Sneaky Tax Increases: Ignored Provisions in the TCJA

Introduction

The Tax Cuts and Jobs Act (P.L. 115-97) has generated perhaps unprecedented levels of pre- and post-enactment scrutiny and discussion. A recent Google search produced 45 million results for the TCJA, the first 10 pages of which were focused on topics such as summaries of the act, how it affects individuals versus corporations, who benefits the most based on income level, advice on withholding changes and filing for 2018, and technical advice for return preparers and tax advisers about various provisions. Of course, the average taxpayer isn’t going to sort through 45 million results. Most will rely on quick and simple sound bites that often obscure the complexity still inherent in the code.

Most of the mainstream media coverage and statements by GOP leadership have focused on what individual taxpayers stand to gain from tax reform. For example, in November 2017 Kellyanne Conway, a counselor to President Trump, told the press that a House GOP version of the tax plan would increase “the number of Americans who pay zero percent in taxes” and “help moms and dads.”¹ In an Op-Ed several weeks later, Senate Majority Leader Mitch McConnell, R-Ky., characterized the Senate tax bill as a “historic opportunity to give a break to middle-class families.”² The website for House Speaker Paul D. Ryan, R-Wis., praises the passage of the TCJA as a “generational defining moment for our country” and a “historic victory for taxpayers.” And Trump has often hailed the TCJA as one of the biggest tax cuts and reforms in American history and said it is at “the center of America’s resurgence.”³

Media reporting of economic and tax analysis has been slightly less optimistic — especially as specific details of the TCJA emerged after its passage in December. A search of “Who benefits from tax reform?” yields a wide range of fact-based discussion and an even wider range of opinions. A recent analysis by Americans for Tax Fairness shows that corporations are mainly enriching themselves rather than their employees with the corporate tax cut,⁴ and a report from the Urban-Brookings Tax Policy Center (TPC) finds that although taxpayers in all income brackets will see a decrease in taxes paid starting in 2018, that trend will reverse into a tax increase for 53 percent of taxpayers in 2027, after expiration of the TCJA’s individual tax provisions in 2025.⁵ (An initial outline of the GOP’s “tax reform 2.0” legislation includes proposals to make the tax cuts for individuals permanent.) In the same vein, although much has been made of the “simplicity” of the proposed postcard-size Form 1040, the new format merely shifts onto six schedules many of the items that used to appear on the main form.⁶

So is the TCJA one of the biggest tax cuts in American history? Will all taxpayers receive the benefits publicized by the GOP leadership and mainstream media? At first blush, the TCJA appears to be a net positive for individual taxpayers in the short term, given the reduction in marginal tax rates and the increased standard deduction. But individuals have also lost the personal and dependency exemptions and various individual deductions — a fact that has received relatively little attention.

A detailed examination of the TCJA reveals that it makes many amendments to individual tax provisions that could significantly reduce or eliminate the legislation’s much-touted benefits for individual taxpayers. This report examines the effect of several seemingly small changes to the individual provisions that are actually sneaky increases to tax liability.

Repeal of Moving Expense Benefits

The U.S. Census Bureau reports that from 2016 to 2017, approximately 27.5 million people moved their households from one place to another.⁷ That means nearly 11 percent of the U.S. population moved somewhere — either within the same county, to a different county in the same state, to a different state in the same division, to a different division in the same region, to a different region, or completely out of the United States.

Although moving is often a pathway to new opportunities — more than 5 million people reported moving for an employment-related reason⁸ — it is not a cost-free endeavor. Online articles, blogs, and tools to help determine the cost of relocation provide moving estimates, with $800 at the low end, $7,500 at the high end, a typical range of $1,376 to $4,335, and a national average of $2,837.⁹

Congress has subsidized this cost for several decades through sections 217 and 132(g). The provisions are two sides of the same coin: Section 217 allows a deduction to adjusted gross income for qualified, unreimbursed moving expenses (subject to some restrictions on distance from original residence and length of employment after the move), and section 132(g) allows employees to exclude from income the amounts received from employers for qualified moving expense reimbursement. The deduction and exclusion were both repealed as part of the TCJA, effective through 2025.¹⁰

Why would Congress target a decades-old deduction whose repeal will likely hurt the very taxpayers the TCJA is purportedly intended to help? IRS Statistics of Income data might help explain the rationale for choosing this deduction to AGI. Figure 1 is an aggregation of total moving expenses claimed by individuals from 2003 to 2015¹¹ (see Figure 1).

