The 2/37 rule is a new limit on itemized deductions for taxpayers in the top federal bracket, created by the One Big Beautiful Bill Act and effective for 2026. It reduces your itemized deductions by 2/37 of the smaller of two amounts: your total itemized deductions, or the amount by which your taxable income, measured before itemized deductions, exceeds the start of the 37% bracket. For 2026 that bracket begins at $768,700 of taxable income for married couples filing jointly and $640,600 for single filers. The practical effect is that each itemized deduction dollar saves a top-bracket taxpayer roughly 35 cents of federal tax rather than 37. The rule is permanent, it replaces the old Pease limitation, and it applies last, after every other limit on a deduction has already been applied.
What does the 2/37 rule actually do?
The statute, the new Section 68 of the Internal Revenue Code, says that an individual's itemized deductions are reduced by 2/37 of the lesser of two amounts. The first is the itemized deductions themselves. The second is the amount by which taxable income, computed with those itemized deductions added back, exceeds the point where the 37% bracket begins.
The arithmetic has a clean interpretation. A deduction worth 37 cents, reduced by 2/37 of itself, is worth 35 cents. So for a household comfortably inside the top bracket, the rule is equivalent to capping the value of itemized deductions at a 35% rate. For a household whose income before itemized deductions is only slightly above the threshold, the second measure is smaller, so the cut is smaller too. Because deductions are added back before the comparison, a household can be cut even when its actual taxable income sits in the 35% bracket.
Two features matter for planning. The rule applies after everything else, including the SALT cap, the 7.5% medical floor, the new 0.5% charitable floor, and the AGI percentage limits on charitable gifts (Section 68(b)). And the income measure counts all taxable income, including long-term capital gains and qualified dividends taxed at 20%, which the American College of Trust and Estate Counsel and the AICPA have both flagged as possibly unintended. As enacted, it applies.
Which deductions does it reach, and which does it leave alone?
It reaches every itemized deduction alike: mortgage interest, state and local taxes after the cap, charitable contributions after the floor, medical expenses after the 7.5% floor, investment interest, and casualty and gambling losses. The old Pease limitation exempted several of these; the new rule exempts none of them.
It does not reach deductions that are not itemized. The standard deduction, the 20% qualified business income deduction, the new senior deduction, and the new non-itemizer charitable deduction are all outside it, and Congress separately amended Section 199A so that the QBI deduction is computed without regard to Section 68. Amounts that never enter adjusted gross income in the first place are also untouched, which is why the structure of a deduction now matters as much as its size.
| Item | Affected by 2/37? |
|---|---|
| Mortgage interest, SALT, charitable, medical, investment interest | Yes, after all other limits |
| Standard deduction | No |
| QBI (Section 199A) deduction | No |
| Senior deduction; non-itemizer charitable deduction | No |
| Qualified charitable distributions from an IRA | No; excluded from income entirely |
| Pass-through entity tax paid at the entity level | No; deducted by the business, not itemized |
| 401(k) and HSA contributions | No; reduce income before deductions |
Who does it actually affect?
Only taxpayers whose taxable income, before itemized deductions, exceeds the start of the 37% bracket, so the population is narrow, but within it the rule is nearly universal. A household with $1,000,000 or more of income that itemizes will generally feel it every year.
Non-grantor trusts and estates are the exception to "narrow." Trusts reach the 37% bracket at just $16,000 of taxable income in 2026, and the new law removed the old carve-out that kept trusts and estates outside the Pease limitation. How far the 2/37 cut reaches inside a trust is unsettled, and it is serious enough to warrant its own discussion in how trusts and estates are taxed after OBBBA.
Does it change how you should plan?
The dollar effect is modest relative to other 2026 changes: about two cents per deduction dollar. But it shifts the relative value of different tools in ways that compound over time.
Deductions that bypass Section 68 gain value.A qualified charitable distribution from an IRA for those 70½ and older, a pass-through entity tax election for business owners, and pre-tax retirement and HSA contributions all deliver their full benefit because they never become itemized deductions. Where a choice exists between an itemized route and one of these, the non-itemized route now wins by an additional two cents on the dollar. The PTET mechanics are covered in the SALT cap and the PTET election.
The reward for timing deductions into a top-bracket year shrinks.Conventional advice is to concentrate deductions in your highest-income years. Under the 2/37 rule, a deduction in a 37% year is worth about 35 cents, the same as in a 35% year, so the last two points of that advantage disappear. Moving a large gift into a peak-income year still helps if the alternative year would put you in the 32% bracket or lower, but not merely to capture the gap between 35% and 37%. Bunching itself still works, as discussed in the charitable giving playbook, and the order in which the charitable limits apply is laid out in the charitable deduction order of operations.
