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Tax deductions: Your questions answered

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George W Bush would never raise taxes, oh no. But according to a trial balloon

being floated today in the New

York Times and a few weeks ago in the LA

Times, he might eliminate tax deductions, especially those which

overwhelmingly benefit those notoriously blue states New York and California.

The federal deduction for state and local taxes, we’re told, is alone worth

$46 billion a year.

Despite having an extra three weeks to write the story, the New York Times

piece, by Ian Urbina, still doesn’t really add anything to the LA Times story:

in fact, it raises one enormous question which it doesn’t even attempt to answer.

The way this deduction works is that you don’t need to pay federal income tax

on money which you’ve already given to the state in the form of state and local

income tax. If you earn $100,000 a year and you pay $5,000 of that in state

and local taxes, you pay federal income tax not on your full $100,000 income,

but only on the $95,000 which is left over.

According to a New York City official quoted in the New York Times piece, the

change would mean that New Yorkers "could expect an 11 percent increase

in the amount they pay the IRS," because they take deductions not only

for New York State taxes but also for New York City taxes.

Then, however, things get confusing. According to the New York Times, "the

change would affect about 3.2 million households in New York"; the LA Times

is more useful, saying that those 3.2 million households comprise 37% of all

tax filers in the state.

Both papers quote Bruce Bartlett, a former Treasury official. In the LA Times,

he says that "it’s one of the biggest deductions most people have on their

tax returns". But in fact, even in New York and California, "most

people" turns out to be just 37% of tax filers.

This makes little sense to me. If you pay federal income tax, then you pay

state income tax. If state income tax is deductible, how come 63% of filers

fail to deduct it? I’ve been poring over my 2003 tax returns, and not only can’t

I find the deduction anywhere, I can’t even find a place where I might be able

to claim it.

Thanks to ehow.com,

however, I’ve worked out what’s going on here. Americans have a choice on their

tax returns: they can either itemize deductions, or they can claim the standard

deduction, which last year was $4,750 for single people like me, $9,500 for

married couples filing jointly, or $7,000 for people who qualify as "head

of household". After I worked out my adjusted gross income, I then subtracted

$4,750 from it along with $3,050 for each person dependent on me, which in my

case was just me alone. So my taxable income, on line 40 of my 1040 tax return,

was actually $7,800 lower than my adjusted gross income, on line 35. And that’s

actually the minimum amount by which adjusted gross income is decreased.

It’s possible to reduce your adjusted gross income by more than that, by itemizing

your deductions. The main ones are mortgage interest, state and local taxes,

and charitable contributions. If you add all those things up and they come to

more than your standard deduction ($4,750 in my case), then you should itemize.

Most people, however, don’t. Since I don’t have a mortgage and I paid much less

than $4,750 in state and local taxes, I was better off taking the standard deduction,

even after accounting for my stunning generosity to sundry charities.

All of which raises another question, however. If people stop being able to

deduct state and local taxes on their federal tax returns, more of them will

take the standard deduction instead. So while the LA Times says that "the

deduction is valued at $46 billion" this year, it’s not clear whether that

number represents the total amount of state and local taxes deducted from federal

tax returns, or whether it represents the amount of money that the federal government

would receive if the deduction was abolished.

What’s more, it certainly seems that New York City officials are being alarmist,

not for the first time.

What with all the other deductions people can take, and the continued existence

of the standard deduction, I simply can’t imagine that New Yorkers would pay

the IRS 11% more if the state and local tax deduction is abolished. I, for instance,

along with 63% of other New Yorkers, wouldn’t see my federal income tax rise

at all. But as ever, when it comes to questions about taxes, reporters tend

to find it much easier to quote duelling officials than to uncover the actual

truth of the matter.


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