4.

¹¹ See Internal Revenue Service, Internal Revenue Bulletin No. 2013-47, November 18, 2013, at http://www.irs.gov/pub/irs-irbs/irb13-47.pdf.

¹² For the 2014 tax year (2015 filing season), the standard deduction for a dependent is limited to the greater of $1,000 or the sum of $350 and the individual's earned income. See ibid.

¹³ For the 2014 tax year (2015 filing season), the additional standard deduction for the aged or the blind is 1,200. The additional standard deduction amount is increased to $1,550 if the individual is also unmarried and not surviving a spouse. See ibid.

¹⁴ See Sally Wallace, "Itemized Deductions," in Encyclopedia of Taxation and Tax Policy, ed. Joseph J. Cordes, Robert D. Ebel, and Jane G. Gravelle (Washington, DC: Urban Institute Press, 2000), p. 215. For an explanation of reforms to particular itemized tax deductions in the Tax Reform Act of 1986, see U.S. Congress, Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986, committee print, 100^th Cong., 1^st sess., May 4, 1687, JCS-10-87 (Washington: GPO, 1987).

¹⁵ Internal Revenue Service, 2012 Schedule A (Form 1040), at http://www.irs.gov/pub/irs-pdf/f1040sa.pdf.

¹⁶ Internal Revenue Code (IRC) Section 162(a).

¹⁷ IRC §163(h).

¹⁸ Ibid.

¹⁹ The deductions not subject to the Pease limitation are medical and dental expenses, investment interest, qualified charitable contributions, and casualty and theft losses.

²⁰ The statutory tax rate is the marginal tax rate a tax filer faces based on their AGI. In contrast, the effective marginal tax rate is the net rate a taxpayer pays on an increment of income that includes all forms of taxes, including the different rate for itemized deductions under Pease. The average effective tax rate is calculated by dividing total tax liability by total gross income.

²¹ For more information on the Pease limitation and sample calculations, see CRS Report R41796, Deficit Reduction: The Economic and Tax Revenue Effects of the Personal Exemption Phaseout (PEP) and the Limitation on Itemized Deductions (Pease), by Thomas L. Hungerford.

²² U.S. Congress, Joint Committee on Taxation, Description of Revenue Provisions Contained in the President's Fiscal Year 2013 Budget Proposal, committee print, 112^th Cong., 2^nd sess., June 2012, JCS-2-12 (Washington: GPO, 2012), p. 200.

²³ These Pease income thresholds will be adjusted for inflation for tax years after 2013.

²⁴ See Internal Revenue Service, Internal Revenue Bulletin No. 2013-47, November 18, 2013, at http://www.irs.gov/pub/irs-irbs/irb13-47.pdf.

²⁵ For more information about each provision, please refer to the latest IRS tax guide or the specific Internal Revenue Code provision within the U.S. Code. These summary tables are not meant to be a substitute for professional tax assistance.

²⁶ Some provisions in the tax code are phased out (i.e., their value is reduced as income rises) for higher-income taxpayers as a way to target tax benefits on middle- and lower-income households and to limit the loss of revenue.

²⁷ Joint Committee on Taxation, Estimates of Federal Tax Expenditures, For Fiscal Years 2012-2017, 113^th Congress, 1^st session, February 1, 2013, JCS-1-13 (Washington: GPO, 2013).

²⁸ P.L. 93-344, Section 3(3).

²⁹ For a discussion of the debate over what is and what is not a tax expenditure, see Leonard E. Burman, "Is the Tax Expenditure Concept Still Relevant?," National Tax Journal, vol. 56, no. 3 (September 2003), pp. 613-627, and Donald B. Marron, "Spending in Disguise," National Affairs, no. 8 (Summer 2011), at http://www.nationalaffairs.com/publications/detail/spending-in-disguise.