c. Other itemized deductions (1) Disallowance of deduction for nonbusiness personal property taxes Present Law Under present law, itemizers may deduct three types of State and local taxes whether or not incurred in a trade or business or in an investment activity-individual income taxes, real property taxes, and personal property taxes. (State and local sales taxes were made nondeductible under the Tax Reform Act of 1986, beginning in 1987.) In general, personal property taxes on nonbusiness property are deductible only if imposed (1) on an annual basis, and (2) substantially in proportion to the value of the personal property that is subject to tax. (For example, itemized deductions are allowed for personal property taxes imposed, in some States, on automobiles, motorcycles, and boats used for personal purposes.) A tax on personal property that is based in part on criteria other than the value of the property, or that is collected either more or less frequently than once per year, may qualify for deductibility, as may a tax imposed in the form of a privilege. For example, vehicle registration fees based partly on value and partly on other criteria (such as weight) may be deductible in part. At present, some 26 States (or their subdivisions) impose taxes on one or more types of tangible personal property not used for business or investment purposes, such as boats or automobiles used for personal purposes. Possible Proposal The itemized deduction for personal property taxes that are not incurred in a trade or business or in an investment activity could be repealed. (The May 1985 tax reform proposals of President Reagan called for disallowing itemized deductions for all nonbusiness taxes, including nonbusiness personal property taxes.) Arguments for the proposal Pros and Cons 1. Personal property taxes that are not incurred in a trade or business or in an investment activity-for example, such taxes imposed on personal vehicles or boats-are expenditures of a personal or consumption nature. Personal expenditures generally are not deductible in light of tax policies that deductions should be allowed only for expenditures essential to earning income, and that personal consumption should not be subsidized through the tax system. 2. Deductions for State and local personal property taxes benefit only those taxpayers with a narrow range of consumption patterns (in contrast to State and local income taxes) and do not benefit home ownership (in contrast to State and local real property taxes). Less than one-third of returns filed by itemizers for 1983 claimed deductions for nonbusiness personal property taxes. Arguments against the proposal 1. The deduction disallowance could adversely affect the ability of State and local governments to utilize personal property taxes in meeting their revenue needs. 2. The deduction disallowance would result in more favorable treatment to itemizers living in States that impose only real property or income taxes than to taxpayers in States that rely in part on personal property taxes to meet their revenue needs. (2) Imposition of floor under aggregate itemized deductions for higher-income taxpayers Present Law Individuals may elect to itemize their allowable deductions for certain personal expenditures if the total of itemizable deductions exceeds the applicable standard deduction amount. Under present law, there is no other overall limitation imposed on the allowance of itemized deductions. However, present law imposes floors under certain of the itemized deductions. Medical expenses may be deducted only to the extent exceeding 7.5 percent of the taxpayer's adjusted gross income (AGI). Casualty and theft losses greater in amount than $100 each may be deducted only to the extent that the sum of all such losses (net of related gains) exceeds 10 percent of AGI. Miscellaneous itemized deductions generally are allowed only to the extent the total amount exceeds two percent of AGI. Possible Proposal A floor equal to 10 percent of the taxpayer's adjusted gross income in excess of $100,000 ($50,000 for a single individual) could be placed under the total amount of the taxpayer's itemized deductions. For example, if married individuals with AGI of $210,000 had total itemizable deductions (allowable after taking into account the present-law specific floors) of $28,000, their allowable itemized deductions would be reduced to $17,000. Arguments for the proposal Pros and Cons 1. Most itemized deductions represent expenses incurred for personal consumption or financial purposes, and are not related to costs of earning income in a trade or business. Accordingly, limiting the aggregate amount of itemized deductions is consistent with the general tax policy that deductions should be allowed only for expenditures essential to earn income, and that personal consumption should not be subsidized through the tax system. 2. The proposed floor under aggregate itemized deductions also would be consistent with the policy (reflected in the specific floors under certain itemized deductions) that deductions for personal expenditures should be limited to involuntary and unusually large expenditures that may exhaust a large proportion of the taxpayer's total income for a particular year, thereby significantly affecting his or her ability to pay taxes. Since the proposal would impose a floor under, but not a ceiling on, itemized deductions, the taxpayer still could deduct amounts of expenses or losses that could be catastrophic relative to the taxpayer's income and ability to pay taxes. 3. By reducing the number of taxpayers who itemize, rather than using the standard deduction, the proposed floor would contribute to tax simplification and reduce recordkeeping, verification, and audit burdens on taxpayers and the IRS. The allowance of itemized deductions has long been recognized as a primary cause of complexity for individual taxpayers, particularly since intricate rules and limitations apply in determining eligibility for, and in computing, most itemized deductions. Arguments against the proposal 1. The largest itemized deductions for most taxpayers are home mortgage interest and State and local income and real property taxes. Limitations placed on these deductions would contravene long-standing tax policies with respect to home ownership and comity with State and local governments. 2. There is no rationale for imposing an overall floor in addition to the specific floors that already place significant limitations on the deductibility of medical expenses, casualty and theft losses, and certain miscellaneous itemized deductions. 3. If an overall floor reflects appropriate tax policy, the floor should apply to all itemizers, including those with AGI below $100,000/$50,000. Further, a more equitable and straightforward way to impose a higher effective tax rate on individuals with AGI above a specified level would be through adjustments to the rate structure. (3) Limitation on tax-liability reduction for top-bracket individuals Present Law Under present law, the allowance of itemized deductions provides a greater tax benefit for such expenditures of a personal or consumption nature to higher-bracket taxpayers than to lower-bracket taxpayers. For example, itemized deductions of $10,000 in 1988 will reduce the tax liability of an individual in the 15-percent bracket by $1,500, but will reduce the tax liability of an individual in the 28-percent bracket by $2,800. Possible Proposal The deduction for itemized deductions could be allowed only against the lowest (15 percent) tax rate. Alternatively, the deduction could be converted into a 15-percent tax credit. Argument for the proposal Pros and Cons All taxpayers would receive the same tax benefit from the same dollar amount of itemized deductions. This would eliminate the greater proportionate benefits that higher-income taxpayers receive under present law, so that charitable contributions (for example) would receive the same tax subsidy regardless of the income level of the donor. Arguments against the proposal 1. The proposal would conflict with the rationales and objectives for allowing itemized deductions, such as the encouragement of home ownership and charitable giving and the proper measurement of the ability to pay taxes, and would affect adversely the ability of State and local governments to raise needed tax reve nues. 2. The proposal would add further complexity to tax computations for itemizers; also, taxpayers would have difficulty understanding the reason for changing the basic structure of the itemized deductions. |