Earn a Higher Income? Be Careful of Limits on Itemized Deductions & Personal Exemptions

If you earn a higher income, it is important to note that many tax breaks are reduced or even eliminated at certain income levels. Two examples include the Itemized Deduction reduction and the Personal Exemption phase-out.

How High is Higher Income?

For 2016, the adjusted gross income (AGI) thresholds are:

  • $259,400 for single filers
  • $285,350 for head of household
  • $311,300 for married couples filing jointly
  • $155,650 for those that are married but filing separately

If your AGI exceeds this threshold, most of your itemized deductions will be reduced by 3% of the amount of your AGI that is in excess of the threshold. Note that this amount cannot exceed 80% of otherwise allowable deductions. There are some deductions for which these limits don’t apply: medical expenses, casualty, theft, wagering losses or investment interest.

Should your AGI exceed the threshold, you may see a reduction in your personal exemptions – or total elimination. The phaseout of personal exemptions reduces these exemptions by 2% for each $2500 in excess of the threshold your AGI reaches. Those taxpayers that are married filing jointly see this 2% exemption reduction for each $1250 in excess income.

Also, it is important to note that these income thresholds can change every year.

An Example

The facts are simple, the higher your AGI, the more taxes you pay. Here’s an example:

Steve and Mary are married and have four dependent children. In 2016, they expect to have an AGI of $1 million and will be in the top tax bracket (39.6%). Without the AGI-based exemption phaseout, their $24,300 of personal exemptions ($4,050 × 6) would save them $9,623 in taxes ($24,300 × 39.6%). But because their personal exemptions are completely phased out, they’ll lose that tax benefit.

The AGI-based itemized deduction reduction can also be expensive. Steve and Mary could lose the benefit of as much as $20,661 [3% × ($1 million − $311,300)] of their itemized deductions that are subject to the reduction — at a tax cost as high as $8,182 ($20,661 × 39.6%).

These two AGI-based provisions combined could increase the couple’s tax by $17,805!

Tax Tips for This Year’s End

If you believe that your AGI for this year might exceed, or even be close to the applicable threshold, we suggest you employ some strategies to reduce your adjusted gross income. You can contribute to a retirement plan or Health Savings Account contributions can help you stay under the threshold. If these strategies don’t work, consider at least reducing the deductible expenses that will be affected with reduced tax benefits to minimize the loss in benefit. You may be better off even deferring certain deductible expenses to next year – if you think your income levels will fall below the threshold.

As a tax expert with more than 40 years of experience, I can help you devise the best strategies for reducing these tax burdens for your specific income and deduction situation. Call our office for a consultation today!

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