The House Tax Bill: Analyzing the Total Itemized Deduction Limitation

Recently, the Committee on Ways and Means released “The One Big Beautiful Bill.” For more information, you can read our analysis of the SALT cap and the standard deduction.

It’s important to note that this is just a bill and has not been signed into law. Anything discussed is for informational purposes only, as the bill is very likely to change before becoming law. However, it does give an idea of what lawmakers are thinking and where they want things to go.

The old Pease limitation and TCJA

Before the Tax Cuts and Jobs Act (TCJA), higher-income taxpayers faced a reduction in allowable itemized deductions known as the Pease limitation. This rule increased the effective tax rate paid by high earners — without officially creating a new tax bracket — by reducing deductions, which in turn raised taxable income and the amount of tax owed.

The TCJA temporarily eliminated the Pease limitation, and the current proposal seeks to make that repeal permanent. While the Pease rule is no longer in effect, it’s relevant background for understanding the proposed changes.

The new deduction limitation

As is often the case with tax law, this new proposal isn’t straightforward. Similar versions have been discussed in prior administrations and are expected to garner support from Democratic lawmakers.

Under the proposal, itemized deductions would be reduced by 2/37 times the lesser of total itemized deductions or the amount by which taxable income plus itemized deductions exceeds the 37% tax bracket threshold.

Example

Peta and Robin are married and filing jointly (MFJ) with taxable income before itemized deductions of $1,000,000. Their itemized deductions total $100,000 without regard to the limitation and assume the 37% bracket starts at $750,000.

We can calculate the limitation as follows:

• 2/37 x $100,000 = $5,405
• 2/37 x ($1,000,000 – $750,000) = $13,513
• The total itemized deductions are $94,595

This causes the itemized deductions to “cap out” at a benefit level of 35% rather than the marginal rate of 37%.

Who might be affected?

Unlike the proposed SALT cap rollback (which would affect MFJ starting at $400,000 of income), this new limitation kicks in at much higher income levels. It’s most likely to impact high earners who claim large charitable deductions, such as wealthy donors or philanthropically inclined taxpayers.

If you want to know more about how the tax law changes could impact your family, contact your wealth advisor. Not a Mercer Advisors client? Let’s talk.

Mercer Advisors Inc. is a parent company of Mercer Global Advisors Inc. and is not involved with investment services. Mercer Global Advisors Inc. (“Mercer Advisors”) is registered as an investment advisor with the SEC. The firm only transacts business in states where it is properly registered or is excluded or exempted from registration requirements.

All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. Some of the research and ratings shown in this presentation come from third parties that are not affiliated with Mercer Advisors. The information is believed to be accurate but is not guaranteed or warranted by Mercer Advisors. Content, research, tools and stock or option symbols are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. Hypothetical examples are for illustrative purposes only. For financial planning advice specific to your circumstances, talk to a qualified professional at Mercer Advisors.