What is the 2% reduction?
The 2% reduction is a limit placed on individuals who earn a relatively high level of income, which serves to slightly increase their tax burden. For the 2006 tax year, the 2% reduction applies to those taxpayers who have an adjusted gross income in excess of $150,500 (or $75,250 if they are married and filing separately). When a taxpayer has an adjusted gross income greater than this amount, the 2% reduction is generally applied to all of their deductions except for medical expenses, casualty and theft losses, gambling losses and investment interest expenses.
The 2% reduction works by decreasing the total amount of deductions one can take. In particular, if it applies to you, your overall deduction amount will be reduced by 2% of the difference between your adjusted gross income and the amount discussed above. For example, if your adjusted gross income for 2006 was $200,000, the difference between that amount and $150,500 is $49,500. Two percent of that is $990, which means that your total deductions would be reduced by $990.
To further complicate things, where your adjusted gross income is very high, there is an eventual limit to how much your deductions can be reduced by. Particularly, the 2% reduction can only reduce your deductions by 20% So if your deductions were originally $15,000, the 2% reduction could only reduce them by $12,000. But for your 2% reduction to even reach the amount of $12,000, your adjusted gross income would have to be $750,000!
Finally, it’s worth noting that this reduction is slowly being phased out so, unless the law changes again, there will be no more reduction from 2010 going forward.