How the ‘Pease Rule’ Impacts Itemized Deductions
One of the tax reform ideas being batted around in Washington is a curb or repeal of certain itemized deductions.
For example, President Trump has proposed a dollar limit on all itemized deductions of $100,000 for single filers and $200,000 for joint filers. Taking another tack, House Republican leaders have pledged to eliminate most itemized deductions, other than the “sacred cows” of mortgage interest and charitable contributions.
It remains to be seen how this will play out once Congress gets down to business. However, for the time being, taxpayers must still contend with the “Pease rule,” which reduces itemized deductions for high-income individuals. This rule was named after Ohio Congressman Donald Pease who introduced the tax law provision into legislation.
Here’s how it works in a nutshell: Generally, you can use the full amount of your itemized deductions claimed on Schedule A of Form 1040 to offset your annual tax liability. However, under the Pease rule, most itemized deductions are reduced by 3 percent of the amount exceeding an adjusted gross income (AGI) threshold, but not by more than 80 percent overall.
The thresholds for 2016 returns are $259,400 of AGI for single filers and $311,300 for joint filers. For 2017, the thresholds increase to $261,500 and $313,800 of AGI, respectively.
For instance, suppose a taxpayer has an AGI of $200,000 above the annual threshold and claims $50,000 in itemized deductions subject to the Pease rule. As a result, the taxpayer’s itemized deductions must be reduced by $6,000 (3 percent of the $200,000 excess AGI), so he or she can deduct only $44,000 rather than $50,000. Note that the 80 percent limit only affects the upper crust.
This tax rule applies to itemized deductions that aren’t subject to some other built-in tax return limit or floor, including potential big-dollar deductions for mortgage interest, charitable contributions, and state and local income taxes. But it doesn’t apply to medical and dental expenses, investment interest expenses, and casualty and theft losses.
One anomaly: Although you can only deduct miscellaneous expenses in excess of a 2 percent-of-AGI floor, this deduction is still subject to the Pease rule.
If things stay the same, the Pease rule might impact decisions by clients during the year. For instance, if the deduction for a large charitable donation of property is reduced, the client may want to postpone the gift until next year. Similarly, some shifting may occur at year-end if a client has an AGI that’s higher or lower than expected.
The best overall strategy is to monitor the situation as the year progresses.
Of course, tax reform could render the Pease rule obsolete, especially if other restraints on itemized deductions are imposed. Advise your clients to adopt a wait-and-see attitude. If and when tax reforms are enacted, prompt action may be required, so your clients will likely be looking to you for guidance.
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Ken Berry, Esq., is a nationally known writer and editor specializing in tax, financial, and legal matters. During his long career, he has served as managing editor of a publisher of content-based marketing tools and vice president of an online continuing education company. As a freelance writer, Ken has authored thousands of articles for a...