First, the deduction itself is expensive. In 2015, the most recent year reported, taxpayers claimed $3.6 billion of moving expenses. That isn’t the case every year; the deduction fluctuates with the economy and the state of the labor market. But even at the lowest point in the study period — 2009, the height of the Great Recession — taxpayers claimed more than $2 billion in moving expense deductions.

However, the more interesting viewpoint is the annual number of taxpayers who claim this deduction. With the exception of 2009, that number hovers around 1 million taxpayers. In 2015 the deduction was claimed on 1.1 million returns — less than 1 percent of all tax returns filed.¹² Because most taxpayers never claim the section 217 deduction and it is often a one-time deduction for those who do, it was an easy target for repeal.

What does this mean for taxpayers? Closer examination of the SOI data supports the aforementioned figures on the average cost to move. The average moving expenses claimed range from $2,000 to $3,000 each year in the sample.

Although more specific tax return data is needed to calculate an average effect for all taxpayers, it’s clear that repealing the section 217 deduction will increase AGI and thus taxable income (plus already incurred out-of-pocket moving costs) for taxpayers who incur qualified moving expenses from 2018 to 2025. Moreover, because 1 million out of the 5 million people who moved for employment-related reasons in 2016 to 2017 reported income of at least $100,000, according to U.S. Census Bureau data,¹³ the resulting increase in AGI might ensure a phaseout of other deductions and credits. For many taxpayers, the loss of the section 217 deduction could be a disincentive to relocate, or it might cause them to decrease spending on common discretionary items during the moving process.

The other and perhaps more significant part of the repeal is section 132(g). Data on the number of employees taking advantage of the exclusion for qualified moving reimbursement are not publicly available, but the U.S. Census Bureau data can give us an approximation. As mentioned earlier, approximately 5 million people moved their households for employment reasons in 2016 to 2017, and tax returns reporting moving expenses have remained steady at approximately 1 million for most years in our sample. Thus, the remaining 4 million people either didn’t qualify for a moving expense deduction or reimbursement, or they were reimbursed by an employer and those amounts were excluded from income under section 132(g).

Insight into the cost of the section 132(g) exclusion to the federal government can be gleaned from an extensive corporate relocation survey conducted annually by Atlas Van Lines. The survey asks representatives of 435 companies about relocation reimbursements, lump sums for relocation, and reasons for providing those funds. Although companies reported a range of dollar amounts for both lump sum payments and relocation reimbursements, they were more likely to provide higher dollar amounts (full reimbursement) to current employees transferring within the company than to new hires. Perhaps not surprisingly, companies report a continuing trend toward using lump sum payments for relocation. With the repeal of section 132(g), those payments will now essentially be treated like salary.

Interestingly, small, midsize, and large companies (based on number of employees) all report a similar median range amount for lump sum payments: $10,000 to $14,999. Although some of those costs wouldn’t be deductible or excludable under pre-TCJA law (for example, the costs of house hunting or temporary housing), that range gives us a baseline from which to estimate some of the amounts that would have been excluded.

The survey also provides a range of the estimated number employees relocated by the 435 respondents.¹⁴ A quick calculation indicates that the total for those companies alone is anywhere from 43,000 to 100,000 employees. Using the median amounts reported earlier, and based on lump sum payments and reimbursements, we can estimate that the cost of employee relocation for these companies in the aggregate ranges anywhere from $432 million to $648 million at the low end (based on 43,000 employees) to between $1 billion and $1.5 billion at the high end (based on 100,000 employees).

An extrapolation across all U.S. companies that pay for relocation would allow us to conclude that the federal government’s yearly revenue loss from the section 132(g) exclusion was significant. In fact, the Joint Committee on Taxation estimates that revenue gain over the 2018 to 2025 period will be $4.1 billion from the repeal of section 217 and $2.7 billion from the repeal of section 132(g).¹⁵

The survey results suggest that those estimates may even be on the low side. The top factors in employee relocation for the respondents were company growth and lack of local qualified talent. Although 90 percent of the respondents believed that relocation budgets and costs would be affected by tax reform, more than half of the 435 companies still expected to increase budgets for relocation costs. The most popular method proposed (by about a third of the respondents) to address the effect of the TCJA was to gross up the now-taxable relocation benefits and expand lump sum payments.

