- Bargaineering - http://www.bargaineering.com/articles -

Comprehensive Guide to IRS Income Phase Outs Rules

Posted By Jim On 07/16/2007 @ 8:18 am In Taxes | 4 Comments

As you may well know, your modified adjusted gross income (MAGI) will determine what sort of tax benefits you’ll be eligible for. What you may not know, is how your MAGI will determine those benefits and what benefits fall under the phase out rules. You probably don’t know that because it’s not all written down in one place… until now. The majority of these fall into one of two categories, education-related or retirement-related, and it’s a great example of how you can change behavior through tax laws. The government wants to help you prepare for the future and stop being stupid.

First off, the IRS defines adjusted gross income as your gross income minus adjustments, which happen to all be deductions but do not include the standard or itemized deductions. Some of these adjustments are the IRA deduction, student loan interest deduction, tuition and fee deduction, moving expenses, etc. The modified adjusted gross income is your AGI plus some of the stuff that you deducted put back. For more information, please refer to IRS.gov [3] on both topics.

(All figures have been updated for 2008 unless otherwise specified)

Child Tax Credit

  • About: How about $1,000 each year for you to not keep it in your pants? For each qualifying child under 17, you can reduce your federal income tax bill by up to $1,000. [IRS Pub 972 [13]]
  • Phase Out: The phase out for single filers starts at $75,000 and at $110,000 for married filing jointly.
  • Phase Out Calculation: Take the difference between your MAGI and the start of the phaseout, round it up (always) to $1,000 increments and take 5% of that. That 5% is how much your child tax credit is reduced by.
  • Example Calculation: Let’s say you are a $80,001 MAGI, single filer with one qualified child. The difference between your MAGI and the phaseout is $5,001 which is rounded up to $6,000. 5% of $6k is $300 so your child tax credit is reduced to $700.
  • How To Use This Information: As you can see in the above example, that extra dollar ended up costing you $50 off your tax bill. If you contributed two dollars more to a retirement account, you would’ve resulted in an additional $50 credit.

Itemized Deductions

  • About: This is the rule where the amount of your deductions is reduced if you earn over a certain amount. If you make over the phase out, your deductions are reduced by 1% of your MAGI over $156,400. Most of the major deductions are subject to this phaseout but the ones that aren’t are medical/dental expenses, gambling losses, investment interest expenses and nonbusiness casualty and theft loss. Charitable contributions, mortgage interest, and a few bigger ones are. However, there is good news, starting in 2006 this was slowly getting phased out. For 2006 and 2007, it’s only 2%; for 2008 and 2009, it’ll only be 1%; starting 2010, this phaseout will no longer apply.
  • Phase Out: Anything over $156,400, same for single and married filing jointly.
  • Phase Out Calculation: Subtract your MAGI from $156,400 and get 2% of that, your deduction is automatically reduced by that amount.
  • Example Calculation: Let’s say you’re a $200,000 MAGI single filer. The difference between your MAGI and $156,400 is $43,600, 2% of that is $872. After you calculate all of your deductions, subtract $872 from that.
  • How To Use This Information: There is very little you can do with this information other than to know it exists.

Personal and Dependency Exemptions

  • About: This particular phaseout reduces the value of your personal and dependency exemptions, which are deductions you get just for being you.
  • Phase Out: For singles the phaseout range is $156,400 to $278,900 and for married filing jointly, it’s $234,600 to $357,100.
  • Phase Out Calculation: For each $2,500 you exceed the bottom of the phaseout ($1,500 for married filing jointly), you lose 1% of your exemption’s value.
  • Example Calculation: Let’s say you’re single and your MAGI is $158,900, or $2,500 over the beginning of the phaseout range. You are claiming one exemption, worth $3,400, but now it’s really only worth 99% of that, or $3,366.
  • How To Use This Information: If your MAGI is $156,401, consider adding more to your 401K in order to avoid losing 1% of your deductions! If you’re at the fringes of any of the steps, consider reducing that AGI so that you can recapture some of your deductions. 1% can be a lot!

