Erosion of a Good Idea

The deduction no one loves

By Kaye A. Thomas
Posted April 16, 2008

Accounting for Active Traders

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The standard deduction is good policy, but Congress keeps chipping away at it.

Many of the most popular tax benefits fall into a category called itemized deductions. The good thing about them is they allow you to lower your tax bill by claiming things like mortgage interest, state and local taxes, charitable contributions and, if large enough, medical expenses.

The bad thing about them is they're a royal pain.

To claim itemized deductions you have to learn a lot of complicated rules. You can deduct all your interest from this type of mortgage but maybe not from that type of mortgage. You can deduct contributions to this type of organization but not that type of organization. It goes on and on.

But that's only the beginning. Having learned all these rules, you have to maintain records for every type of expense that might be deductible. You need to get a receipt showing what you donated to the Salvation Army and come up with a value for each item. You need to track down the amount of state and local income tax you paid (and don't forget to check to see if you come out better deducting sales tax instead). If you're deducting medical expenses you probably have a thick stack of confusing paperwork, bills for things that were covered by insurance and for other things that were not. In the best case, itemizing is a small chore you'd rather avoid; in the worst case it's a big job calling for professional help.

This probably won't bring any tears to your eyes, but itemized deductions are bad for the IRS, too. I'm not talking about the reduction in your taxes. I'm talking about the increase in paperwork. Returns with itemized deductions cost more to process. They're more likely to contain mistakes. Then there's the little problem that itemized deductions offer a tempting way to cheat.

Fortunately, for most taxpayers, all of this is irrelevant.

The standard deduction

Once in a while Congress gets something right, and that was definitely the case on the day they came up with the idea of the standard deduction. That's a deduction you're allowed to claim instead of all those itemized deductions. It's big enough so the average Joe (or Jo) will come out ahead when they ignore all the complexity and paperwork of the itemized deductions and put this one simple number down on their tax return. Think of it: a rule that for most people makes taxes both simpler and lower at the same time. Better still, it does this without eliminating the opportunity to itemize, for those who have large enough deductions to justify the effort. It's a win-win-win. What's not to like?

Chipping away

Unfortunately, many in Congress are unclear on the concept. They lament the fact that people who don't itemize cannot deduct charitable contributions, or property tax, or whatever item is the topic du jour. I imagine myself yelling at these guys, no, you lunkhead, people who don't itemize get to deduct these items whether they pay them or not. That's the beauty of the standard deduction. They should be happy about that situation, and so should you.

My imaginary yelling has had no effect on Congress, so we're seeing a gradual erosion of the standard deduction. They keep coming up with items you can deduct even if you don't itemize. Great! Another deduction! Yes, and a longer tax return. More paperwork. Complexity that's completely unnecessary in a world where we have something called the standard deduction.

Deductions you claim without itemizing are called adjustments to income. They're the ones at the bottom of page 1 on Form 1040. There used to be just a few of them, and they were mostly the kinds of things you wouldn't reasonably include among itemized deductions, like IRA contributions and alimony payments. Not any more. That section of the tax return is up to 15 lines, and that's in spite of some compression, as when the IRS stopped asking for each spouse's IRA contribution on separate lines. Many of the items have no business appearing in this list. They should be itemized deductions, but the honorable representative from the state of South Pander won't stand for it because then people who don't itemize won't be able to claim the deduction. No, you lunkhead!

Student loan interest is an example. We used to claim this as an itemized deduction, right there along with mortgage interest (and, in those days, credit card interest, woohoo!). The Tax Reform Act of 1986 eliminated this deduction, among many others, on the theory that when the government allows fewer deductions it can get by with lower tax rates. That's an important point, but one for another day. The point here is that when Congress restored the student loan interest deduction, it converted it to an adjustment, one of those things you deduct even when you don't itemize.

Here's what that means. People who borrow for college have to learn about this deduction. If they're smart they take this into account when determining how to finance their education. Then, every year when they prepare their tax return (or give their information to a professional preparer) they have to track down the amount of this deduction. And they have to maintain paperwork that will justify the deduction if the IRS decides to audit the return.

Don't get me wrong, I like the idea that student loan interest is deductible. It should be an itemized deduction, though. Why treat it different than mortgage interest? Making it an itemized deduction would allow most people to deduct it the simple way, as part of the standard deduction.

What else have we got? How about "educator expenses," something we allow so that a teacher who buys construction paper for the classroom when the school runs out can claim a deduction. Noble idea, but something that could be allowed as part of the charitable contribution deduction, perhaps with a little tweak of the rules. Does this expense deserve different treatment than a contribution of supplies to a church or a charity?

What else? I see a line for "certain business expenses of reservists, performing artists, and fee-basis government officials." I'm not kidding: performing artists. There's a tuition and fees deduction, on the off chance the government hasn't provided enough tax benefits for education through 529 accounts, Coverdell accounts, the Hope credit, the lifetime learning credit, the exclusion of interest on savings bonds, etc. There's something called the domestic production activities deduction, which you likely don't have to worry about other than to wonder why it's sitting there as an adjustment to income.

There's more to come. Congress is considering adding to the list as a way to provide relief to homeowners in the mortgage crisis. The idea of a charitable contribution deduction for non-itemizers keeps coming back like a bad penny. Other ideas pop up from time to time. Each one is another barnacle on the hull.

The standard deduction is a thing of beauty. Its ongoing erosion is a lamentable development that contributes significantly to the complexity of tax planning and compliance.

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