Deductions are a way to account for your day-to-day business or living expenses. Income tax is intended to tax net income, not gross income. And the IRS figures income to be income net of expenses. Individual taxpayers may elect to take the standard deduction to simplify their tax preparation. As of tax year 2011, the standard deduction for individual taxpayers is $5,800 for single filers, and $11,600 for married couples filing jointly. If you have expenses in excess of this amount, it may benefit you to itemize your deductions on Schedule A. However, the IRS phases out itemized deductions for higher income taxpayers. Additional restrictions apply to taxpayers subject to alternative minimum tax rules.
Overview of Itemization and Deduction Rules
For individual taxpayers, there are two basic kinds of itemized deductions: Medical and dental expenses, which are deductible to the extent that they exceed 7.5 percent of your adjusted gross income, and miscellaneous deductions, which are deductible to the extent they exceed 2 percent of your adjusted gross income. Entertainment and meal expenses incurred for business purposes are also itemized deductions, but are generally only 50 percent deductible. This means you may not deduct all your expenses.
Temporary Tax Relief
Under normal circumstances, the federal government restricts the ability of higher income earners to deduct itemized expenses. However, as of 2010, those restrictions have been temporarily lifted through calendar year 2012.
Alternative Minimum Tax Rules
Taxpayers who make income over a certain amount may have some deductions disallowed under alternative minimum tax rules. These rules apply a tax rate of between 26 percent and 28 percent on income over a certain exemption amount—$72,450 as of 2011. AMT rules disallow certain itemized deductions, including state and local income tax and home mortgage interest. The 7.5 percent threshold that applies to medical expenses is also increased to 10 percent.
The limitations on itemized deductions for higher income earners are known as the "Pease limitations" or the "Pease provisions." They are named for former U.S. Rep. Donald Pease, the Ohio Democrat who introduced the legislation that created them. The Pease limitations have been temporarily repealed through 2012. Unless Congress moves to extend the repeal, however, the restrictions will return for tax year 2013. They reduce itemized deductions by one-third of 80 percent of the total itemized deductions claimed, or by 3 percent of the adjusted gross income exceeding a specific inflation-indexed threshold—whichever is less.