The structure and effects of a phaseout will depend on whether it’s reducing a credit or a deduction. When a phaseout is applied to a credit, it has the same impact on all affected taxpayers. When it is applied to a deduction, the dollar impact will depend on the taxpayer’s marginal tax rate. Let’s look at an example. You might have paid $3,000 toward an expense that qualifies for an itemized deduction. The phaseout for this particular deduction begins at an income of $75,000 per year. You might lose 5% of the deduction for every $1,000 that your income exceeds this amount. In this case, your deduction would therefore fall to $2,250 if you earn $80,000 a year: $150 x five for each $1,000 increment you earned from $75,000 to $80,000. In other words, your deduction would be reduced by $750.
Phaseouts Consider Your Modified Adjusted Gross Income
Phaseouts aren’t based on your total gross income, but rather on your modified adjusted gross income (MAGI)—that portion of your income that remains taxable after you’ve claimed every tax deduction and exclusion that’s available to you (with certain exemptions and deductions then added back in). Most taxpayers find that their MAGIs are the same as their adjusted gross incomes (AGIs). The only difference is those add-backs, and most of these only apply to a few taxpayers. Tax credits and deductions phase out when your MAGI reaches the beginning income threshold, gradually diminishing until they become unavailable entirely.
Types of Phaseouts
The amounts, income thresholds, and structure of phaseouts can vary considerably from one tax break to another. Below, learn about the most common tax breaks that have phaseouts.
The Alternative Minimum Tax (AMT)
The alternative minimum tax (AMT) applies to taxpayers with high income who make use of many common itemized deductions. You’re subject to the AMT if you earn more than certain income limits. The AMT provides exemptions that you can subtract from your overall income. You would only be potentially liable for the AMT on the balance that remains. The exemption thresholds are $75,900 for single filers and $118,100 for married taxpayers who file joint returns as of tax year 2022. But these exemption amounts phase out at the rate of 25 cents per dollar for incomes over $539,900 for single filers and $1,079,800 for married taxpayers filing jointly.
The Child Tax Credit
The child tax credit is worth $2,000 per qualifying dependent child if your MAGI is below the phaseout thresholds of $200,000 for single filers and $400,000 for joint filers. After those thresholds, the credit reduces by $50 for every $1,000 of MAGI.
The Earned Income Tax Credit
The earned income tax credit (EITC) is specifically intended to put money back into the pockets of low- and low-middle income families. It, too, is subject to two phaseouts. The full credit is only available to those whose incomes are less than the first threshold. Families are disqualified from claiming any credit at all at the second threshold. As of 2022—for the taxes you will pay in 2023—the maximum amount you can earn to get the full credit for single taxpayers, heads of household, and married taxpayers filing jointly are:
$7,320 with no child dependents$10,980 with one child$15,410 with two children or more children
The EITC is eliminated entirely for single taxpayers and heads of household with adjusted gross incomes at or above:
$16,480 with no child dependents$43,492 with one child$49,399 with two children$53,057 with three or more children
These thresholds increase slightly for married taxpayers who file jointly to:
$22,610 with no child dependents$49,622 with one child$55,529 with two children$59,187 with three or more children
Individual Retirement Accounts (IRAs)
You can deduct contributions you make to a traditional or Roth IRA—at least until your AGI reaches certain levels. As of 2022, the deduction you can claim begins reducing at an income of $68,000 annually if you’re single or qualify for the head of household filing status; $109,000 for married couples who file jointly if the spouse who makes the contribution is an active participant in the plan. The deduction phases out entirely for those earning $78,000 and $129,000 a year respectively.
Criticism of Phaseouts
It’s been argued that imposing phaseouts discourages taxpayers from earning more. Losing out on various deductions and credits increases taxable incomes from what they would have been had the taxpayer had been eligible to claim them. It can also push people into a higher tax bracket when these tax breaks are eliminated entirely at the upper-income thresholds. Literally, a single dollar of income can tip the scale. You could lose the student loan interest deduction, for example, if you earn $85,000 rather than $84,999. Another criticism stems from the fact that the phaseout thresholds for married taxpayers who file jointly are sometimes less than double those for unmarried filers. This creates a “marriage penalty”—meaning a couple owes more income tax when filing a joint return rather than what they would owe if they each filed as single or head of household. These phaseouts were doubled over the single limits by the Tax Cuts and Jobs Act (TCJA) in 2018, but the TCJA is set to expire at the end of 2025 unless Congress takes steps to renew it.
