Tax Deductions: Estimates of Taxpayers Who May Have Overpaid	 
Federal Taxes by Not Itemizing (12-APR-01, GAO-01-529). 	 
								 
When computing their federal taxes, taxpayers either claim a	 
standard deduction or itemize deductions. In this report, GAO	 
estimated the number of taxpayers who may have overpaid their	 
taxes by claiming the standard deduction instead of itemizing	 
their deductions, as well as the amount of taxes they may have	 
overpaid. GAO found  that on about 510,000 tax year 1998	 
individual tax returns, taxpayers did not itemize their 	 
deductions yet had mortgage interest payments that exceeded the  
standard deduction amount for their tax filing status. These	 
taxpayers may have overpaid their taxes by about $311 million.	 
The average overpayment amount was $610 and about 35 percent of  
the taxpayers had overpaid their taxes by more than $500.	 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-01-529 					        
    ACCNO:   A00820						        
    TITLE:   Tax Deductions: Estimates of Taxpayers Who May Have      
             Overpaid Federal Taxes by Not Itemizing                          
     DATE:   04/12/2001 
  SUBJECT:   Federal taxes					 
	     Income taxes					 
	     Interest						 
	     Mortgage loans					 
	     Tax returns					 
	     Taxpayers						 
	     IRS Information Returns Master File		 

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GAO-01-529

Report to the Honorable Dick Armey, Majority Leader, House of
Representatives

United States General Accounting Office

GAO

April 2001 TAX DEDUCTIONS Estimates of Taxpayers Who May Have Overpaid
Federal Taxes by Not Itemizing

GAO- 01- 529

Page 1 GAO- 01- 529 Tax Deductions

April 12, 2001 The Honorable Dick Armey Majority Leader House of
Representatives

Dear Mr. Armey: When computing their federal taxes, taxpayers either claim a
standard deduction or itemize deductions. These deductions are subtracted
from adjusted gross income in determining taxable income. Taxpayers in
general claim the type of deduction that is larger because that minimizes
their taxable income. In recent years, approximately 70 percent of taxpayers
have claimed the standard deduction, while the remaining 30 percent have
itemized.

This report is our initial response to your request for an estimate of the
number of taxpayers who may have overpaid their taxes by claiming the
standard deduction instead of itemizing their deductions, as well as the
amount of taxes they may have overpaid. For this report, we estimated the
number of returns where taxpayers who claimed the standard deduction may
have had deductible mortgage interest expense in excess of their standard
deduction. We developed our estimate by matching data from different
Internal Revenue Service (IRS) databases.

We limited our estimate to itemizable mortgage interest because that was the
only type of itemizable expense for which data were readily available. Not
all mortgage interest payments can be claimed as itemized deductions. When
the data allowed, we excluded certain categories of mortgage interest
payments, such as interest on business mortgages, that may have been
nonitemizable. Because of data limitations, we had to exclude some mortgage
payments that likely were itemizable- to that extent our estimates are
understated. We attempted to identify and exclude the most common
nonitemizable mortgage interest payments. However, we could not exclude all
cases of nonitemizable mortgage interest- to that extent our estimates are
overstated. In a future report, we plan to do further estimates regarding
the number of taxpayers who had a broader range of

United States General Accounting Office Washington, DC 20548

Page 2 GAO- 01- 529 Tax Deductions

itemizable expenses, not just mortgage interest. 1 This will increase the
size of our estimate.

As agreed with your office, we did not attempt to determine the reasons why
taxpayers claimed the standard deduction when they might have paid less tax
had they itemized deductions.

We estimate that on about 510,000 tax year 1998 individual tax returns,
taxpayers did not itemize their deductions yet had mortgage interest
payments that exceeded the standard deduction amount for their tax filing
status. 2 We estimate these taxpayers may have overpaid their taxes by about
$311 million. The average overpayment amount was $610 and about 35 percent
of the taxpayers 3 had overpaid their taxes by more than $500. In oral
comments on this report, IRS officials stated that our methodology for
developing our estimates was reasonable.

