Taxpayers who declare adjusted gross income in excess of a certain threshold must reduce their itemized deductions by 3% of that excess. Itemized deductions include state and local taxes, mortgage interest, and other itemized deductions, as well as charitable deductions. The reduction is limited to no more than 80% of the taxpayer's total itemized deductions.
For example, the threshold adjusted gross income for the 3% rule in 2001 was $132,950 ($66,475 if married filing separately). If a taxpayer declared $200,000 of taxable income in 2001, his excess income was $200,000 - $132,950 = $67,050. 3% of $67,050 is .03 x $67,050 = $2,011.50. If the taxpayer declared $50,000 in itemized deductions, he would have beed able to actually deduct only $50,000 - $2,011.50, or $47,988.50.
The 3% rule was suspended in 2010. This suspension was extended for 2011 – 2012 by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.