Article Highlights:

  • Phase-out Thresholds
  • Personal Exemption Phase-outs
  • Itemized Deduction Phase-outs

Generally, taxpayers are allowed to deduct personal exemption allowances of $4,000 (2015) each for themselves, their spouses and their dependents. In addition, taxpayers are allowed a standard deduction or, if their deductions are large enough, itemized deductions.

However, both the personal exemption allowances and itemized deductions are being phased out for higher-income taxpayers. The phase-out begins when a taxpayer’s adjusted gross income (AGI) reaches a phase-out threshold amount that is annually adjusted for inflation.

The phase-out threshold amounts for 2015 are based on taxpayers’ filing statuses, and they are: $258,250 for single filers, $284,050 for individuals filing as heads of households, $309,900 for married couples filing jointly and $154,950 for married individuals filing separately. Here is how the phase-outs work:

  • Personal and Dependent Exemptions – The otherwise allowable exemption amounts are reduced by 2% for each $2,500 or part of $2,500 ($1,250 for a married taxpayer filing separately) that the taxpayer’s AGI exceeds the threshold amount for the taxpayer’s filing status.
    Example: Ralph and Louise have an AGI of $422,400 for 2015 and two children, for a total of four exemptions worth $16,000 (4 × $4,000). The threshold for a married couple is $309,900; thus, their income exceeds the threshold by $112,500. Each $2,500 part of this amount reduces the exemption by 2%; there are 45 parts of this amount ($112,500 ÷ $2,500 = 45). Thus, 90% (45 × 2%) of their $16,000 exemption allowance is phased out, leaving them with a reduced exemption deduction of $1,600 ([100%–90%] × $16,000). Assuming Ralph and Louise are in the 33% federal tax bracket, the phase-out costs them an additional $5,643 ($16,000 × 90% × 33%).

    Divorced or separated parents subject to the phase-out should consider relinquishing the exemption of a dependent child to the other parent. When a taxpayer is a party to a multiple support agreement, the taxpayer may want to allow another contributing member of the agreement who is not affected by the phase-out to claim the dependent’s exemption.

  • Itemized Deductions – The total amount of itemized deductions is reduced by 3% of the amount by which the taxpayer’s AGI exceeds the threshold amount. The reduction is not to exceed 80% of the otherwise allowable itemized deductions.

    Not all itemized deductions are subject to the phase-out. The following deductions escape the phase-out:

    o Medical and dental expenses
    o Investment interest expenses
    o Casualty and theft losses from personal-use property
    o Casualty and theft losses from income-producing property
    o Gambling losses

    Thus, a taxpayer who is subject to the full phase-out still gets to deduct 20% of the deductions subject to the phase-out—and 100% of the deductions listed above.

    Example: Ralph and Louise from the previous example, who had an AGI of $422,400 for 2015, exceed the threshold for a married couple by $112,500. Thus, they must reduce their itemized deductions subject to the phase-out by $3,375 (3% of $112,500), but the reduction must not exceed 80% of the deductions subject to the phase-out. For 2015, Ralph and Louise had the following itemized deductions: 

    Subject to Phase-out    Not Subject to Phase-out
    Home mortgage interest:
    Charitable contributions:
    Casualty loss:

    The phase-out is the lesser of $3,375 or $19,200 (80% of $24,000) which is $19,200. Thus, Ralph and Louise’s itemized deductions for 2015 will be $32,625 ($24,000 – $3,375 + $12,000). Assuming Ralph and Louise are in the 33% federal tax bracket, the phase-out will cost them an additional $1,114 ($3,375 × 33%). 

Conventional thinking is to maximize deductions. However, taxpayers who normally are not subject to a phase-out may have a high-income year because of unusual income. In these cases, it may be appropriate, if possible, to defer paying deductible expenses to the year following the high-income year or perhaps to deduct the expenses in the preceding year. The standard deduction is not subject to the phase-out.

If you have questions about how these phase-outs will impact your specific situation, if you want to adjust your withholding or estimated taxes, or if you want to make a tax planning appointment, please give this office a call.

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