The tax code allows taxpayers to subtract from gross income either a
standard deduction or certain itemized deductions. The standard deduction is
the sum of two components, the basic standard deduction and the additional
standard deduction for taxpayers that are age 65 or over and/ or blind. Both
the basic and additional standard deductions vary in amount, depending on
filing status. Basic and additional standard deduction amounts are set by
Congress and are adjusted annually for inflation.

Itemized deductions are specified personal and other expenses that Congress
has chosen to allow as deductions in arriving at taxable income. Deductible
personal expenses include certain of the taxpayer's interest payments, such
as mortgage interest and points, which are charges paid, or treated as paid,
by a borrower to obtain a home mortgage; certain

1 For example, other key itemizable deductions include state and local
taxes, property taxes and charitable contributions. 2 The five filing
statuses are single, married filing jointly, qualified widow( er) with
dependent child, head of household, and married filing separately. The
standard deduction amounts vary by filing status. For tax year 1998, the
basic standard deduction was $4, 250 for filing single, $7, 100 for married
filing jointly or as a qualified widow( er), $6,250 for head of household,
and $3, 550 for married filing separately.

3 95- percent confidence level: 30 to 40 percent. Results in Brief

Background

Page 3 GAO- 01- 529 Tax Deductions

nonfederal taxes, such as state and local income taxes, real estate taxes,
and personal property taxes; gifts to charity; medical and dental expenses;
and casualty and theft losses. Other deductible expenses include certain
payments related to the production or collection of income and expenses
related to the management of property held for the production of income.

Generally, a taxpayer is allowed to deduct the greater of itemized
deductions or the standard deduction. To minimize their tax liability,
taxpayers could compare their total standard deduction (the sum of their
basic standard deduction and any additional standard deductions) to their
total itemized deductions. If itemized deductions are less than their
standard deduction, taxpayers would compute taxable income using the
standard deduction. If their itemized deductions exceed the standard
deduction, taxpayers would compute taxable income by itemizing.

To estimate the number of taxpayers who potentially overpaid their taxes by
claiming the standard deduction instead of itemizing and the amount of taxes
they may have overpaid, we used IRS' Statistics of Income (SOI) data for tax
year 1998 (the most recent year for which data were available). The SOI data
consist of a random sample of about 164,000 individual returns filed in
1999, which is statistically representative of the 124.8 million tax year
1998 individual returns filed. To the sampled returns, we matched data from
IRS' Information Returns Master File, which contains data from the various
information returns, such as form 1098 for mortgage interest and form W- 2
for wages. We used this matched file to obtain mortgage interest payment
amounts for taxpayers in the sample who did not itemize their deductions.

We first identified the returns of all taxpayers in the SOI sample that did
not itemize their deductions but whose mortgage interest exceeded the
standard deduction available to them. We included only those taxpayers whose
mortgage interest alone exceeded their standard deduction because the
Information Returns Master File did not contain any data on taxpayers'
itemizable deductions other than mortgage interest payments. Thus, we could
not incorporate any of the other itemizable deductions- such as state and
local income taxes, real estate and personal property taxes, and gifts to
charities- in our estimates. Other taxpayers may also have overpaid their
taxes because their total deductible expenses may have exceeded their
standard deductions, but the data on expenses other than mortgage interest
were unavailable. Scope and

Methodology

Page 4 GAO- 01- 529 Tax Deductions

We attempted to identify and exclude from our sample the most common
situations in which mortgage interest could not be claimed as an itemized
deduction. We excluded:

? Returns with no tax liability. Because these filers had no tax liability,
there was no potential gain to them from itemizing deductions.

