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Minimizing the Effect of the Phaseout

If your family income is high enough to be affected by the phaseout of itemized deductions, your marginal tax rate may actually be several percentage points higher than the rates shown on our rate table. The negative effects of the phaseout can sometimes be reduced by careful tax planning.

Reduce taxable income. The most basic strategy, of course, would be to reduce your adjusted gross income below the threshold for your filing status. Business owners can do this more easily than other taxpayers, because their ability to plow earnings back into the business is virtually unlimited.

Some other simple ways of doing this include maximizing your contributions to any retirement plans available to you, or to a nondeductible IRA or Roth IRA. While these IRA contributions won't lower your AGI for the current year, they will lower your taxable income in the future because earnings on the accounts are tax-free.

Another simple strategy is to receive investment income in a nontaxable form, by investing in tax-free municipal bonds. You might also decide to invest more heavily in non-dividend paying growth stocks, to avoid receiving currently taxable dividends.

You may also want to consult a financial planner or tax expert who can suggest more specific ways to trim your current income, including various family income-splitting tactics, charitable remainder trusts, etc.

Reverse planning for deductions. If it looks as if you're going to lose some percentage of your deductions anyway, you might want to reduce some of your deductible expenses. In particular, consider paying down your home mortgage or refinancing it at a cheaper rate, since the interest deduction is less valuable to you.

If, like many business owners, your income fluctuates from year to year, you might be able to pay for more deductible expenses in years when you have lower income and the deductions are less likely to be reduced.

Tip

Tip

Charitable gifts should be made in January of a low-income year, rather than in December of a high-income year.


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