Here's where itemizing deductions gets a little tricky and where a qualified tax preparer or accountant becomes essential. Congress has generously created many categories of itemized deductions, but there are limits on that generosity. Those limits come in the form of floors, ceilings and phase-outs.
Floors set a minimum amount at which you can start to deduct and ceilings put a cap on how much you can deduct in certain categories.
Common deduction floors:
- As we mentioned earlier, you can only deduct medical and dental expenses that exceed 10 percent of adjusted gross income (AGI) (7.5 percent if you or your spouse is over 65).
- There are several miscellaneous deductions that fall under the 2 percent rule, meaning you can only deduct the amount within each category that exceeds 2 percent of AGI. Examples include job expenses, tax preparation fees and safety deposit box rentals [source: Sit].
Common deduction ceilings:
- Your total deductions for charitable contributions cannot exceed 50 percent of AGI.
- You can only deduct 50 percent of business-related meal and entertainment expenses.
- If claiming gambling losses, they cannot exceed your winnings. In other words, you can't gamble away your taxable income at the craps table.
In addition to these limits, Congress has instituted an itemized deduction phase-out for high-income filers. If you file singly and have an AGI greater than $254,200 or file jointly with an AGI greater than $305,050, some of your deductions are subject to limitations: mortgage interest paid, taxes paid, charitable gifts, job expenses and a few miscellaneous expenses. Deductions that are not limited include medical expenses, and casualty and theft losses [source: IRS: Limit on Itemized Deductions and IRS: Inflation Adjustments].
To figure out the dollar value of the phase-out limit requires some math. Your deductions are limited by the smaller of these two amounts [source: IRS]:
- 80 percent of itemized deductions are affected by the limit, or
- 3 percent of the amount by which your AGI exceeds $300,000 if filing jointly, $250,000 if single, or $150,000 if married filing separately
It's called a phase-out because the itemized deduction limit increases with each dollar earned above the AGI threshold up to a maximum amount of 80 percent of total deductions affected by the limit. If you earn enough to qualify for the phase-out on itemized deductions, you can probably afford a good accountant, but it's important to note that the floor and ceiling limits are applied before calculating additional limits for high-income filers.
Despite the potential tax savings, relatively few Americans itemize their deductions. Read on to find out who does and why.