The amounts deducted on your personal income tax return for personal exemptions and itemized deductions must be reduced if your adjusted gross income (AGI) exceeds specified thresholds. For 2005, itemized deductions must be reduced if AGI exceeds $145,950 ($72,975 for married taxpayers filing separately).

The itemized deduction phase-out does not apply to deductions for medical expenses, investment interest expense, and casualty, theft, or wagering losses. The potential phase-out is capped at 80 percent of itemized deductions for taxes, other interest expense (such as mortgage interest), charitable donations, job expenses (above the 2 percent floor), and miscellaneous deductions.

Example 1. Arthur and Beulah have itemized deductions of $82,000. Of this amount, $42,000 is for medical, investment interest, and casualty expenses. The applicable cap on the phase-out of itemized deductions is $32,000 ($82,000 minus $42,000 x 80 percent). Arthur and Beulah's adjusted gross income is $265,950. The phase-out threshold of $145,950 is subtracted, leaving $120,000. This figure is multiplied by 3 percent, for a total of $3,600. Since $3,600 is less than the $32,000 cap, Arthur and Beulah must subtract $3,600 from their itemized deductions of $82,000. Their allowable itemized deductions are $78,400.

Personal exemptions. Each personal exemption for yourself, spouse, and children is worth $3,200. The phase-out threshold depends on filing status. For 2005, the thresholds are: $145,950 for a single taxpayer; $182,450 for a taxpayer who files as head of household; and $218,950 for married taxpayers filing jointly ($109,475 for married filing separately).

Example 2.  Charlie lives with his child and qualifies for head of household status. His AGI is $204,100. He subtracts the applicable threshold, $182,450, from his income, leaving $21,650. He divides this amount by $2,500 and rounds his answer up to the next whole number. $21,650 divided by $2,500 equals 8.66, which is rounded up to 9. This number is multiplied by 2 percent, which equals 18 percent. Charlie claimed two exemptions, which are equal to $6,400. This exemption amount is multiplied by 18 percent, which equals $1,152. Charlie's allowable person exemptions are $6,400 minus $1,152, or $5,248.

Alternative minimum tax.  The limit on itemized deductions does not apply for the alternative minimum tax. This means that all allowed itemized deductions must be added back to regular taxable income. No deduction for personal exemptions can be claimed against alternative minimum taxable income, so the exemptions (and any phase-out) are ignored.