? Returns where the filing status was “married, filing
separately.” Taxpayers in this filing status are required to use the
same type of deductions as their spouse (i. e., if one spouse claimed the
standard deduction, the other must also). Some of these taxpayers may have
been required to claim the standard deduction because their spouse did so.
We did not have data on the filing status of their spouse, so we excluded
these taxpayers from our analysis.

? Returns where taxpayers reported mortgage interest on either their
Schedule C: Profit or Loss From Business, Schedule E: Supplemental Income
and Loss, or Schedule F: Profit or Loss From Farming. We assumed that all
the mortgage interest payments shown on these taxpayers' forms 1098 were for
business purposes and not for personal expenses. Thus our estimates of the
number of taxpayers who may have overpaid their taxes may be understated to
the extent that the mortgage interest payments were actually personal
expenses.

? Returns of taxpayers that were in the phase- out range for itemizing
deductions and who would not have lowered their taxes by itemizing. Certain
itemized deductions are subject to being phased out beginning at certain
levels of adjusted gross income. The income levels are $124,500 for filing
single; married, filing jointly; qualified widow( er) with dependent child;
and head of household; and $62,250 for married, filing separately, for tax
year 1998. The itemized deductions subject to phase- out are home mortgage
interest, including points; state and local income taxes; real estate and
personal property taxes; gifts to charities; unreimbursed employee expenses;
and some other itemizable expenses.

? Returns that later were amended by taxpayers. Because these taxpayers may
have itemized their deductions when they filed their amended return and we
did not have data to indicate which taxpayers did later itemize deductions,
we eliminated all returns that later were amended. Thus our estimates of the
number of taxpayers who may have overpaid their taxes may be understated to
the extent that

Page 5 GAO- 01- 529 Tax Deductions

taxpayers who filed amended returns did not later itemize their deductions.

In certain cases we were unable to exclude mortgage interest that may not
have been itemizable. To the extent that these cases included nonitemizable
mortgage interest payments, our estimates are overstated. Home mortgage
interest payments that we identified as not being fully itemizable, but
could not exclude from our estimates are:

? Interest payments on mortgage balances over $1 million, where the
mortgage( s) were used to acquire (that is, buy, build, or improve) the
residence( s). Although we could not exclude them, it is unlikely that our
sample included many such large mortgages. Less than one percent of the
returns that we projected to have overpaid taxes had associated mortgage
interest payments of $50,000 or more, which would be the interest payment on
a $1 million mortgage at an interest rate of 5 percent.

? Interest payments on home equity debt, where the mortgage totaled over the
lesser of $100,000 or the fair market value of the home, reduced by
acquisition indebtedness. The amount of such interest could be limited by
lending institutions.

? Interest payments on a third home. Taxpayers who meet this nondeductible
category generally would have to have three nonincome- producing homes. If
any of the three homes were used for business purposes, including rental
property, the mortgage interest payments would have been reported on the
taxpayers' Schedules C, E, or F. If so, they were already excluded from our
sample.

Our estimates may be affected by the accuracy of the form 1098 data we used.
We assumed that the data were accurate for both the amount of the mortgage
interest payments and the taxpayer that made the interest payments. If there
are any errors in the data, our estimates are overstated to the extent that
the mortgage interest amounts were overstated. Conversely, our estimates are
understated to the extent that the mortgage interest amounts are
understated. Also, if there are any taxpayers whose names and Social
Security numbers appear on the forms 1098 who were not the persons legally
entitled to claim a mortgage interest deduction, our estimates may be
overstated.

All sample results in this report have been weighted to reflect the entire
population and are subject to sampling error. Unless otherwise indicated,

Page 6 GAO- 01- 529 Tax Deductions

all estimates are surrounded by a 95- percent confidence interval. The
confidence interval ranges are shown in tables 1 and 2. We did our work in
March and April of 2001 in accordance with generally accepted government
auditing standards.

We requested and received oral comments from the Director of SOI and other
SOI staff on a draft of this report. They stated that the methodology we
used for developing our estimates was reasonable.

