TAX ADVICE from Julian Block

renowned tax advisor and Larchmont neighbor, Julian Block, provides help for Gazette readers

Tucked into the Internal Revenue Code is a restriction on itemized deductions by upper-income individuals – a curtailment enacted during the senior Bush’s presidency that flat-taxers like Steve Forbes and Pat Buchanan deride as yet another one of those devious backdoor increases that Washington politicians favor.

This restriction reduces the write-off for most itemized deductions on Schedule A of Form 1040 when AGI, short for adjusted gross income, tops a specified amount. AGI is the figure you show at the bottom of Page 1 of Form 1040 after listing wages and other sources of income and offsetting income with deductions like outlays for alimony payments and money moved into traditional IRAs and other retirement plans and before claiming itemized deductions.

The magic number is indexed, meaning it is automatically adjusted annually to reflect inflation. For 2003, it is $139,500, up from 2002’s $137,300. So this year, you forfeit deductions equal to 3 percent of the amount that AGI exceeds $139,500.

Put another way, every $1,000 of AGI above $139,500 results in the loss of $30 of itemized deductions. The $139,500 figure drops to $69,750 for someone who is married and files a separate return; that tactic does not raise the threshold for a couple to a combined $279,000.

The 3-percent percent restriction applies to deductions for interest on home mortgages, real estate taxes, state and local taxes, charitable contributions, and miscellaneous expenses (already allowable, in most cases, only for the amount above two percent of AGI).

While four kinds of write-offs merit reprieves, the exceptions are for deductions already subject to limitations. The 3-percent percent rule does not apply to: (1) medical expenses (deductible only for the amount above 7.5 percent of AGI; (2) casualty and theft losses (allowable only to the extent such uninsured losses exceed $100 (for each casualty or theft), plus 10 percent of your AGI); (3) gambling losses (allowable just to the extent of gambling winnings); and (4) interest on funds borrowed to finance investments, such as margin accounts used to buy stocks (allowable just to the extent of investment income, a category that includes dividends, interest and, subject to restrictions, capital gains).

EXAMPLE: Abby and Adam Anderson anticipate an AGI for 2003 of $199,500, and their otherwise allowable itemized deductions for charitable donations, home-mortgage interest, real estate taxes and the like aggregate $20,000. So the couple’s income tops the $139,500 threshold by $60,000, and, as $60,000 times 3 percent equals $1,800, they are able to deduct just $18,200; they forfeit $1,800.

Abby and Adam suffer the same $1,800 disallowance, whether their itemized deductions are $20,000 or $100,000; the disallowance is based on the amount by which AGI exceeds $139,500, not the total of itemized deductions. If it is any consolation, the curtailment cannot cancel more than 80 percent of their deductibles. They are still allowed to deduct 20 percent.

A 2001 law change authorizes relief for people like the Andersons, but not right away. It starts a gradual elimination of the automatic cutback in 2006 and finishes the job in 2009. And who’s willing to bet the farm that a revenue-hungry Congress won’t rescind the cancellation? Meanwhile, it stays on the books, at least through 2009.

Julian Block is a syndicated columnist, attorney and former IRS investigator who has been cited by the New York Times as “a leading tax professional” and by the Wall Street Journal as an “accomplished writer on taxes.” His “Tax Tips For Freelance Writers” shows how to save truly big money on taxes – legally – and explains the steps you should take to reduce taxes for this year and even gain a head start for future years. Send $9.95 for an e-mailed copy or $12.95 (in the U.S.) for a postpaid copy to: J. Block, 3 Washington Square, #1-G, Larchmont, NY 10538-2032. Contact him at julianblock@yahoo.com.