How the $17,000 Mitt Romney-Proposed Cap on Itemized Deductions Would Impact IRA Deductions

By Jeffery Levine, IRA Technical Expert  

Follow Me on Twitter: @IRAGuru4EdSlott

Recently, Presidential candidate Mitt Romney indicated that a $17,000 cap on itemized deductions could be used as a way to help pay for his plan to cut tax rates across the board.

This has caused some to wonder how their deduction for an IRA contribution would be affected by such a provision.

Thankfully, the answer is both favorable and easy to understand. It wouldn’t be! That’s because IRA deductions are not itemized deductions and therefore, would not be impacted at all.

Here’s the deal in a nut shell. There are different types of deductions on your personal tax return. One category of deductions is referred to as “above-the-line deductions.” A second grouping is known as below-the-line deductions, which are more commonly known as itemized deductions. The “line” being referred to in both cases is the line on your tax return that indicates your adjusted gross income, or AGI. In essence, you can think of AGI as the midpoint of your tax return and the barrier between these two different types of deductions.

The deduction for an IRA contribution is one of the above-the-line deductions and not an itemized deduction. Above-the-line deductions are looked at on a one-by-one basis. In other words, there are separate criteria for each deduction and your ability, or lack thereof, to claim one above-the-line deduction has no impact on your ability to claim any other above-the-line deduction. After each above-the-line deduction’s unique requirements have been reviewed separately from one another, the total amount of above-the-line deductions you’re entitled to is calculated and factored into your tax return before your AGI is calculated.

In general, if you make an IRA contribution, you are entitled to take an above-the-line deduction. However, if you and/or your spouse actively participate in a company plan, like a 401(k), and your income is above certain thresholds, your deduction could be phased-out or eliminated. For 2012, the maximum IRA deduction is $5,000 (or $6,000 if you are 50 or older by the end of the year). That amount may increase next year when indexed for inflation.

Once your above-the-line deductions have been figured and your AGI has been calculated, the second set of deductions comes in to play. These below-the-line deductions (itemized deductions) are treated very different than their above-the-line counterparts. For one thing, there’s generally a choice to make with respect to itemized deductions. Most people get to choose between their itemized deductions and the standard deduction, which is just a flat amount established by IRS each year.

Another difference between the above-the-line and below-the-line deductions is that for the most part, there are not different limits and qualifications for each deduction. You simply calculate the total below-the-line deductions and if the total is more than your standard deduction (if available), then you claim them in lieu of the standard amount to arrive at your “taxable income.” It’s this total that Romney’s proposal would limit.

The non-partisan Tax Policy Center at the Urban Institute and Brookings Institution just released an analysis of Romney’s tax plan.  There are others who come to different empirical conclusions.

That might leave you wondering which of your deductions would be limited and/or possibly eliminated. Although the list is rather long, some of the more common itemized deductions that could be impacted on your return would be the deductions for mortgage interest, charitable contributions, unreimbursed employee expenses, state and local taxes, real estate taxes and medical expenses in excess of 7.5% of AGI (10% for most beginning in 2013).

Of course, if the plan goes through and rates are lowered, it’s possible your tax bill could be lower overall, even if some of your itemized deductions are disallowed. What will ultimately be the fate of our tax system is anyone’s guess at this point. However, for the time being at least, you can rest easy knowing your IRA deduction is safe.

Article Highlights

• Mitt Romney has proposed a $17,000 cap on itemized deductions to help pay for reduced tax rates across the board
• The deduction for an IRA contribution is NOT an itemized deduction and would be unaffected by such a provision
• There are two main types of deductions on a personal tax return (Form 1040); above-the-line deductions and below-the-line deductions)