One of the impacts from the fiscal cliff legislation to be felt by high-income earners is the reintroduction of the Pease limitation, reduces the amount of itemized deductions that certain taxpayers are allowed. While the American Taxpayer Relief Act of 2012 reduced the impact of the Pease Limitation, it is still around, and it can greatly limit itemized deductions like mortgage interest and charitable gifts.
The infamous Pease limitation was first incorporated into the Omnibus Budget Reconciliation Act of 1990 and it is named after former Congressman Donald Pease. The purpose of the Pease limitation was to raise revenue by limiting some popular and common itemized deductions among high-income earners. Pease limitations aim to reduce the benefit of the following itemized deductions:
- Charitable Contributions
- Mortgage Interest
- State, Local, and Property Taxes
- Miscellaneous Itemized Deductions
The limitation for 2013 will kick in on AGI levels that exceed $300,000 for joint filers and $250,000 for individuals, indexed for inflation. Income over the applicable amount will trigger an itemized deduction limitation that is the lesser of (a) 3% of the adjusted gross income above the applicable amount, or (b) 80% of the amount of the itemized deductions otherwise allowable for the taxable year.
It should be noted that the Pease limitation doesn’t apply to medical expense deductions, the investment interest deduction, casualty, theft, or gambling loss deductions. That said, most of these exempted deductions are not very common or they are difficult to qualify for due to their high AGI hurdles. As an example, deductions for medical expenses only apply to qualified medical expenses over 10% of an individual’s AGI in 2013.
While most people are fixated on tax rate increases adding to their income tax bill in 2013 and beyond, very few people are aware that the Pease limitation reinstatement can add to their income tax bills by phasing out some key itemized deductions.