For the moment, the repeal of sections 217 and 132(g) appears to be a fairly cost-free revenue win for the federal government. But if the labor market grows ever tighter because of changing demographics and stricter immigration policies, expect companies to lobby for Congress to reinstate the exclusion after the TCJA sunsets in 2025.

Increase of the Standard Deduction

Although many of the TCJA’s provisions seemed to fly under the radar, its increase of the standard deduction and repeal of the personal and dependency exemptions (along with the decreased marginal rates) were a major focus of discussion surrounding the act’s individual tax provisions. Of course, an increase in the standard deduction will result in fewer taxpayers choosing to itemize. One analysis posited that 94 percent of taxpayers would take the standard deduction in 2018.¹⁶

To put that figure in context, Figure 3 is a graph of the SOI data of taxpayers who itemized under section 63 versus claiming the standard deduction for 2003 to 2015.

We can see from the trend line that claiming itemized deductions (on Schedule A of Form 1040) versus taking the standard deduction was at a high during the housing bubble (when interest rates were also higher) but that it has since stabilized to represent about 30 to 31 percent of all tax returns filed.

Another look at the data gives us the total dollar amounts claimed on Schedule A for this period: approximately $1.2 trillion for each year after 2004, with the exception of 2006 and 2007, when the housing bubble drove up interest expense and real estate taxes claimed on Schedule A.

More relevant to the current discussion are the average amounts claimed on Schedule A. Approximately 45 million to 50 million taxpayers filed a Schedule A each year from 2003 to 2015, claiming on average $25,000 in miscellaneous deductions. In 2015, for example, 45 million taxpayers filed Schedule A and claimed an average of $27,000 in miscellaneous deductions.

Unfortunately, because the SOI data on Schedule A isn’t broken down by filing status, it is difficult to estimate exactly how the increase in the standard deduction will affect the 30 percent of taxpayers who now itemize their deductions. The number of taxpayers filing Schedule A will also be affected by the TCJA’s limitation on the deduction for state and local tax (discussed next). So we don’t know the split between (1) single taxpayers who have $27,000 in itemized deductions and thus will be unaffected by the increase in the standard deduction to $12,000, and (2) married taxpayers filing jointly who have $27,000 in itemized deductions and, as a result of the limited SALT deduction and the increase of the standard deduction to $24,000, will default to the standard deduction.

Complicating things further is the TCJA’s repeal of personal and dependency exemptions, whose loss is purportedly offset by the doubling of the standard deduction and an increase in the amount of the child tax credit. Although the increased child tax credit will provide some relief from repeal of the exemptions, use of the credit is limited to those who have tax due (although up to $1,400 can be refundable, subject to phaseouts). The TCJA also put into place a new, nonrefundable $500 credit for qualifying dependents who aren’t children — but again, taxpayers must have tax due to benefit from this credit. However, as discussed later, taxpayers who were subject to the alternative minimum tax in past years because exemptions and itemized deductions were included in the calculation of alternative minimum taxable income might see a complete offset in ordinary income taxes due.

To simplify, we can calculate a few basic effects on taxable income for a family of five. Although we don’t have statistics on how many taxpayers claimed three children as dependents each year, the 2015 SOI line count data for the earned income tax credit (Schedule EIC) reports 3.4 million taxpayers providing a Social Security number for a third child.¹⁷ Using 2017 numbers, a family of five would be allowed a standard deduction of $12,700, plus an additional two personal exemptions and three dependency exemptions of $4,050 each — a $32,950 reduction in taxable income.

Under the TCJA, by contrast, that reduction in taxable income would be limited to the $24,000 standard deduction and thus increase taxable income by $8,950. Of course, each of the three children could be eligible for the $2,000 child tax credit if they meet age limitations and there is tax due for offset. Again, this will vary based on many factors, which means that the doubling of the standard deduction and the repeal of exemptions might be the TCJA’s sneakiest increase to tax liability.

