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Standard Vs. Itemized Deductions: How the New Tax Proposal Could Affect the Decision


Tuesday, June 20, 2017
tax returns
Thinkstock/alfexe

By YiLi Chien, Senior Economist, and Paul Morris, Senior Research Associate

In late April, President Donald Trump revealed an outline of his tax proposal. The details of the proposal are still unclear as the announcement is quite brief. However, the tax proposal includes many significant changes, including some regarding tax deductions.

Standard Deductions Versus Itemized Deductions

When filing their tax returns, taxpayers can choose a standard deduction or an itemized deduction. These deductions are subtracted from taxable income and, hence, reduce taxpayers' bills. Larger deductions mean lower tax bills.

The standard deduction is a flat amount for each filing status.1 The new tax proposal seeks to double the standard deduction. 

The itemized deduction is calculated by summing eligible deductible expenses. 

These expenses include items such as:
  • Medical and dental expenses
  • State and local taxes paid
  • Mortgage interest payments
  • Gifts to charity
  • Casualty and theft losses
  • Job expenses

Given that households have different expenses, the amount of itemized deductions varies across taxpayers. The proposed changes for itemized deductions include eliminating all deductions but mortgage interest and charitable contributions.2

Who Uses Which Type?

According to tax return data for 2014 (the latest available), around 70 percent of tax returns filed used the standard deduction.3 

Under the new proposal of doubling the amount of the standard deduction, the fraction of taxpayers using the standard deduction should increase. Taxpayers who choose the standard deduction will likely continue to do so, and some of the taxpayers currently using the itemized deduction would switch. 

The table below shows that the fraction of taxpayers who use itemized deductions increases quickly with income.

Itemized Deductions by Income Groups
Income Group % Using Itemized Deduction Average Itemized Deduction
Overall 29.7% $27,300
$1 - $10,000 3.4% $15,700
$10,000 - $25,000 7.3% $15,400
$25,000 - $50,000 19.8% $15,800
$50,000 - $75,000 39.5% $17,800
$75,000 - $100,000 55.1% $20,200
$100,000 - $200,000 76.9% $25,500
$200,000 - $500,000 93.3% $43,100
$500,000 - $1 Million 92.8% $84,000
$1 Million or more 90.9% $423,800
SOURCE: Internal Revenue Service and authors' calculations
Federal Reserve Bank of St. Louis

The fraction using itemized deductions is in single digits for the two lowest incomes groups, while it exceeds 90 percent for those with incomes above $200,000. 

In addition, the average amount of itemized deductions claimed increases rapidly with income. This is not surprising given that the eligible deduction expenses tend to increase with income. 

For example, high-income households typically pay more state and local taxes and tend to give more to charity. The interest payments on mortgages can also increase with income as high-income households tend to live in more expensive houses. 

How Might Deduction Usage Change?

To evaluate the effects of the proposed change in itemized deductions, it is important to know how large mortgage interest payments and charitable contributions are relative to the total amount of itemized deductions and how the share changes with income. This will allow us to get a rough idea of how much the proposed change might impact the taxpayers' decision of choosing the standard or itemized deduction. The table below shows how much of the total these two deductions accounted for.

Mortgage Interest and Charitable Contribution Deductions
Income Group Mortgage Interest and Charitable Contributions Share of Total Deductions Average Mortgage Interest and Charitable Contributions Amount
Overall 40.8% $11,200
$1 - $10,000 27.0% $4,200
$10,000 - $25,000 30.9% $4,800
$25,000 - $50,000 37.0% $5,900
$50,000 - $75,000 41.1% $7,300
$75,000 - $100,000 43.2% $8,700
$100,000 - $200,000 43.5% $11,100
$200,000 - $500,000 39.5% $17,000
$500,000 - $1 Million 36.8% $30,900
$1 Million or More 41.8% $177,300
SOURCE: Internal Revenue Service and authors' calculations
Federal Reserve Bank of St. Louis

Mortgage interest and charitable contribution deductions accounted for around 40 percent of the total. This figure is fairly uniform across the income groups, excluding the two groups with the lowest incomes, which would be very likely to switch to the standard deduction if it is doubled. This suggests that the proposed tax reform cuts around 60 percent of claimed deductible income.

Finally, we computed the average amount of these two categories across income groups. For the highest income group, it is still significant at $177,300. Most of this comes from charitable contributions. The amount is reduced to $30,900 for the second-highest income group. 

For the rest of the groups, many of the itemized taxpayers would switch to the standard deduction, because their remaining deduction amounts would either drop below or approach the doubled standard deduction in 2014.4 

Notes and References

1 The filing statuses include single, married filing jointly, married filing separately, head of household and qualifying widow(er) with dependent child. Each filing status has a corresponding flat amount for the standard deduction. 

2The One-Page White House Handout on Trump’s Tax Proposal,” CNN, April 26, 2017. 

3 The data are from the Internal Revenue Service: SOI Tax Stats — Historic Table 2

4 For 2014, the standard deduction was $6,200, $9,100 or $12,400 depending on filing status. Doubling would amount to $12,400, $18,200 or $24,800.

Additional Resources

Posted In Financial  |  Tagged yili chienpaul morristaxesstandard deductionitemized deductionmortgage interestcharitable contributions
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