Absent any new legislation from Congress, a tax law provision that limits the dollar amount of itemized deductions for high-income taxpayers is returning with a vengeance. The so-called “Pease rule” or “Pease amendment”—named for the Congressman who originally introduced it more than 20 years ago—could have a significant impact on your 2013 tax liability.

Background: Under the Pease rule, certain itemized deductions are reduced if your adjusted gross income (AGI) exceeds a specific dollar threshold. This provision was initially included in the Omnibus Budget Reconciliation Act of 1990. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) gradually reduced the impact before the reduction was completely eliminated for 2010. Due to the “sunset” aspects of EGTRRA, it was scheduled to return in 2011, but the 2010 Tax Relief Act extended the repeal through 2012. Now the Pease rule is scheduled to revert to pre-EGTRRA status in 2013.

Note that the Pease rule does not apply to all itemized deductions, although several “big-ticket items” are on the list. This includes charitable donations, mortgage interest, state and local income taxes and property taxes, and miscellaneous expenses. It does not cover medical expense deductions, investment interest deductions, casualty and theft deductions, or gambling loss deductions, but these other deductions already have built-in limits. For instance, medical expense deductions are generally limited to the excess above 10% of your AGI in 2013 (up from 7.5% in 2012).

The dollar threshold for the Pease rule is the same for single filers as it is for joint filers (but it is halved for a married taxpayer filing a separate return). Currently, the reduction is equal to 3% of the excess over the applicable threshold (projected to be $178,150 of AGI for 2013). However, in no case can the reduction be greater than 80% of your total deductions.

Example 1: Suppose that John exceeds the AGI threshold by $200,000 and has $50,000 in annual deductions from charitable gifts, mortgage interest, and state and local taxes. As a result, the reduction is equal to 3% of the $200,000 excess, or $6,000. So his itemized deductions of $50,000 are scaled back to $44,000.

Example 2: Now say that Jane exceeds the AGI threshold by $1 million and has $35,000 in annual deductions from charitable gifts, mortgage interest, and state and local taxes. Normally, the reduction would be equal to 3% of the $1 million excess, or $30,000, cutting back her deductions to only $5,000. But this would be a reduction greater than 80%. As a result, the reduction cannot be more than $28,000, so Jane can deduct $7,000.

The Pease rule does not figure in the alternative minimum tax (AMT) calculation for individual taxpayers. But certain itemized deductions—including certain home equity interest, and state and local income taxes—are already disallowed under the AMT.

Another comparable tax law rule phases out the tax benefit of personal exemptions for certain high-income taxpayers. Obtain more details from a Lohman Company advisor.

Consider the potential impact of the Pease rule in 2013. It may encourage you to postpone charitable gifts to a low-tax year or accelerate deductible expenses into this year if you anticipate being below the AGI threshold. Finally, these rules might change, so stay on top of any new developments.