After the beginning of every year, after the Christmas decorations are put away and New Year’s resolutions are planned, most people begin the dread of preparing for tax season.  You may have already asked your manager what happened to your pay check, due to the increase in payroll taxes.  There are also several changes to personal exemptions and itemized deductions this year that you need to be aware of.

Limitation on Personal Exemptions and Itemized Deductions to Impact High Income Taxpayers in 2013

Among the tax increases recently enacted in the 2012 American Taxpayer Relief Act are provisions that impose caps on tax breaks for high income taxpayers. The new rules reinstate the personal exemption phase‐out (PEP) and the limitation on itemized deductions known as the “Pease Limitation.” This limitation is named for the former U.S. Representative Donald Pease, an Ohio Democrat who introduced the legislation that created it. The Pease limitation was temporarily repealed through 2012 but will return for the 2013 tax year.

Personal Exemption Phase‐Out (PEP):

Taxpayers claim personal exemption deductions for themselves, their spouses and their dependents. The personal exemption amount per person is $3,800 in 2012 and $3,900 in 2013.  Beginning in 2013, the value of each personal exemption is reduced by 2% for each $2,500 (or portion thereof) by which the taxpayer’s adjusted gross income (AGI) exceeds the applicable threshold. The starting thresholds are:

  • $300,000 for married couples filing jointly and surviving spouses
  • $275,000 for heads of household
  • $250,000 for unmarried  taxpayers
  • $150,000 for married taxpayers filing separately

For example, consider a married couple filing a joint return with no other dependents that has an adjusted gross income of $400,000. The PEP “applicable percentage” applies to $100,000 – the $400,000 AGI amount minus the $300,000 threshold amount for married filing joint filers. For each $2,500 of that $100,000 amount, a 2% reduction in the exemption amount of $3,900 applies. So the percentage reduction is 80% [2% x ($100,000 / $2500)], resulting in an exemption amount of $780 [$3,900 – (80% x $3,900)] per person. Therefore, only $1,560 ($780 x 2) will be allowed as the personal exemption deduction on the joint return.

Limitation on Itemized Deductions:

Also beginning in 2013, the “Pease Limitation” of itemized deductions is reinstated. The phase‐out limitation reduces the amount of deductions you can take by 3% of your adjusted gross income (AGI) above the specified thresholds, but not to exceed 80% of the affected deductions.  This means that taxpayers whose AGI is greater than the specified thresholds won’t be able to deduct all of their home mortgage interest, charitable contributions and state & local income tax payments. Medical expenses, investment interest, casualty & theft losses and gambling losses are not subject to the Pease limitation, although those deductions could be subject to other limitations.  The thresholds for this limitation are the same as the personal exemption phase‐out:

  • $300,000 for married couples filing jointly and surviving spouses
  • $275,000 for heads of household
  • $250,000 for unmarried taxpayers
  • $150,000 for married taxpayers filing separately

For example, consider a married couple filing a joint return with adjusted gross income of $400,000 who has $50,000 of itemized deductions, consisting of $20,000 of mortgage interest, $10,000 of real estate taxes and $20,000 of charitable contributions. The couple’s total itemized deductions of $50,000 are reduced by $3,000 [3% x (400,000 – 300,000)].  The $3,000 reduction is the lesser of (a) 3% of the excess of AGI over the applicable threshold amount or (b) 80% of the itemized deductions otherwise allowable for the tax year.

However, don’t panic!  The CPA’s at Warren Averett are here to make tax season easy for you and your medical practice.   Do not hesitate to contact any of our health care advisors.