The 3 Big Limitations with Itemized Deductions
By: Tom Wheelwright | Posted: 18th July 2009
There has been a lot of talk recently about itemized deductions. Itemized deductions are the deductions you can claim for certain personal expenses, such as, taxes, interest, charitable donations and investment expenses.
The big discussion right now centers on President Obama's proposal to limit itemized deductions to the 28% tax bracket. This means it would provide at most a 28% tax benefit - even if you are in the 35% tax bracket!
Limit #1: The Floors There are "floors" applied to itemized deductions that limit the amount that is ultimately deducted.
A floor is a minimum amount of deductions that you have to have before you begin receiving any benefits. This means you only receive a benefit for the amount of deductions you have above the floor.
There are two types of itemized deductions that have floors.
The first floor applies to medical expenses. This floor is equal to 7.5% of your adjusted gross income (AGI) which can be found on the first page of your tax return.
Example: If your AGI is $100,000, then you don't get to deduct the first $7,500 of your medical expenses.
The second floor applies to miscellaneous itemized deductions. This includes job expenses, investment expenses and, for many people, tax return preparation and planning fees. This floor is 2% of AGI.
Example: With $100,000 of AGI, the first $2,000 of miscellaneous itemized deductions is not deductible.
Limit #2: Alternative Minimum Tax The second limit on itemized deductions is the Alternative Minimum Tax, or AMT. The AMT is an alternative tax calculation to the regular income tax. If your tax calculated under AMT is higher than your tax calculated under the regular calculation, you pay the higher AMT amount.
There are several differences in how they are calculated under AMT. Taxes and miscellaneous itemized deductions are not allowed as itemized deductions under AMT. The floor for medical deductions under AMT is increased to 10% from 7.5%. Plus, there is a limitation on home mortgage interest under AMT. All of these differences limit even further. Often times, those in AMT are in it because of these differences in how they are calculated.
Limit #3: Limit on Total Itemized Deductions The third limit on is a little more complex. Once your income reaches a certain level, your itemized deductions are reduced by 3% of the amount your income exceeds this level. The current level is $166,800 for most people.
Example: If your AGI is $20,000 more than the current level, your itemized deductions are reduced by $600 ($20,000 excess x 3%). There is a cap on this reduction, so that nobody has their itemized deductions reduced by more than 80% - which still leaves 20% available to chop off!
This limit is phasing out under current law and is scheduled to entirely phase out at the end of 2009.
What Can You Do About These Limits on Itemized Deductions? Whether you are currently limited or would be under President Obama's new proposal, there is something you can do to legally avoid these limitations.
Here it is:
Do everything you can to change your deductions from itemized deductions to business deductions. Business deductions are not limited!
Take tax planning fees as an example. If the fees are for your business, they can (and should) be deducted as a business expense. Deducting them as a business expense avoids all of the itemized deduction limitations. If you receive a bill for tax planning fees that includes both personal and business tax planning, ask your vendor to split the bill into two bills - one for the business portion and one for personal portion.
Look at Your Tax Return Look at the last personal tax return you filed. Go to Schedule A, which is the form where itemized deductions are reported, and look for the following items:
Are there any deductions that were really business expenses? If so, you may want to consider amending your tax return.
Are there any deductions that can qualify as business expenses in future years? If so, start working on qualifying them now! The sooner you can qualify them as business expenses, the sooner you will avoid the limitations on itemized deductions and reduce your taxes!
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Itemized deductions being limited isn't just an issue with the proposal, it is an issue with the current tax law! While itemized deductions are often perceived as a great way to reduce taxes, there are several limitations placed on itemized deductions that minimize their effectiveness to reduce taxes.
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Tags: job, tax bracket, proposal, medical expenses, charitable donations, income tax, adjusted gross income, personal expenses, alternative minimum tax, tax benefit, tax return preparation, obama