President Trump's tax reform repealed a long-standing cap on some of your high-net-worth clients’ deductions, and that might benefit clients’ tax situation–if they still itemize deductions and calculate the influence of more-familiar tax scenarios.
The Pease limitation, named after the late U.S. Rep. Donald J. Pease from Ohio, capped the value of itemized deductions for taxpayers. Depending on a taxpayer's filing status, the caps apply to those with annual adjusted gross income (AGI) of more than $156,900 to more than $313,800. Designed originally to increase taxes paid by the wealthy without actually raising tax rates, Pease limits trimmed the deduction HNW taxpayers could take for charitable donations, among other write-offs.
The reduction was generally 3 percent of AGI above the applicable threshold (meaning your wealthy clients had to trim their total itemized deductions by three cents for every dollar their AGI was over the threshold that applied to them). A relatively few wealthy taxpayers were instead limited to 80 percent of the amount of itemized deductions, if this 80 percent was less than the AGI-calculated amount.
The Pease limitations remain in effect for 2017 taxes but, under Trump's tax reform, are suspended for 2018 through 2026.
“Many taxpayers don’t understand this limitation,” said Scott Eichar, a CPA/CFP and tax senior manager with GBQ Partners in Columbus, Ohio. “It was essentially a hidden surtax. Second, although the Pease limitation was enacted in 1991, it was phased out for tax years 2010 through 2012 and returned for tax years 2013 through 2017. Many taxpayers lost track of whether it applied to them.”
Deductions unaffected by Pease limits included investment interest, medical expenses, casualty and theft losses and wagering losses, according to Patrick Daly, a CPA and partner at Citrin Cooperman in New York. “Most [wealthy taxpayers] believed if they contributed $25,000 to charity they were getting a deduction based on this amount,” he added.
The repeal should benefit taxpayers with AGI that would have exceeded the thresholds, particularly those who will not be affected strongly by the new $10,000 cap on the state and local taxes (SALT) deduction. “Taxpayers will need to be in a position to itemize deductions to realize that benefit,” Eichar said, adding that tax reform appears to mean fewer taxpayers itemizing in general.
“Those that still itemize will get more benefit for their charitable, mortgage interest and medical deductions. Highly charitable clients will get more tax benefit for their donations,” said Mike Crabtree a CPA and partner with Boulay in Minneapolis.
“I’ve never seen a client very upset about the 3 percent limitation. The numbers were always minor in comparison to the increased tax rates in prior tax laws and other issues,” added Joel Olbricht, a CPA and partner at OSGroup CPAs and Business Advisors in Hampstead, N.H.
Some wealthy clients’ tax situations may benefit from tinkering. “A lot of clients will bunch itemized deductions going forward,” added Gail Rosen, a CPA with Wilkin & Guttenplan in Martinsville, N.J. “They’ll be making all their charitable deductions in one year and then take the standard deduction in other years.”