Manage Your Itemized Deductions.
Each year, taxpayers have the choice of whether to claim a set amount known as the standard deduction or to itemize; that is to claim the actual amount of their deductions. The 2016 standard deduction amounts are as follows – $6,300 – single (S) and married filing separately (MFS), $12,600 – married filing jointly (MFJ) and $9,300 – head of household (HOH).
If the total of your itemized deductions exceeds your standard deduction, it’s most likely beneficial to itemize. Some of the more common deductions include medical expenses that exceed 10% of adjusted gross income (AGI) (7.5% if you are over 65), mortgage interest, state income and property taxes and charitable donations. If possible, consider bunching your expenses into one year for medical and miscellaneous deductions (2% of AGI) that are subject to AGI floors. In fact, unless Congress acts, the medical expense floor will increase in 2017 to 10% for those 65 or older, so you may want to take care of any unpaid medical bills in 2016 even if it means using a credit card to do so.
For high income taxpayers, however, itemized deductions are limited when AGI reaches $259,400 (S), $311,300 (MFJ), $285,350 (HOH) and $155,650 (MFS) and are fully phased out when AGI hits the following levels – $381,900 (S), $433,800 (MFJ), $407,850 (HOH) and $216,900 (MFS) (Incidentally, these phase out thresholds also apply to your personal and dependency exemptions – known as the PEP limitation). Itemized deductions are reduced by 3% of the amount of AGI that exceeds the specified beginning threshold. This is known as the Pease limitation and is subject to a maximum phase out of 80% of total itemized deductions.
It should be noted that for those subject to AMT, the PEP and Pease limitations do not apply, since AMT already denies personal exemptions (PEP) and eliminates many itemized deductions (Pease). Because PEP and Pease can only increase regular tax liabilities, its result tends to be higher than that calculated under AMT.
Since the itemized deduction limitation is based on income (AGI) and not on actual deductions, adding more deductions does not reduce total allowable deductions. To illustrate (ignoring PEP and AMT), Peter, a single taxpayer has AGI of $309,400 which is $50,000 above the individual threshold and has total itemized deductions of $46,500 that will be limited by $1,500 (3% X $50,000), for allowable itemized deductions of $45,000 ($46,500 less $1,500). Now let’s say Peter is considering making a $1,000 charitable contribution in December 2016 on a pledge he made that is due in January 2017. He also intends to make his January 2017 mortgage payment on New Year’s Eve that will enable him to claim additional mortgage interest of $1,000 in 2016. By making these payments in 2016, he will increase his allowable deductions to $47,000. There is no effect on these additional payments since the Pease limitation is based on AGI, not total itemized deductions.
In contrast, Peter has just learned he won a taxable prize from a radio station and will now have another $2,000 in income for total 2016 AGI of $311,400. In this case, his income will now exceed the threshold by $52,000, thereby increasing his limitation to $1,560 to reduce his allowable deductions to $46,940 ($46,500 + $2,000, less $1,560).
The end result and the year-end tax planning takeaway is that when subject to the Pease limitation, a change in income affects both AGI and allowable itemized deductions; whereas a change in deductions only impacts allowable deductions, with no change in the 3% limitation. So with proper planning, one can determine whether it is more beneficial to accelerate or defer certain itemized deductions in conjunction with the anticipated timing of the receipt of income.
When it comes to serving your accounting needs, no one has more experience than our team at DSJ. Call us today at 516.541.6549 or email us at to set up an appointment. We look forward to working with you!