[Updated for latest levels] Legislation a few years ago raised the threshold for those required to pay higher tax rates and also included provisions to restart limits on certain itemized deductions (Pease) and personal exemptions (PEP) that were phased out and eventually removed as part of the turn of the century Bush-era tax cuts. PEP and Pease were the two provisions in the tax code that increased taxable income for high-income earners. PEP is the phaseout of the personal exemption and Pease (named after former Senator Donald Pease) reduces the value of most itemized deductions once a taxpayer’s adjusted gross income (AGI) reaches a certain point.
But the definition of higher income thresholds for these provisions is much lower than the one used for higher federal tax rates and so will apply to a lot more people. These income limits are tied to official CPI measures and hence are adjusted for inflation every year. Past and upcoming year trends are shown in the following table.
|Filing Status||Annual Income (AGI) Limit Range for Claiming Itemized Deductions and Personal Exemption Phase-out|
|Single Filer||$259,400 to $381,900||$259,800 to $382,700|
|Married Filing/Joint Return||$311,300 to $433,800||$311,900 to $434,400|
|Heads of Households||$285,350 to $407,850||$285,550 to $408,250|
|Married Individuals Filing Separate Returns||$155,650 to $216,900||$155,850 to $217,500|
The re-instituted phase-out limitation on itemized deductions cuts the amount of deductions you can take by 3% of adjusted gross income (AGI) above the specified income thresholds but you cannot lose more than 80% of the affected itemized deductions. This means that tax payers whose AGI is greater than the specified income thresholds won’t be able to take all of the deductions associated with items like home mortgage interest, charitable donations and state/local income tax payments. While a lot of itemized deductions are affected by the itemized deduction limitation, some such as medical expenses, investment interest and gambling losses are not subject to the limit.
For an example of the above consider a married couple with income of $400,000 who file their tax return with $50,000 in itemized deductions. This couple is $100,000+ above the itemized deduction AGI threshold meaning that their allowed deductions would be reduced —potentially adding to their tax liability by about $1,000.
You are generally allowed to deduct the personal exemption for yourself, your spouse, and your eligible dependents. The personal exemption for tax year 2016 rose by $50 to $4,050, up from $4,000 last year. But with the new Personal Exemption Phase-out (PEP) the value of each personal exemption is reduced from its full value by 2 percent for each $2,500 above the specified income thresholds in the table above. It phases out completely at $381,900 ($433,800 for married couples filing jointly.)
What This Means For You
If your AGI is below the above thresholds then you should see no impact from the above changes and can claim your personal exemptions and itemized deductions as you normally would. Higher income taxpayers though will face reductions and likely see higher tax bills as the value of their personal exemptions and itemized deductions are reduced.