Limitation on the SALT Deduction

The SALT deduction has been allowed as an itemized deduction on Schedule A for several decades, partially as way to ensure that the same income isn’t double-taxed by multiple entities. Later, a deduction for state sales taxes was added as an option for taxpayers in states where there is no income tax (Florida, New Hampshire, Nevada, South Dakota, Texas, Washington, and Wyoming). Taxpayers can also itemize and deduct real estate and personal property taxes, as well as other deductible taxes such as foreign income taxes paid.

Figure 6 shows the total tax expenses claimed on Schedule A (line 9) from 2003 to 2015, according to SOI data.

From the federal government’s perspective, even though only 30 percent of taxpayers itemize the SALT deduction to reduce their federal taxable income, it represents a significant dollar amount and has steadily increased over time — from $310 billion in 2003 to $553 billion in 2015. Of course, states often compete for residents and businesses through tax-related promises and thus use different methods to fund their governments. Most use a combination of income, property, and sales taxes.¹⁸ Taxpayers in high-tax states have often relied on the federal deduction as a cushion against the state tax burden — every dollar paid represented a reduction (although not a dollar-for-dollar reduction) of federal taxes owed.

There is likely wide variation in who is claiming tax expense on Schedule A. This would, of course, vary based on income level, property value, and consumption of taxable goods, but it would also depend on other Schedule A items such as mortgage interest expense (which also varies based on loan value and interest rate). Overall, the SOI data indicate that the amounts claimed have mostly risen steadily over time, with a dip during the Great Recession. In 2015, 29 percent of returns (44 million taxpayers) claimed on average $12,500 in tax expense on Schedule A (see Figure 7).

Perhaps because of its status as a sacred cow of our income tax system, the SALT deduction famously almost derailed the Tax Reform Act of 1986.¹⁹ It was a surprise to many politicians and pundits when, in the 2017 tax reform effort, the GOP first proposed to eliminate the deduction entirely and later proposed to limit it to $10,000.²⁰

Under the final version of the TCJA, the total SALT deduction allowed per person is $10,000 per year ($5,000 if married filing separately). That limitation generated perhaps the most criticism, debate, and attention out of all the TCJA’s provisions, culminating in national news stories reporting thousands of taxpayers in high-tax states rushing to prepay their property taxes before year-end, despite warnings from the IRS that those payments likely wouldn’t be deductible in 2017.²¹

In 2014 the TPC reported that more than 90 percent of the households making more than $200,000 claimed the SALT deduction, while less than 20 percent of the households making under $50,000 claimed it.²² This is often a reflection of geography rather than tax rate. Although California, Iowa, Minnesota, and Oregon imposed the four highest income tax rates in 2016,²³ most people wouldn’t mention Iowa or Minnesota on a list of high-tax states — perhaps because the overall dollars paid in Iowa and Minnesota are lower, commensurate with wages that are lower than in California or Oregon. Similarly, although New York has a lower property tax rate than eight other states, because of median home prices, it ranks fourth in terms of dollars paid — right behind New Jersey, New Hampshire, and Connecticut, all of which are states with relatively high median home values.²⁴

In some combined high-tax states (based on property, sales, and income taxes) such as California, Connecticut, Maryland, New Jersey, and New York, the limitation on the SALT deduction will be especially relevant. A 2016 TPC study found that completely eliminating the deduction would result in a tax increase for 40 percent of the taxpayers in Maryland and 35 percent of the taxpayers in Connecticut, while 30 percent of the tax increase resulting from elimination of the deduction overall would be borne by taxpayers in New York and California.²⁵

The $10,000 limitation imposed by the TCJA will not only reduce the number of taxpayers who itemize, it could also significantly increase the taxable income of taxpayers in high-tax states. The 2016 TPC study also found that taxpayers with income greater than $100,000 would pay for 90 percent of the tax increase resulting from elimination of the SALT deduction, whereas limiting the deduction to $6,000 would result in those taxpayers paying for 97 percent of the tax increase.

To mitigate the impact of the change, Congress doubled the standard deduction, but that amount doesn’t offset the itemized deductions lost by taxpayers residing in high-tax states. Despite the overall decrease in individual marginal rates, the limitation on the SALT deduction is a (perhaps not so) sneaky increase in tax liability resulting from the TCJA.

