Itemized deduction differences relative to TAXSIM35

[martinholmer]

This topic discusses tax differences between PolicyEngine-US and TAXSIM35 when itemized deduction logic is active. This explanation assumes the reader has read discussion topic #2389 on the methods used to generate differences and has reviewed the most recent results in issue #993.

A number of states have income tax laws that require a taxpayer to use on the state form the same itemization method as the taxpayer uses on the federal form. Given such a state rule, it can pay to itemize on the federal form (paying somewhat higher federal taxes than if not itemizing) if the state rules on itemized deductions are such that itemizing on the state form reduces state taxes by more than the increase in federal tax.

Both TAXSIM35 and the PolicyEngine-US test script (when operating in the optional loop mode) attempt to make the federal itemization decision that minimizes the sum of federal and state income tax liability. So, for example, TAXSIM35 will sometimes print out the following message:

This taxpayer reduced the sum of federal and
state income tax by itemizing, despite having
few deductions to claim.

However, there appears to be a problem with the TAXSIM35 code that implements this tax minimization procedure. It appears as if TAXSIM35 does not always correctly recompute the federal tax when it is comparing the sum of federal and state income taxes in the two situations (that is, itemizing on the federal form and not itemizing on the federal form). In such a case, TAXSIM35 can sometimes produce an incorrect federal itemization decision.

We have not yet been able to locate and correct this problem in the TAXSIM35 source code. All the evidence gathered so far does point to this being a TAXSIM35 problem. Evidence supporting that view is the fact that when replacing the self-employment income in the k21 test sample with wage income in the m21 sample produces no tax differences for the states listed below. This suggests that the TAXSIM35 problem may be related to the calculation of the qualified business income deduction in the presence of itemized deductions.

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STATE    k21 DIFFS    m21 DIFFS
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 DC          40            0
 GA          23            0
 MD          35            0
 ME           2            0
 MO          50            0
 NE          17            0
 NM          88            0
 OK          12            0
 VA          50            0
-------------------------------