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Itemized Deductions-Reductions for High Income Taxpayers (MS Word)

Itemized Deductions-Reductions for High Income Taxpayers (.pdf)

 

Itemized Deductions—Reductions for High-Income Taxpayers

Dear Reader:

You have asked me why the total itemized deduction amount shown on your return is less than the sum of the individual deduction amounts. For example, how can you have $10,000 in mortgage interest deductions, $10,000 in state and local taxes, and $7,000 in charitable contributions, and wind up with an itemized deduction less than $27,000.

This can occur because total itemized deductions are reduced for taxpayers with adjusted gross income (AGI) above specified levels. The general rule is that certain itemized deductions are reduced by 3% of the amount by which your AGI exceeds $159,950 in 2008 ($166,800 for 2009). (The threshold AGI amount increases each year to reflect inflation. For married taxpayers filing separately, the threshold amount is half the regular figure: $79,975 in 2008 ($83,400 in 2009).

There are several limitations that make the reduction rule (also referred to as the “Pease limitation”) less onerous:

(1) Certain itemized deductions aren't subject to the reduction rules and will always be fully deductible. These “protected” deductions are medical expenses, investment interest, casualty and theft losses, and gambling losses.

(2) No matter how high your AGI is, you will never lose more than 80% of your other (unprotected) itemized deduction total. That is, you will always be allowed to deduct at least 20% of these itemized deductions.

These rules can be expressed as a formula as follows: Your itemized deductions will be reduced by the lesser of;

3% of the excess of AGI above the threshold amount, or

80% of the itemized deductions subject to the reduction rules.

But the applicable overall limitation on itemized deductions is itself reduced. Specifically, for 2008 and 2009, the overall limitation amount is one-third of the otherwise applicable limitation amount, so that the overall limit is reduced by two-thirds.

Example. For 2008, Larry had the following itemized deductions: $10,000 mortgage interest, $12,000 state and local property and income taxes, and $5,000 in charitable deductions, for a total of $27,000, all “unprotected” from the reduction rules. Larry's AGI is $199,950, which is $40,000 above the threshold for 2008. His itemized deductions for the year would be reduced by $1,200. This is the $27,000 total reduced by the lesser of:

(a) $1,200 (3% of $40,000), or

(b) $21,600 (80% of $27,000).

However, given the two-thirds reduction of the overall limitation for 2008, Larry would only have to reduce his itemized deductions by $400 ($1,200 × 1/3 = $400). So, his total itemized deductions for 2008 would be $26,600 ($27,000 − $400).

Please call if you would like us to assist you in determining the impact of these rules on your tax situation or wish to discuss this area further.