Limitations on Deductible Interest

Another sacred cow of the code is the mortgage interest deduction. Although some economists mentioned elimination of this deduction as an option for tax reform, the politicians who drafted the TCJA never seriously considered it. But SOI statistics make the case for eliminating or phasing out the home mortgage interest deduction entirely. Figure 8 shows the total home mortgage interest expense claimed (lines 10 and 11) on Schedule A for 2003 to 2015.

The home mortgage interest deduction is very costly to the federal government. At one point during the housing bubble, it was even costlier than the SALT deduction. But after a sustained period of low interest rates, it has settled to a level just below $300 billion.

Although Congress chose to keep the mortgage interest deduction, the TCJA imposed some limitations on it. First, the deduction is limited to interest on up to $750,000 of home acquisition indebtedness (reduced from $1 million of indebtedness under prior law). The TCJA also repealed the home equity loan interest deduction through 2025; but the IRS has clarified that the deduction will still be allowed if the funds are used to “buy, build or substantially improve the taxpayer’s home that secures the loan.”²⁶

That change might seem innocuous, but home equity loans and home equity lines of credit (HELOCs) were on a rapid upswing at the end of 2017, having recovered from a bad reputation earned during the housing bubble and crash. A home is usually the largest asset an individual owns, and a report from TransUnion in October 2017 predicted that 10 million homeowners would take out HELOCs in the next four years.²⁷ Unsurprisingly, as property values and equity²⁸ increase over time, some homeowners become more reliant on home equity to cover necessary expenses. Before the TCJA, that cash was often used to pay for vacations, moving expenses, college expenses for children, or unreimbursed medical expenses.

The interest expense claimed by 33 million taxpayers in 2015 averaged around $8,500. As discussed earlier, taxpayers eligible to claim itemized deductions will decrease in future years, but it’s unclear what will happen to average amounts.

Although many taxpayers and lawmakers may frown at using home equity debt to pay for a trip to Disney World or to purchase a new car, the pre-TCJA tax benefit has been a significant factor in individual decisions to incur many of those expenses. When the cost of those expenses increases because the tax break has been removed, industries that benefit from this spending might be in trouble, and many parts of the country rely heavily on income from elective consumer expenses such as travel or auto purchases.

One thing is certain: The compliance concerning this deduction will increase in the wake of the TCJA’s changes.

Casualty and Theft Losses

The notion of allowing a deduction for loss from casualty or theft to reduce income existed even before the federal income tax was passed in 1913.²⁹ Early on, Congress recognized that the tax system should allow for a loss that is beyond the taxpayer’s control. Section 165 established a deduction for a loss that was sustained during the tax year but was not reimbursed by insurance or otherwise. Section 165(c)(3) extended the deduction to individuals who didn’t have a business, if the losses arose from “fire, storm, shipwreck, or other casualty, or from theft.”

The big caveat was that the taxpayer had to itemize to deduct those expenses, and they had to exceed $100 per casualty and theft incident. The even bigger caveat was that the deduction was limited to expenses exceeding 10 percent of the taxpayer’s AGI.

Despite those limitations, the deduction did cost the federal government in lost tax revenue over the years. The SOI data from 2003 to 2015 indicate that the deduction is worth anywhere from $1.6 billion to $5 billion every year. One exception is 2005, when hurricanes Katrina and Rita hit the United States and there was an extensive outbreak of wildfires in California, leading 813,000 taxpayers to claim casualty and theft expenses (see Figure 9).

Interestingly enough, 2005 didn’t represent a high in average casualty and theft claims. The record year was 2012, when Hurricane Sandy hit the Northeast and taxpayers claimed an average of $31,000 in casualty and loss expenses. However, those expenses were reported on only 160,000 Schedules A for 2012.

Fortunately, relatively few taxpayers have occasion to use the casualty and loss deduction. As with the moving deduction, many taxpayers never use the deduction, and those who do usually claim it only once.

The TCJA didn’t repeal the casualty and loss deduction, but it significantly narrowed it to apply only to losses that occur where there has been a presidentially declared disaster. This could have a significant effect on taxpayers because losses from events such as a property fire, robbery, or other damage that isn’t covered by insurance can no longer be deducted on Schedule A.

