Q: Tax Playa, I recently bought my first home. How will tax filing change for me?
Jennifer, Washington DC
A: 70% of taxpayers take the standard deduction. The remaining 30% add up their various itemized deductions, and claim them instead because they are bigger. While there are many advantages to itemized deductions, they are limited by each deduction's internal constraints, the Pease phaseout, and the AMT...
The Standard Deduction
Click here to read about the standard deduction, the deduction that 70% of households claim.
2. Taxes You Paid. This includes state and local income or sales tax, personal property tax (usually on cars), and real property tax on your residence and second home. If you itemize your deductions, deduct state income tax, and get a refund, it becomes taxable the next year.
3. Interest You Paid. This is broken down into two parts. The first is the mortgage interest deduction. The other is a deduction for interest paid in a brokerage margin account. This interest deduction is limited to the amount of investment returns (capital gains, interest, and dividends) from that account.
4. Gifts to Charity.
If your AGI is high enough, your itemized deductions between to get phased out. This is known as the "Pease" phaseout, named after the Congressman that invented it.
For 2007, your itemized deductions begin to phase out if your AGI is $156,400 or higher ($78,200 if married filing separately). Specifically, they are reduced by 3% of the extent that your AGI exceeds this level. For instance, if you have AGI of $200,000, your itemized deductions are reduced by (200000-156400)*.03, or $1308.
The reduction is not comprehensive. There are two limits on the Pease phaseout:
- The medical and expense deduction, investment interest deduction, casualty and theft losses, and gambling losses are exempt from the Pease phaseout;
- All remaining itemized deductions can only be 80% phased out.
Therefore, at the very least 20% of all non-exempt itemized deductions and 100% of the exempt itemized deductions can be retained. In some cases, this may cause one to want to claim the standard deduction instead.
Even if an itemized deducter has gotten past the internal limits of each deduction, and has run the gauntlet of the Pease phaseout, he may have to grapple with the alternative minimum tax, or AMT.
The AMT serves as a further phaseout of itemized deductions. Specifically:
- Medical and expense deductions have a wall of 10% of AGI to climb, as opposed to the normal rule of 7.5% of AGI.
- All state and local tax deductions, casualty and theft losses, and miscellaneous itemized deductions are disallowed.
- Home equity loan interest is not deductible.