Tax Phaseouts What High-Income Taxpayers Need to Know in 2023

A tax phaseout is the decline in the value of certain tax advantages above a certain income level. The more money you make over specific thresholds, the lower the amount that some tax breaks will apply to you until, after a certain point, you get disqualified from using those tax breaks due to your high-income level.

To put it another way, some tax credits or deductions decrease as your income increases.

The IRS adjusts the phaseout levels yearly to account for inflation, meaning that the phaseout thresholds may change annually. It’s beneficial to be aware of how these changes impact your situation so that you can adjust your tax strategies accordingly.

This is where it gets more complicated: Various phaseouts work differently at different rates and therefore impact taxpayers differently. Some work at a constant rate over a specific range, while others reduce benefits by a set amount at specific incremental income thresholds. Some phaseouts reduce credits for all taxpayers over the thresholds, while others reduce deductions instead, meaning their impact in terms of dollar amount depends on the taxpayer’s marginal tax rate. (However, it’s also essential to understand the difference between tax phaseouts and marginal tax brackets — more on that in a moment.)

In short, think of this blog post as a general informational resource, not specific advice for your tax phaseout situation. For personalized guidance, always consult tax professionals (like us!).

What do high-income taxpayers need to understand about tax phaseouts?

Generally speaking, high-income taxpayers need to be aware of phaseouts that reduce tax credits, deductions, or other strategies for which they qualify within their given tax bracket. For example, let’s say you have a taxable income of $150,000 and qualify for a tax credit worth $2,500. If there is a phaseout in place, you may only be able to claim $1,500 of the credit, meaning you will only be able to take advantage of a reduced tax break. (Remember, these specific dollar amounts are just an arbitrary example to demonstrate the point — not necessarily a practical, real-world example!)

Lastly, it’s also essential to understand the difference between tax phaseouts and marginal tax brackets. While tax phaseouts reduce the number of deductions or credits for which you are eligible, marginal tax brackets determine the tax rate on your last dollar of income, as opposed to your first.

A marginal tax rate generally divides taxpayers into brackets, or ranges, based on taxable income — as your income rises, the last dollar you earn is taxed at the higher rate of the highest bracket for your total income. In contrast, the first dollar you earn is taxed at the rate for the lowest bracket. Meanwhile, the money in between is taxed at the rate for the bracket into which it falls.

The concepts of tax phaseouts and marginal tax brackets are similar in that they are both based on progressive taxation (taxation that increases with income). However, they are distinct — and understanding how they work together to determine your overall tax liability can help you maximize your tax advantages and minimize your bill.