Interest on Student Loans

  • About: This rule affects those of us with student loans, if you make over the phaseout period the amount of your interest payments that you can deduct from your taxes is reduced. The maximum deduction is the lesser of $2,500 or how much you’ve paid in interest, regardless of income, on a qualified student loan. IRS Publication 970] [14]
  • Phase Out: The range is $65,000 to $80,000 for single filers and $135,000 to $165,000 for married filing jointly. One of the few phaseouts that actually doesn’t penalize you for getting married.
  • Phase Out Calculation: This one sounds tricky but it’s not, it’s basically a straight line phaseout with no fancy rounding whatsoever. Just subtract your MAGI from the bottom of the phaseout income range and divide by the size of the range, $15k for singles and $30k for married filing jointly. Then, subtract that from 1 and multiple that with how much interest you’ve paid (with a maximum of $2,500).
  • Example Calculation: You’re single, your MAGI is $70,000 and you’ve paid $3,000 in interest on your qualified student loans. $70k minus $65k is $5k, divided by $15k is 0.33. Subtract 1 by 0.33 and you get 0.67, multiplied by $2,500 (the max) gives you $1,667.50. You are permitted to deduct $1,667.50 from your taxes.
  • How To Use This Information: This is another one of those phaseouts that you really can’t do much with. The phaseout is completely linear so there’s no gaming to be done near the edges, be happy you’re making more than $65,000.

HOPE Scholarship & Lifetime Learning Education Credits

  • About: The HOPE Scholarship and the Lifetime Learning Education Credits give taxpayers a tax credit for education costs. The HOPE Scholarship applies to the first two years of post-secondary education and is limited to $1,650 for each student. The Lifetime Learning Education credit applies to everything else and is limited to $2,000 per return. There are more rules to that and it’s an equation to figure the credit so you’ll want to consult IRS Publication 970 [14] for the full details.
  • Phase Out: For singles the phaseout range is $47,000 to $57,000 and for married filing jointly, it’s $94,000 and $114,000.
  • Phase Out Calculation: This one is just like the student interest one above, it’s a straight line phaseout with no rounding. Just subtract your MAGI from the bottom of the phaseout income range and divide by the size of the range, $10k for singles and $20k for married filing jointly. Then, subtract that from 1 and multiple that with how much the deduction would be if you weren’t in the phase out range.
  • Example Calculation: You’re single, your MAGI is $50,000 and you’d like to claim the $2,000 Lifetime Learning Education Credit. $50k minus $47k is $3k, divided by $10k is 0.30. Subtract 1 by 0.30 and you get 0.70, multiplied by $2,000 gives you $1,400. You are permitted to claim $1,400 of the credit on your taxes.
  • How To Use This Information: This is another one of those phaseouts that you really can’t do much with. The phaseout is completely linear so there’s no gaming to be done near the edges.

Coverdell Education Savings Accounts (Education IRA)

  • About: The Coverdell Education Savings Account is an education IRA that lets parents save for education expenses, the contributions are not tax deductible but the earnings are tax free if used for qualified education expenses. Contributions are limited to $2,000 each year and it’s that $2,000 limit that is affected by your income. Again, IRS Publication 970 [14] covers the full details but Tax Topic 310 [15] puts it in plain English.
  • Phase Out: For singles the phaseout range is $95,000 to $110,000 and for married filing jointly, it’s $190,000 and $220,000.
  • Phase Out Calculation: Again, another straight line phaseout. Just subtract your MAGI from the bottom of the phaseout income range and divide by the size of the range, $15k for singles and $30k for married filing jointly. Then, subtract that from 1 and multiple that with how much the deduction would be if you weren’t in the phase out range.
  • Example Calculation: You’re single and your MAGI is $100,000. $100k minus $95k is $5k, divided by $15k is 0.33. Subtract 1 by 0.33 and you get 0.67, multiplied by $2,000 gives you $1,340. You are permitted to contribute a maximum of $1,340 to a Coverdell.
  • How To Use This Information: This is another one of those phaseouts that you really can’t do much with. The phaseout is completely linear so there’s no gaming to be done near the edges.

