What Is a Phaseout in Taxes?

Tax Phaseouts Explained

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Tax phaseouts reduce—and eventually eliminate—certain tax breaks for high-earning taxpayers. This means that the value declines after one’s income reaches a certain level. You might find that a deduction is off-limits for you, or that a $2,000 tax credit is only worth $1,000 for you, if your income is over the threshold that's applied to a particular tax benefit. 

The concept reduces several tax credits and tax deductions, and different phaseouts apply to various tax breaks. They’re not one-size-fits-all. Learn how a phaseout works, the types that exist, and when it may impact you.

Definition Example and of a Phaseout in Taxes

Section 68 of the Internal Revenue Code (IRC) provides for phaseouts. The section states that the claimable percentage of some itemized deductions and credits begins reducing when a taxpayer hits a certain income limit. The credit or deduction continues to reduce for each dollar you earn over this threshold until your ability to claim the tax break disappears entirely.

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 your income exceeds this amount. In this case, your deduction would therefore reduce 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. As a result, your deduction would be reduced by $750. 

The idea behind Section 68 is that these tax breaks are targeted for and intended to benefit low- and middle-income families and taxpayers. Retirement savings, family tax breaks, and education-related tax breaks are most commonly subject to phaseouts.

How Does a Phaseout Work?

The structure and effects of phaseouts will depend on whether or not it's reducing a credit or a deduction. When a phaseout is applied to credits, it has the same impact on all affected taxpayers. When it is applied to deductions, the dollar impact will depend on the taxpayer’s marginal tax rate.

Phaseouts aren't based on your total gross income, but rather on your modified adjusted gross income (MAGI)—that portion of your income which 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 reducing until they become unavailable entirely. 

Some tax credits, such as the child tax credit, require that you add back certain claimed deductions or exclusions to arrive at your MAGI. This tax credit makes you add back foreign earned income, which is normally excluded from taxable income, as well as income derived from Puerto Rico or American Samoa.

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 where phaseouts are applicable.

The Alternative Minimum Tax (AMT)

The alternative minimum tax (AMT) applies to taxpayers with high economic income by setting a limit on those benefits. You're subject to the AMT tax if you earn more than the income limits.

The AMT provides for exemptions that you can subtract from your overall income. You would only be potentially liable for this tax on the balance that remains. The exemption thresholds are $73,600 for single filers and $114,600 for married taxpayers who file joint returns as of tax year 2021. But these exemption amounts phase out at the rate of 25 cents per dollar for incomes over $523,600 for single filers and $1,047,200 for married taxpayers filing jointly.

The Child Tax Credit

The American Rescue Plan (ARP) pumped up this tax credit in 2021 in response to the global health crisis, increasing it by $1,600 for the tax year 2021. But phaseouts apply. One phaseout only affects eligibility for this extra $1,600, while the other applies to the base amount of the child tax credit before the ARP increase. 

The first phaseout thresholds are:

  • $150,000 for married taxpayers filing joint and qualifying widow(er)s
  • $112,500 for heads of household
  • $75,000 for single filers or married taxpayers who file separate returns  

The second phaseout thresholds are:

  • $400,000 for married taxpayers filing joint returns
  • $200,000 for all others

The extra portion of the credit is reduced, or phased out, by $50 for each $1,000 of income over these limits.

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 2021—for the taxes you will pay in 2022—the full credit phaseout thresholds 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
  • $15,410 with three 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 2021, the deduction you can claim begins reducing at an income of $66,000 annually if you’re single or qualify for the head of household filing status. 

This increases to $105,000 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 $76,000 and $125,000 a year respectively.

This list is by no means all-inclusive, it merely provides some examples of phaseouts. If you think you’re eligible to claim a credit or deduction that may be subject to phaseout limits, check in with a tax professional. 

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 they 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 were 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.

Key Takeaways

  • Tax phaseouts reduce—and eventually eliminate—certain tax breaks for high-earning taxpayers.
  • Phaseouts are applied to both tax deductions and tax credits, but not all deductions and credits are subject to them.
  • The idea behind phaseouts is to steer these tax breaks toward lower-income taxpayers who need them most and limit their availability to wealthier taxpayers.