Weekly SSRN Tax Article Review And Roundup: Layser Reviews Field’s Taxpayer Choices, Itemized Deductions, And The Federal And State Tax Systems

This week, Michelle Layser (Illinois; Google Scholar) reviews Heather M. Field (UC Hastings; Google Scholar), Taxpayer Choices, Itemized Deductions, and the Relationship Between the Federal & State Tax Systems, 13 Col. J.Tax L. __ (forthcoming 2021).

Some of most significant changes implemented under the Tax Cuts & Jobs Act of 2017 (the “TCJA”) were an increased standard deduction and the scaling back of several itemized deductions. Together, the anticipated impact of these changes was to dramatically reduce the number of taxpayers who report itemized deductions on their tax returns. Proponents touted these changes as a simplification measure. But how well did it work?

In a new article, Professor Heather Field provides empirical evidence to suggest that itemization rates fell considerably more in some states than others, and in some states, the TCJA may have even complicated tax filing more than it simplified it. Field demonstrates that these geographic disparities can be traced to states’ different approaches to conformity with federal law. Not only do these findings have important implications for how we understand the impact of the TCJA, but they also show how state law can interact with federal law in ways that undermine federal policy.

Field’s article begins with a review of the changes made under the TCJA. The TCJA “roughly doubled” the standard deduction for both single and married taxpayers, and it scaled back several common itemized deductions, including the deduction for state and local taxes and the mortgage interest deduction. Since taxpayers nearly always claim the larger of the standard deduction or their total itemized deductions, these changes were expected to—and did in fact—reduce the number of taxpayers filing itemized returns.

The most commonly stated policy goal for these changes was simplification. In theory, a decline in itemization rates could serve as a proxy for compliance simplification. But Field pushes back on the simplification narrative, especially from the perspective of the taxpayer. She acknowledges that lower itemization rates do increase administrative simplicity for tax authorities. There were “almost 30 million fewer Schedule A forms that needed to be processed in 2018 as compared to 2017,” which means there were far fewer itemized returns to process and audit. This may be a positive outcome, as it represents “a real decline in the IRS resources spent administering one part of the individual income tax.”

However, Field argues that it is less clear how much the TCJA simplified compliance burdens for taxpayers. For one thing, “taxpayers still ‘have to do the math to determine if they should itemize,’ meaning that much of the simplification benefit of switching to the standard deduction would be ‘illusory.’” Meanwhile, some taxpayers may have to keep records and plan transactions as if they will itemize, just in case they and up needing to. So, even theoretically, reductions in itemization rates are “only a weak proxy for the simplifying effect.”

In practice, the relationship between itemization choices and simplicity may be even murkier. Field’s empirical research suggests that taxpayers’ itemization decisions are not only a reaction to federal law, but also to state law. After the TCJA was enacted, some states increased their state-level standard deductions to match the larger federal deduction, but not all of them. Some states permit taxpayers to make different deduction elections (standard vs. itemized) on their state and federal tax returns, but not all of them. Field exploits these differences among state tax regimes to analyze how state law has affected itemization rates under the new federal law.

Consider, for example, the state of Oregon. Under Oregon law, taxpayers are allowed to make independent itemization elections, whereby they itemize on one return but not the other. Oregon’s conformity rules incorporated some of the new limits to itemized deductions, but the state did not significantly increase the size of its standard deduction. For this reason, one might expect that many Oregon taxpayers would choose to claim the standard deduction for federal purposes, but not for state purposes. Field’s analysis of 2017 and 2018 tax filings confirms this expectation. Her analysis reveals that “more than 90% of Oregon taxpayers who switched to the federal standard deduction . . . continued to itemize for Oregon state purposes.” The TCJA arguably did little to simplify compliance for those taxpayers—and it may have even complicated compliance for them by creating conflicting deduction preferences.

Meanwhile, some states require “itemization election uniformity,” whereby taxpayers must make the same election for state and federal purposes. Practically speaking, taxpayers should choose the approach that yields the lowest net tax burden (i.e., taxpayers should either itemize both returns or apply the standard deduction to both, depending on the math). The IRS “declined to gather and provide the data” to analyze how often taxpayers opted to itemize for federal purposes even though the standard deduction exceeded their federal itemized deductions. Nevertheless, Field demonstrates through hypothetical models that at least some taxpayers “who might have preferred to take the federal standard deduction in 2018 . . . opted to itemize instead because of the value to them of itemizing for state purposes.” With respect to those taxpayers, state law may undermine the federal policy of encouraging the standard deduction.

Field’s research shows that states’ itemization election uniformity rules have likely affected the impact of the TCJA, and whether taxpayers have benefited from simplification has varied across states. Field further argues that similar analyses can be made for many other tax elections. For this reason, she recommends that “federal policymakers should consider how states’ tax election uniformity rules might advance or hinder” the federal policy objectives of any federal tax law change. I agree that, in most cases, it is probably undesirable for state tax regimes to undermine federal tax policy goals. However, I also wonder whether there may be some examples when the opposite is true. To the extent that federal law may be inefficient, inequitable, or needlessly complex, it seems possible that state law may sometimes serve to counteract those failed federal policies.

This article provides an excellent case study of the interaction of federal and state tax law, and it should be of interest to any tax scholar focused on tax compliance, procedure and administration, state and local taxation, or geography and tax law.

Here’s the rest of this week’s roundup:

• Steven Z. Hodaszy (Robert Morris), ETFs Use Section 852(b)(6) for Tax Avoidance, Not Just Tax Deferral: So Why Is This Loophole Still Open?, 75 The Tax Lawyer (forthcoming 2022).
• Leopoldo Parada (Leeds), Hybrid Financial Instruments and Anti-Hybrid Rules in the EU ATAD, in: W. Haslehner, K. Pantazatou, G. Kofler and A. Rust, A Guide to the Anti-Tax Avoidance Directive (Edward Elgar, 2020).
• Teresa Pidduck (Pretoria) & Sumarie Swanepoel (Pretoria), Sobering up in South Africa: The Sin Tax Consequences of a Pandemic, 72 New Zealand J. Tax’n L. & Pol’y 331 (2021).
• Peter Koerver Schmidt (Copenhagen - Business School), Jacob Graff Nielsen & Helle Vogt (Copenhagen - Law), How Taxation Shaped Danish History, Copenhagen Business School, CBS LAW Research Paper No. 21-11 (December 6, 2021).
• Ad van Doesum (Maastricht), Non-Payments in EU VAT Law, CJEU: Recent Developments in Value Added Tax 2021 (Linde 2022).