It interacts with the charitable floor.A charitable gift is first reduced by the 0.5% of AGI floor, then included in itemized deductions, then subject to the 2/37 cut. For a top-bracket donor, both haircuts apply to the same gift in sequence.
A worked example: two households
The following is a hypothetical illustration using 2026 figures for married couples filing jointly, ignoring state tax.
The first couple has $1,500,000 of adjusted gross income, all ordinary, and itemizes: $10,000 of state and local taxes (the cap has phased down to its $10,000 floor at their income), $30,000 of mortgage interest, and $100,000 of charitable gifts. The 0.5% floor removes $7,500 of the gifts, leaving total itemized deductions of $132,500. Their income exceeds the $768,700 threshold by $731,300, far more than their deductions, so the cut is 2/37 of $132,500, or $7,162. At a 37% rate, that costs them about $2,650 of additional tax, exactly 2% of their deductions.
The second couple has $800,000 of adjusted gross income and $60,000 of itemized deductions. Their income before itemized deductions exceeds the threshold by only $31,300, which is less than their deductions, so the cut is 2/37 of $31,300, or about $1,692. Their taxable income, about $741,700 even after the cut, sits in the 35% bracket, so the cut adds roughly $592 of tax. This couple is affected even though none of their taxable income is in the top bracket, because the statute adds deductions back before comparing income to the threshold. The examples are hypothetical and simplified.
Key numbers at a glance
| Item | 2026 figure |
|---|---|
| Reduction | 2/37 of the lesser of itemized deductions or income (before itemized deductions) above the 37% threshold |
| 37% bracket begins, married filing jointly | $768,700 |
| 37% bracket begins, single and head of household | $640,600 |
| 37% bracket begins, married filing separately | $384,350 |
| 37% bracket begins, trusts and estates | $16,000 |
| Effective value of an itemized deduction in the top bracket | About 35 cents per dollar |
| Status | Permanent; replaces the Pease limitation |
Frequently asked questions
What is the 2/37 rule?It is the new Section 68 limit on itemized deductions, effective in 2026. It reduces itemized deductions by 2/37 of the lesser of total itemized deductions or income above the start of the 37% bracket, which effectively caps their value at about 35 cents per dollar for top-bracket taxpayers.
Who does the 2/37 rule affect?Taxpayers whose taxable income, measured before itemized deductions, exceeds the start of the 37% bracket, which begins at $768,700 for joint filers and $640,600 for single filers in 2026, and non-grantor trusts and estates, which reach that bracket at just $16,000.
Does the 2/37 rule affect the QBI deduction or the standard deduction?No. Both are outside the definition of itemized deductions, and the law separately directs that the QBI deduction be computed without regard to Section 68. The senior deduction and the non-itemizer charitable deduction are also unaffected.
Is the 2/37 rule the same as the old Pease limitation?No. Pease reduced deductions by 3% of income above a threshold and exempted several categories. The 2/37 rule is calculated differently, exempts no itemized deduction, and is permanent. The Pease limitation itself was permanently repealed.
Do QCDs escape the 2/37 rule?Yes. A qualified charitable distribution is excluded from income rather than deducted, so neither the 0.5% charitable floor nor the 2/37 cut applies to it.
Does the 2/37 rule apply after the SALT cap and the charitable floor?Yes. The statute applies it after every other limitation on itemized deductions, so a charitable gift is first reduced by the 0.5% floor and a state tax deduction by the SALT cap before the 2/37 cut is calculated.
Sources
- 26 U.S. Code § 68: Overall limitation on itemized deductions, Legal Information Institute, Cornell Law School
- 26 U.S. Code § 63: Taxable income defined, Legal Information Institute, Cornell Law School
- Rev. Proc. 2025-32: Inflation adjustments for tax year 2026, Internal Revenue Service
- Comments to Treasury and the IRS on the One Big Beautiful Bill Act, American College of Trust and Estate Counsel, November 10, 2025
- What OBBB means for your clients: itemized deductions, Thomson Reuters
How Atlatl Advisers can help
Atlatl Advisers is a boutique multi-family office in Madison, Wisconsin, serving accomplished families as an independent, fee-only, SEC-registered fiduciary. We act as your personal CFO: one coordinated team for investments, financial planning, tax strategy, and estate coordination, organized around our Liquidity, Lifetime, and Legacy framework.
This article is provided by Atlatl Advisers LLC for informational and educational purposes only. It is not investment, legal, tax, or insurance advice, and it does not consider the particular circumstances of any reader. Consult your own advisers before acting. Atlatl Advisers is an SEC-registered investment adviser; registration does not imply a certain level of skill or training. Information is believed accurate as of November 2026 and may change.
