IN DEFENSE OF THE ITEMIZED DEDUCTION FOR TAXES

Here is an argument for allowing an itemized deduction for the full amount of state and local income and property taxes that I have often made, but which I do not hear very much from other sources.

An individual is taxed on gross income – gross salary for a W-2 employee.  So, a person living in New Jersey, where I used to live, and a person living in North East Pennsylvania, where I now live, pays the same tax rate on $100,000 of gross wages. 

But what it you deduct basic living costs, like mortgage principal and interest payments and state and local income taxes and property taxes – assuming that both taxpayers live in the same size home.  If you take the tax paid, using the Standard Deduction instead of Schedule A, as a % of what is left after subtracting these expenses the person in North East Pennsylvania is paying much less federal income tax, as a % of what is left after paying these expenses, than the person living in New Jersey on the exact same gross income – because the NJ resident has a lot less left.

In NJ wages are somewhat artificially inflated to reflect the increased cost of living.  So it is obvious that a $100,000 salary in NJ is not the same as a $100,000 salary in NEPA.

Allowing a deduction in full for state and local income taxes, property taxes, and acquisition debt mortgage interest on a taxpayer’s primary personal residence helps to “geographically equalize” the tax burden so that all taxpayers are treated relatively equally, regardless of where in the US they live.

So, what do you think?

TTFN

JUST SAYING – INCREASING THE MARRIAGE TAX PENALTY

There has been much talk about the effects of the limited $10,000 - $5,000 if Married Filing Separately -  itemized deduction for property taxes and state and local income or sales taxes combined in the GOP Tax Act. 

However, something that has not been mentioned, at least in what I have read, is the fact that this limitation substantially increases the Marriage Tax Penalty.

Two working single individuals, either living together or separately, who itemize can each claim a deduction of up to $10,000 in combined property taxes and state and local income or sales taxes.  That is a total of $20,000 in itemized deductions on the 2 returns. 

For residents of New Jersey, where my clients are from, it is not hard for each individual to reach the $10,000 maximum, or come close to it, even if they both own and live in one home.

If these two individuals, who both work and have their own separate income, were married the itemized deduction would still be limited to $10,000.  Filing separately would not make any difference, as everything I have read specifically identifies the limitation as $5,000 for married taxpayers filing separate returns. 

So, by having joined together in holy wedlock this dual-income couple will probably be paying tax on $10,000 more in net taxable income, which would, again in New Jersey, result in over $2,000 in additional federal income tax.  This tax penalty could be increased if the state tax return follows the federal return.   

I wonder if this is what the idiots in Congress intended.  Of it they actually gave the matter any thought.

Just saying.

TTFN

WHAT DEDUCTIONS WOULD YOU KEEP?

My fellow tax blogger Kelly Phillips Erb – FORBES.COM’s TaxGirl, has a regular feature called “Fix the Tax Code Friday”.  She poses a tax question that concerns a problem with the current mucking fess that is out Tax Code and calls for comments from her readers.

A recent question was -

“If we scrapped all of the deductions under the Tax Code except one, which one would you want to hold onto?”

My answer -

I would keep many of the current deductions, although none of the current credits (FYI – click here for my series of TWTP posts on how I would rewrite the Tax Code).  Specifically I support keeping the deduction for state and local income taxes, and real estate taxes and “acquisition debt” mortgage interest on a principal personal residence (owner-occupied housing).  But my reason is not to encourage home ownership. 

Here is how I explained my reasoning in a post at THE WANDERING TAX PRO back in 2013 -

The Internal Revenue Code taxes Americans based on income measured in pure dollars. However it is a fact that the “value” of one’s level of income differs, sometimes greatly, based on one’s geographical location. A family living in the northeast or California that has an income of $100,000-200,000 (apparently considered “upper-income taxpayers”) may be just getting by, while a similar family that resides in “middle America” lives like royalty on the same level of income. Many components of the Tax Code are indexed for inflation, but nothing is indexed for geography. To be honest I have no idea how one would even begin to index for geography.

It costs an awful lot to live in, for example, New York, certainly New Jersey, Connecticut, Massachusetts, and California. State and local income and property taxes are the highest in the country. The cost of real estate is also excessively high. As a result one must earn a lot more money to be able to live in these states – and salaries are arbitrarily increased to reflect the increased cost of living. Yet $150,000 in income is taxed by the federal government at the same rate in New York City as it is in Hope, Arkansas.

Real estate and state and local income taxes and the cost of a home, and therefore also the amount of “acquisition debt” mortgage interest paid on a residence, are higher in the Northeast, and California. Since we pay taxes on “net income” after deductions, allowing an itemized deduction for these items would help to somewhat geographically “equalize” the tax burden.

I do believe that the itemized deduction for real estate taxes and mortgage interest on secondary personal residences and the itemized deduction for “home equity” mortgage interest (not used for “substantial” home improvement) should be eliminated.

I have two questions for my readers (especially the tax professionals)  –

First – how would you answer Kelly’s “Fix the Tax Code Friday” question?

And second – what do you think about my suggestion, and the issue of “geographical equalization” in general?

TTFN