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July 23, 2004

Deduction Thresholds and Tax Recordkeeping

It's now 4 a.m. I was awakened by my 4-year-old's crying over a bad dream or something and can't get back to sleep after calming her down, because I have such exciting ideas about tax law stimulated by our excellent weekly law-and-econ lunch from yesterday. Here's a question that came up that might be worth formal modelling.

Current U.S. tax law lets me itemize and deduct certain things only to the extent that they exceed a threshold percentage of my adjusted gross income.

For example, I think I can deduct Unreimbursed Employee Business Expenses only to the extent that they exceed 2% of income (I might be wrong on the threshold, so take this as a hypothetical if you like). This is supposed to reduce record- keeping, because if I have such expenses that only add up to 1% of income, there is no point in keeping such records.

I suggested that this ought to apply to expenses deducted in calculating Self Employment Income, an "above the line item" too. While we agreed that it was hard to say why Employee and Self-Employment expenses should be treated differently (except for maybe making it harder to deduct *Self-Employment* expenses, since it's easier to cheat when no employer is involved), the question came up of whether the difference really means that there is less incentive to keep records for Employee expenses. The doubt arises because this is not like partial deductibility when, say, 98% of expenses are deductible instead of 100%. That certainly reduces the incentive to keep records, if only slightly. Instead, it is a threshold. Suppose my income is $100,000 and my Employee expenses are $9,000. I can deduct $7,000 of that, but only if I keep records for the entire $9,000 of expenses, including the first $2,000. Moreover, do we really need to worry about wasteful record keeping by someone who has $100,000 in income but only $1,000 in Employee expenses? That person will only keep the records if the cost of doing so does not exceed the benefit he receives.

So there's the question-- is reduced record keeping really a good motivation? I'll not try answering it now.

Posted by erasmuse at July 23, 2004 05:17 AM

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