There is a lot of talk right now about itemized deductions. Remember itemized deductions? Those great deductions on Schedule A for taxes, interest, charitable donations and investment expenses? The big discussion right now is about President Obama’s proposal to limit itemized deductions to the 28% tax bracket. That’s right. If you haven’t heard, under Obama’s budget proposal itemized deductions would provide at most a 28% tax benefit. Even if you are in the 35% tax bracket!

What most people don’t realize is that itemized deductions are already limited for high-bracket taxpayers. The reason it’s not obvious is that the calculation is complex. Let me see if I can break down all of the limitations on itemized deductions for you.

First, there are the “floors.” A floor is a minimum amount of deductions that you have to have before you begin receiving any benefits from the deduction. And, you only receive a benefit for the amount of deductions you have above the floor. There are two types of itemized deductions that have floors. The first is the deduction for medical expenses. This floor is equal to 7.5% of your page one adjusted gross income (AGI). So if your AGI is $100,000, then you don’t get to deduct the first $7,500 of medical expenses you incur. Only those in excess of $7,500 are deductible.

The other floor applies to miscellaneous itemized deductions. These include job expenses, investment expenses and, for many people, tax return preparation and planning fees. This floor is 2% of AGI. So, in our example, with $100,000 of AGI, the first $2,000 of investment expenses is not deductible.

The second limit on itemized deductions is the Alternative Minimum Tax, or AMT. The AMT is an alternative tax calculation to the regular income tax. If your AMT tax is higher than your regular tax, you pay the AMT. Taxes and miscellaneous itemized deductions are not allowed under AMT. And the floor for medical deductions under AMT is 10% instead of 7.5%. There is also a limitation on home mortgage interest under the AMT.

The third limit on itemized deductions is a little more complex. Once your income reaches a certain level, your itemized deductions are reduced by 3% of the amount your income exceeds this level. The current level is $166,800 for most people. So, if your AGI is $20,000 more than this, your itemized deductions are reduced by $600. This is a cap on this reduction, so that nobody has their itemized deductions reduced by more than 80%.

This last limit is phasing out under current law and is scheduled to entirely phase out at the end of 2009. Perhaps President Obama’s new cap will replace it or perhaps it will be in addition. We will see.

The biggest question, then, is what to do about these limits on itemized deductions. The answer is fairly simple. Do everything you can to change your deductions from itemized deductions to business deductions. Remember that business deductions are not limited. So, if you have tax planning fees, if they are for your business, they can be deducted as business expenses and not subject to all of the itemized deduction limitations. There are even some ways to shift a portion of your home mortgage and real estate taxes to your business. And with proper planning you can completely eliminate the medical expense floor so you receive a deduction for 100% of your medical expenses.

Warmest regards,