Education Savings Bonds

  • About: When you cash in a US Savings Bond (in this it only applies to series EE bond issued after 1989 or a series I bond), you generally pay tax on the interest earned on those bonds unless you do so through an education savings bond program. Whether you can participate and how much you can exclude will depend on your MAGI. More information on this in IRS Publication 970 [14].
  • Phase Out: For singles the phaseout range is $65,600 to $80,600 and for married filing jointly, it’s $98,400 and $128,400.
  • Phase Out Calculation: Yet another straight liner, these education tax law writers were nice and easy on you. Just subtract your MAGI from the bottom of the phaseout income range and divide by the size of the range, $15k for singles and $30k for married filing jointly. Then, subtract that from 1 and multiple that with how much of the interest you can exclude.
  • Example Calculation: I think you get the idea.
  • How To Use This Information: Again, not terribly useful but still someone good to know. Not really actionable information though.

Individual Retirement Accounts

  • About: Whether or not you can deduct your contributions to a SEP-IRA, Traditional IRA, etc. will depend on your income and whether or not your employer offers a qualified plan and you participate. If you participate, then you fall under some phase-out guidelines. If you are not an active participant, there are no phase-outs for you in terms of deductibility.
  • Phase Out: For singles the phaseout range is $52,000 to $62,000 and for married filing jointly, it’s $150,000 – $160,000. If you are married filing jointly and you are not active but your spouse is, your new range is $83,000 to $103,000
  • Phase Out Calculation: This is a straight line phase-out but the final deductible amount is rounded up to the next $10 increment. Subtract your MAGI from the bottom of the phaseout income range and divide by the size of the range, $10k for singles and $20k for married filing jointly. Subtract that number from 1 and multiply that by your contribution, that’s how much you will be able to deduct.
  • Example Calculation: You are single, not active with an income of $57,000. $57k minus $52k is $5,000, divided by $10,000 yields a nice round 0.50. One minus 0.50 is 0.50 times $4,000 results in $2,000, or how much you can deduct from your taxes if you contribute the $4,000.
  • How To Use This Information: Since the steps are so small, this information isn’t terribly valuable unfortunately.

Roth IRA

I, and many other bloggers, have covered the Roth IRA phase-outs probably a million times because the Roth is such a popular retirement vehicle. If you want to see the phase-out information then read over this 2008 Roth IRA Phase-out [16] article.

What do you think? Did I miss anything or screw anything up?


Article printed from Bargaineering: http://www.bargaineering.com/articles

URL to article: http://www.bargaineering.com/articles/comprehensive-guide-to-irs-income-phase-outs-rules.html

URLs in this post:

[1] Tweet: http://twitter.com/share

[2] Email: mailto:?subject=http://www.bargaineering.com/articles/comprehensive-guide-to-irs-income-phase-outs-rules.html

[3] IRS.gov: http://www.irs.gov

[4] Child Tax Credit: #childtaxcredit

[5] Itemized Deductions: #itemizeddeductions

[6] Personal and Dependency Exemptions: #personaldependencyexempt

[7] Interest on Student Loans: #interestonstudentloans

[8] HOPE Scholarship & Lifetime Learning Education Credits: #hopelifetimelearning

[9] Coverdell Education Savings Accounts (Education IRA): #coverdell

[10] Education Savings Bonds: #educationsavingsbonds

[11] Individual Retirement Accounts: #iras

[12] Roth IRA: #rothiras

[13] IRS Pub 972: http://www.irs.gov/pub/irs-pdf/p972.pdf

[14] IRS Publication 970]: http://www.irs.gov/pub/irs-pdf/p970.pdf

[15] Tax Topic 310: http://www.irs.gov/taxtopics/tc310.html

[16] 2008 Roth IRA Phase-out: http://www.myretirementblog.com/roth-ira-contribution-limits-and-income-phaseout-schedule.html

Thank you for reading!