Why Trump tax deductions — for tips, car loans and more — may not carry large benefits for low earners

CNBC

11 hours ago

Tax cuts are the centerpiece of a massive legislative package championed by President Trump and passed Tuesday by Senate Republicans.
Many new tax breaks in the bill — on auto loans, tips and overtime pay, and for older Americans — are structured as tax deductions.
How much money you save with tax deductions, which reduce your taxable income, depends on your bracket. Deductions are more valuable to higher-income households and less beneficial for lower earners, experts said.
"The most modest-income workers can't use a tax deduction at all," said Carl Davis, research director of the Institute on Taxation and Economic Policy, a left-leaning policy think tank.
Senate Republicans passed the legislation with the narrowest of margins on Tuesday. It now heads to the House, where its fate is uncertain.
The Republican bill, originally called the One Big Beautiful Bill Act, has more than $4 trillion of net tax cuts, according to the Committee for a Responsible Federal Budget.
Among them are several new tax deductions:
If enacted as drafted, these deductions would be temporary, available from 2025 through 2028. They also carry various limitations such as income restrictions.
A tax deduction reduces the amount of income that's subject to tax, i.e., taxable income. You can find your taxable income on line 15 of your Form 1040 individual income tax return.
While the proposed tax deductions may sound large, there are a few reasons why low earners may not see much or any benefit, experts said.
Households need some taxable income to benefit from a deduction, said Garrett Watson, director of policy analysis at the Tax Foundation.
Low earners already get a large financial benefit from the standard deduction, Watson said.
The standard deduction is worth up to $15,000 for singles and $30,000 for married couples filing jointly in 2025. (If the bill passes as drafted, it would raise the standard deduction to $15,750 for single filers, and to $31,500 for married filing jointly.)
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To get a financial benefit from the new tax deductions for car loans, seniors, tips and overtime, a household's taxable income would have to exceed these thresholds, experts said.
More than a third, or 37%, of tipped workers in 2022 had incomes low enough that they didn't owe federal income tax, according to an analysis last year by the Budget Lab at Yale University.
That means a "meaningful share" of tipped workers wouldn't benefit from a tax deduction on tips, it said.
The relative value of tax deductions depends on a household's tax bracket, experts said.
There are seven federal income-tax brackets: 10%, 12%, 22%, 24%, 32%, 35% and 37%. Higher-income households generally fall in a higher tax bracket — any therefore can get a bigger benefit from reducing their taxable income.
"If you're in a somewhat higher bracket, every dollar you get to deduct is worth more to you because that dollar would have been taxed at a higher rate," Davis said.
Let's say two households — one in the 22% bracket and one in the 10% bracket — each deduct $1 of tipped income. The former gets a tax benefit worth 22 cents, while the latter gets one worth 10 cents, Davis said.
There are other reasons why households may not be able to max out certain deductions.
For example, households would need a car loan of roughly $112,000 or more to generate $10,000 of annual interest on a typical six-year loan, Jonathan Smoke, chief economist at Cox Automotive, an auto market research firm, told CNBC last month.
Only about 1% of new auto loans are this big, according to Cox Automotive data.
By comparison, the average new car buyer would be able to deduct $3,000 of interest from their taxable income in the first year of their loan, Smoke said. A deduction of that size would yield an average total tax benefit of about $500 or less in the loan's first year, he said.
There are, however, two elements of the tax breaks that seek to better target benefits to low- and middle- income households.
For one, they're all what's known as "above-the-line" deductions.
This means households can claim them regardless of whether they use the standard deduction or itemize their deductions.
High-income households may be more likely to itemize, meaning they detail a list of eligible deductions on their tax return.
Taxpayers itemize when the deductions add up to more than the standard deduction. Some deductions are only available to taxpayers who itemize, such as for "SALT" (or, a deduction for state and local income taxes and property taxes) or mortgage interest.
Also, the new deductions have income limits, barring them from the highest-income households.
For example, the overtime deduction's value starts to decline once an individual's income exceeds $150,000 ($300,000 for married couples filing jointly). The value of the senior "bonus" falls once income exceeds $75,000 ($150,000 if married and filing jointly).
Tax credits are another mechanism to lower a household's tax bill.
A tax credit reduces your tax liability dollar-for-dollar. (If you claim a $1,000 credit, it can reduce your tax bill by $1,000.) Credits have the same dollar value regardless of your tax bracket.
Unlike deductions, the "benefits from tax credits are skewed toward lower- and middle-income households," the Congressional Budget Office wrote in 2021.
Credits can be "refundable" or "nonrefundable":
The largest credits for individuals as measured by total government outlay are the child tax credit, earned income tax credit and the premium tax credit for health insurance, CBO said.
The Senate legislation would permanently raise the maximum child tax credit to $2,200 starting in 2025, and would index this figure for inflation starting in 2026. The credit is partially refundable: Low earners can get up to $1,700 as a tax refund.
But currently, 17 million children do not receive the full $2,000 child tax credit because their families don't earn enough and owe enough taxes, according to the Center on Budget and Policy Priorities.