Over the last several years, the government has launched a sneak attack on the taxpaying public, says U.S. Rep. Bill Archer (R-Texas), chairman of the House Ways and Means Committee.
With great fanfare, Congress instituted a host of lucrative tax breaks over the course of several years, but few Americans realize that 21 hidden tax provisions make these breaks unavailable to roughly 33 million Americans–about one in every four taxpayers, Archer said in a Feb. 4 hearing.
The bulk of these hidden provisions are called “phaseouts.” They take tax breaks away from those who earn more than certain amounts, causing those affected to pay more federal income tax than they might otherwise expect.
Some phaseouts have been around for at least a decade, but last year’s tax act is peppered with them. Many tax accountants fear that middle-income families will encounter them next year when they try to claim the many lucrative tax benefits that were promised by the Taxpayer Relief Act of 1997.
Q–What is a phaseout?
A–It is a provision that limits or eliminates tax breaks for people whose incomes exceed certain amounts.
Q–For example?
A–Consider the Hope tax credit. Starting with tax year 1998, parents who pay the education expenses for a child who is a freshman or sophomore in college can qualify for tax credits–that’s a dollar-for-dollar reduction in the federal income tax you pay–of up to $1,500. But you get the full benefit of this break only if your income falls below $40,000 if single or $80,000 if married. If your income is above that threshold, you’ll get only a partial credit, if any. Once a single filer’s income exceeds $50,000 or a married couple’s exceeds $100,000, the Hope credit is phased out entirely.
Q–How do you figure your credit if your income falls between the thresholds?
A–Let’s say you are single and earn $45,000. You otherwise meet the qualifications to claim a full $1,500 Hope tax credit. You look at the phaseout range for the credit, which is $10,000 in this case. (That’s the difference between $40,000, where the credit is 100 percent available, and $50,000, where it is 100 percent lost.) Compare that range with the amount of income that you have that exceeds the threshold. That’s $5,000 in this case. Since $5,000 is 50 percent of $10,000, you lose 50 percent of the credit. The maximum Hope tax credit this person can claim is $750.
Q–Is that how phaseouts always work?
A–Usually, but not always. The new child tax credit of $400 per child starts to phase out for singles earning more than $75,000 and for married couples with more than $110,000 in income. But there is no specific level at which it phases out completely.
Instead, you reduce your child tax credit by $50 for every $1,000 in “modified adjusted gross income” (for most people that will be the figure on the final line of the front page of your 1040) above the threshold.
So a single person with one child and $80,000 in income would lose $250 of this credit–five times $50–and lose the ability to claim it completely when he’s earned more than $83,000.
However, if this single parent had two children, he’d qualify for $800 in credits. He’d still get a partial credit until his income amounted to more than $16,000 over the threshold, or $91,000.
Q–I’ve heard that there are income phaseouts for Roth IRAs too.
A–If you earn more than $95,000 if single or more than $150,000 if married filing jointly, the amount you can contribute to a Roth is limited. Once your income exceeds $110,000 if single or $160,000 if married, you cannot contribute at all. If you are between the phaseout limits, you figure your maximum allowable contribution just as you figured your maximum Hope tax credit. If the income above the threshold is 30 percent of the phaseout range, the maximum allowable contribution is reduced by 30 percent.
Q–Which tax breaks are subject to phaseouts?
A–In one way or another, nearly every tax break is subject to phaseouts. In addition to the Roth IRA, child and Hope tax credits already mentioned, the new lifetime learning credit, deductions for student-loan interest and adoption tax credits are all subject to phaseouts.
High-income taxpayers also find that their personal exemptions are limited once their taxable income exceeds certain thresholds, and itemized deductions are restricted for wealthy taxpayers, too.
