Until enactment of the One Big Beautiful Bill Act, officially P.L. 119-21, the availability of a below-the-line deduction that was not the standard deduction or an itemized deduction was a rare event. It was usually done for a specific policy reason related to the particular deduction.
The Tax Cuts and Jobs Act gave us the Code Sec. 199 Qualified Business Income Deduction. The QBI deduction was designed to provide to pass-through entities a benefit similar to the corporate tax cut under the TCJA. In order to maintain parity with the corporate tax cut, it was decided that the QBI deduction should be below the line to prevent adjustments to other adjusted gross income-based deductions and credits from upsetting the parity that the QBI deduction was trying to achieve
The QBI deduction replaced the domestic production activity deduction. DPAD was in a similar way designed to focus on promoting domestic manufacturing, production and construction. The below-the-line deduction was intended to keep the focus on business and not provide an incidental personal benefit through a reduction in adjusted gross income.
Over the years, certain disaster-related deductions were also set up as below-the-line deductions, usually on a temporary basis. The most recent example of a new below-the-line deduction before the OBBBA was the charitable deduction for non-itemizers enacted during COVID. The CARES Act created a $300 above-the-line charitable deduction for non-itemizers.
In the Consolidated Appropriations Act the next year, the charitable deduction for non-itemizers was changed to not only add a $600 deduction for joint filers but also change the deduction from an above-the-line deduction to a below-the-line deduction. The motive for this change appears to be primarily the budgetary impact of the change, rather than some change in the policy view concerning charitable deductions for non-itemizers.
The OBBBA seems to now have made the exception into the rule. Each of the new deductions in the OBBBA — the tips deduction, the overtime deduction, the senior deduction, the car loan interest deduction, and the new charitable contribution deduction for non-itemizers — is a below-the-line deduction. The motive here, like for the $600 below-the-line deduction enacted for 2021, appears to be primarily based on budgetary concerns, rather than policy concerns.
Four of the five OBBBA deductions are allowed for both itemizers and non-itemizers: the tips deduction, the overtime deduction, the senior deduction, and the auto loan interest deduction. The new $1,000 charitable deduction for non-itemizers is logically limited to non-itemizers since itemizers already have the itemized charitable deduction. Although interestingly, and also probably motivated primarily by budgetary concerns, the OBBBA also includes a new 0.5% floor on itemized charitable contribution deductions, creating a new limit on itemized charitable deductions at the same time the OBBBA was creating a new charitable deduction for non-itemizers.
The broader impact of below-the-line deductions
Part of the motive for the move toward below-the-line deductions separate from itemized deductions is likely the fact that so few taxpayers take itemized deductions currently. When the standard deduction was increased in the TCJA, the percentage of individual taxpayers claiming itemized deductions fell to around 10%.
Before the TCJA, the percentage of individual taxpayers claiming itemized deductions was closer to 30%. The increase in the state and local tax deduction limit in the OBBBA and adding a new miscellaneous itemized deduction for education-related expenses could increase the percentage of itemized deduction filers.
Even before the standard deduction was increased in the TCJA, itemized deductions were only benefiting around 30% of taxpayers. Therefore, if Congress wants a new deduction to have an impact on a large segment of taxpayers, particularly lower-income taxpayers, itemized deductions are not the way to go.
If Congress is providing significant new deductions such as the tips deduction, the overtime deduction, and the senior deduction, making those deductions above-the-line deductions could have a significant impact, lowering adjusted gross income and making taxpayers eligible for preexisting tax breaks to which they otherwise would not have been entitled. This could significantly increase the projected cost of these provisions beyond the cost of the provision alone. Such budgetary considerations make a below-the-line deduction relatively attractive for budgeting purposes.
Up until now, these one-off below-the-line deductions have appeared as separate lines directly on Form 1040. Now that we have so many below-the-line deductions, it is likely that the IRS will create a new Form 1040 schedule to address them. Each deduction is likely to be a separate part of the schedule. The schedule is likely to include a modified AGI phase-out calculator for each of the deductions subject to phase-outs, a requirement for occupation codes for individuals claiming the tips or overtime deduction, a Vehicle Identification Number and other purchase details for the auto loan interest deduction, and perhaps even age verification for the senior deduction, although the IRS computers seem to already possess information on the age of taxpayers.
The form of tax breaks that Congress chooses to enact tends to shift in popularity from time to time. For a while, it was to continue to add to the list of itemized deductions. Then, for a while, it was the tax credit, to get a dollar-for-dollar benefit regardless of the tax bracket. Then, the above-the-line deduction became the popular area for new tax breaks to help taxpayers reduce AGI. Next, the refundable credit had a period of popularity to help taxpayers who otherwise could not benefit, since they owed no income taxes. The TCJA made a significant increase in the standard deduction, benefiting taxpayers already taking the standard deduction and at least simplifying life for taxpayers who were now better off with the standard deduction than itemizing.
Now, we have an impressive list of below-the-line deductions from the OBBBA — available to taxpayers whether or not they itemize but restricting side benefits from other tax breaks that might have been enhanced or made available by a reduced AGI. We thought we might get tax exclusions for tips, overtime and Social Security benefits.
Instead, the realities of the budget reconciliation process requirements left us to deal with these new below-the-line deductions and new sets of calculations to see if a taxpayer can really qualify for them. Exclusions might have meant simplification. These new below-the-line deductions do not.
