Higher-income individuals whose adjusted gross income (AGI) exceeds specified thresholds must reduce their itemized deductions that are otherwise allowed on their return. This reduction in itemized deductions did not apply to tax years 2010-2012, but has been reinstated, beginning in 2013. The provision does not apply to estates and trusts.
Under the Pease limitation (named for the Congressman who developed it), itemized deductions are reduced by the lesser of:
- Three percent of the taxpayer’s AGI in excess of the applicable threshold, or
- 80 percent of the itemized deductions otherwise allowable.
The thresholds increase for inflation every year. The thresholds for the 2014 tax year are:
- $305,050 for married taxpayers filing joint returns and surviving spouses;
- $279,650 for heads of household;
- $254,200 for other single taxpayers; and
- $152,525 for married filing separately.
The respective inflation-adjusted thresholds for 2015 are projected to be: $309,900; $284,050; $258,250; and $154,950.
In calculating the reduction, other limitations are applied first, such as the two percent floor for miscellaneous itemized deductions and the floor for medical expenses. However, the term “itemized deductions” does not include deductions for medical expenses, investment interest, casualty or theft loss, and allowable wagering losses. Thus, these latter amounts are not subject to the reduction.
Example. For 2014, married taxpayers report AGI of $355,050, or $50,000 over the applicable threshold of $300,000. They have itemized deductions of $15,000 for taxes and charitable contributions, plus $2,000 in medical expenses, for a total of $17,000. The first reduction (based on three percent of excess AGI) is ($355,050 – $305,050) x .03, or $1,500. The alternative reduction (80 percent cap) is .80 x $15,000 (medical expenses excluded), or $12,000. Since the lesser amount is $1,500, allowable itemized deductions are reduced from $17,000 to $15,500.