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Pease Limitation on Itemized Deductions

THE ISSUE
The American Taxpayer Relief Act of 2012 reinstates the Pease provision, which will place limits on itemized deductions, including the charitable deduction, on incomes above a certain threshold.

The Pease limitation on itemized deductions, first instituted by the Omnibus Budget Reconciliation Act of 1990 and named after former Congressman Donald Pease (D-OH), reduces most itemized deductions by 3 percent of the amount by which adjusted gross income (AGI) exceeds a specified threshold. Itemized deductions cannot be reduced by more than 80 percent for any taxpayer. Under current law, the threshold is set at $300,000 for joint filers and $250,000 for individuals. Income under $300,000 for joint filers and $250,000 for individuals is not subject to the limitation.

As an income-based limitation, the Pease provision is intended to serve as a surtax on income above a certain threshold, rather than as a penalty on, or disincentive for, itemized deductions. Recent analyses by the Urban Institute Tax Policy Center and the Center on Budget and Policy Priorities have concluded that the Pease provision's impact on charitable giving would be negligible “because the dollar reduction in itemized deductions under Pease depends on a taxpayer’s income rather than on the amount he or she donates, Pease doesn’t affect decisions on whether to give more to charity.”

Examples of Impact (Joint Filers):

Example One

  • In 2013, a joint-filing couple has an AGI of $400,000 and $100,000 in itemized deductions ($30,000, or 30 percent, of which are charitable donations)
  • The income above the $300,000 threshold for joint filers must be calculated: $400,000 - $300,000 = $100,000 in excess income
  • The $100,000 excess income is multiplied by 3 percent to determine the deduction limitation:$100,000 x .03 = $3,000 limitation on itemized deductions
  • The limitation is then subtracted from the otherwise allowable itemized deductions:$100,000 - $3,000 = $97,000 in allowable deductions
  • For these taxpayers, the Pease provision has reduced itemized deductions from $100,000 to $97,000.
  • The impact on the charitable deduction can be found by multiplying the amount of the limitation ($3,000) by the percentage that charitable donations comprise of total of deductions (30 percent):$3,000 x .30 = $900
  • The Pease limitation has reduced the charitable deduction by $900 from $30,000 to $29,100.

For a point of comparison, previous proposals to cap itemized deductions at 28 percent for taxpayers in the then highest tax bracket of 35 percent would have reduced the charitable deduction for these taxpayers by $6,000.

Example Two

  • In 2013, a joint-filing couple has an AGI of $5 million and $1.25 million in itemized deductions ($375,000, or 30 percent, of which are charitable donations)
  • The income above the $300,000 threshold for joint filers must be calculated:$5,000,000 - $300,000 = $4,700,000 in excess income.
  • The $4,700,000 excess income is multiplied by 3 percent to determine the deduction limitation:$4,700,000 x .03 = $141,000 limitation on itemized deductions.
  • The limitation is then subtracted from the otherwise allowable itemized deductions:$1,250,000 - $141,000 = $1,109,000 in allowable deductions.
  • For these taxpayers, the Pease provision has reduced itemized deductions from $1,250,000 to $1,109,000
  • The impact on the charitable deduction can be found by multiplying the amount of the limitation ($141,000) by the percentage that charitable donations comprise of total of deductions (30 percent): $141,000 x .30 = $42,300.

In comparison, previous proposals to cap itemized deductions at 28 percent for taxpayers in the then highest tax bracket of 35 percent would have reduced the charitable deduction for these taxpayers by $75,000.

The Pease limitation does not apply to deductions for medical expenses, investment interest, casualty and theft losses, and gambling losses.    


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