Repeal of Miscellaneous Itemized Deductions

One final sneaky increase to tax liability could come in the form of the repeal of the Schedule A miscellaneous itemized deductions subject to the 2 percent of AGI floor. Although SOI data perhaps bear out the common refrain that “no one gets to take this deduction anyway” — less than 1 percent of taxpayers claim miscellaneous itemized deductions in any given year — the deductions actually reduced the taxable income of 12.8 million taxpayers for a total of $113 billion in 2015 (see Figure 12).

In fact, the average amount of miscellaneous expenses claimed per taxpayer has been slowly rising over the course of our sample period, from just over $5,000 in 2003 to nearly $9,000 in 2015 (see Figure 13).

This catchall category on the bottom of Schedule A allowed taxpayers to claim expenses ranging from hobby expenses, vehicle expenses for rural postal employees, subscriptions to professional publications related to the taxpayers’ profession, unreimbursed job- or profession-related expenses, union dues, and work-related education. Another section in this category allowed for investment and safe deposit box expenses, and, on its own separate line, the all-important tax return preparation expenses.

Before the TCJA, taxpayers were allowed to deduct those expenses to the extent their sum exceeded 2 percent of AGI. Until 2025, taxpayers who traditionally used the deductions will no longer be allowed to claim them on Schedule A but might try to claim them elsewhere. Perhaps we’ll see a rise in the filing of Form 1040 Schedule C-EZ, “Net Profit From Business (Sole Proprietorship)” in 2018.

Effect of the AMT

There is perhaps one silver lining to the sneaky increases in tax liability: Many of the items repealed or reduced are added back to income when calculating AMTI to determine AMT due.

Since its origins as the “add-on minimum tax” in 1969 — in the wake of revelations that 155 taxpayers in the United States with incomes exceeding $200,000 had paid no income tax in 1966 — the reach of the AMT has expanded exponentially. This is partially the result of changes in the calculation and rates for regular taxable income, with no corresponding changes for the AMT. Because the calculation for AMT due involves a comparison with regular income tax due, a decrease in marginal tax rates for regular income tax will naturally ensure that more taxpayers are subject to the AMT. According to SOI data, by 2015, 10.3 million taxpayers filled out Form 6251, “Alternative Minimum Tax — Individuals,” and 4.5 million taxpayers were subject to the tax, for a total of $31 billion in AMT paid (see Figure 14).

For many of those taxpayers, the AMT is a nasty surprise. Deductions that were helpful in reducing regular taxable income — the SALT deduction and the personal and dependency exemptions — landed them squarely in AMT territory at filing time, at an average amount of $7,000 in 2015.

A few things happened with the TCJA that should reduce the number of taxpayers subject to the AMT. First, as discussed earlier, the elimination of the personal and dependency exemptions and the increase in the standard deduction (resulting in fewer itemizers) will cut out a large swath of otherwise AMT-eligible taxpayers. Form 6251 completions should drop significantly. Also, the limitation on the SALT deduction will reduce the addback to AMTI (a maximum of $10,000), which should lower the number of taxpayers who owe AMT.

Finally, Congress increased both the AMT exemption amount (to $109,400 for joint filers and $70,300 for other filers) and the phaseout threshold for that exemption (to $1 million for joint filers and $500,000 for other taxpayers). However, for taxpayers who haven’t been subject to the AMT, there is little to shield them from the tax increases that follow in the shadow of the “tax breaks” touted when the TCJA was passed.

Conclusion

As many return preparers and taxpayers are realizing, navigating the TCJA is no easy feat. There was virtually no opportunity for planning because it was passed at the end of 2017 and became effective immediately.

For many taxpayers, it is not uncommon to incur in the same year a combination of the expenses discussed earlier. Changes to the standard deduction, the limitation on the SALT deduction, and the elimination of the personal and dependency exemptions will have a significant effect on the taxable income of many taxpayers. Some of that effect may be offset by changes to the AMT, but that must be evaluated on a case-by-case basis.

The best advice is to know the extent of the changes, check withholding throughout the year, and make estimated payments to avoid a sneaky surprise. And, of course, remember that all the TCJA’s individual provisions sunset as of 2025, when we can start all over again.