For tax year 1998, taxpayers filed over 124 million tax returns. On almost
86 million, or about 70 percent of these returns, taxpayers claimed the
standard deduction. On the remaining 38 million, or about 30 percent, they
itemized their deductions. Of the 86 million returns claiming the standard
deduction, we estimate that on about 510,000 returns, taxpayers may have
reduced their taxes if they had itemized deductions, as shown in table 1.
Mortgage Interest

Payments Exceeded the Standard Deduction for Some Taxpayers Who Did Not
Itemize

Page 7 GAO- 01- 529 Tax Deductions

Table 1: Estimated Number of Returns Where Taxpayers May Have Overpaid Their
Taxes Because Their Mortgage Interest Payments Exceeded the Standard
Deduction, Tax Year 1998

Returns Return category Estimated

number Percent of total

95- percent confidence interval

Total returns 124,770,662 100.0 Returns where taxpayer claimed the standard
deduction (i. e., did not itemize) 85,576,463 68.6 85,257,168 to 85,895,758
Returns claiming standard deduction and mortgage interest exceeded the
standard deduction 1,533,346 1.2 1, 467,546 to 1, 601, 308

excluding returns without a positive tax liability 1, 153,643 1.0 1, 096,581
to 1, 212, 883 excluding returns with filing status “married, filing
separately” 1,009,963 0.9 956,590 to 1,065,519 excluding returns where
taxpayers reported mortgage interest on their Schedule C, E, or F

543,416 0. 5 504,387 to 584,653 excluding returns where taxpayers in the
phase- out range for itemizing

deductions could not have lowered their taxes by itemizing 529,526 0. 4
491,000 to 570,262

excluding returns later amended by the taxpayer equals estimated number of
returns where taxpayers may have overpaid their taxes

510,072 0. 4 472,274 to 550,081 Source: GAO analysis of SOI and other IRS
data.

We estimated that these taxpayers may have overpaid their 1998 taxes by
about $311 million. The average overpaid tax amount is $610. On about 35
percent of returns, taxpayers may have overpaid their taxes by more than
$500, as shown in table 2.

Table 2: Distribution of Returns Where Taxpayers May Have Overpaid Their
Taxes Because Their Mortgage Interest Payments Exceeded the Standard
Deduction, Tax Year 1998

Returns Distribution of overpaid tax Estimated

number Percent

of total 95- percent

confidence interval

$1 to $100 97,986 19.2 80,791 to 117,065 $101 to $250 113,149 22.2 94,904 to
133,065 $251 to $500 120,385 23.6 101,691 to 140,676 $501 to $1, 000 109,535
21.5 91,523 to 129,248 $1,001 to $5,000 63,083 12.4 49,002 to 79,513 Over
$5,000 5,934 1.2 2, 059 to 13, 106

Total 510,072 100.0 472,274 to 550,081

Note: Totals may not sum because of rounding. Source: GAO analysis of SOI
and other IRS data.

Page 8 GAO- 01- 529 Tax Deductions

As agreed with your office, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days from
the date of this letter. At that time, we will send copies to Representative
William Thomas, Chairman, and Representative Charles B. Rangel, Ranking
Minority Member, House Committee on Ways and Means; Senator Charles E.
Grassley, Chairman, and Senator Max Baucus, Ranking Member, Senate Finance
Committee; Representative Amo Houghton, Chairman, and Representative William
J. Coyne, Ranking Minority Member, Subcommittee on Oversight, House
Committee on Ways and Means; and the Honorable Charles O. Rossotti,
Commissioner of Internal Revenue. We will also make copies available to
others upon request.

If you have any questions regarding this report, please contact me at (202)
512- 9110 or Ralph Block at (415) 904- 2150. The major contributors to this
report were John Mingus and Anne Stevens.

Sincerely yours, James R. White Director, Tax Issues

(440031)

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