Income-based limits on tax breaks can be costly to higher-income taxpayers. Will your deductions and exemptions provide the tax savings you’re expecting?

There are many tax breaks reduced or removed for higher-income taxpayers. Two in particular are the itemized deduction reduction and the personal exemption phase-out.

AGI Thresholds
If your adjusted gross income (AGI) exceeds the applicable threshold, most of your itemized deductions will be reduced by 3% of the AGI amount that exceeds the threshold (not to exceed 80% of otherwise allowable deductions). For 2016, the thresholds are $259,400 (single), $285,350 (head of household), $311,300 (married filing jointly) and $155,650 (married filing separately). The limitation does not apply to deductions for medical expenses, investment interest, or casualty, theft or wagering losses.

Exceeding the applicable AGI threshold could also cause personal exemptions to be reduced or even eliminated. The personal exemption phase-out reduces exemptions by 2% for each $2,500 (or portion thereof) by which a taxpayer’s AGI exceeds the applicable threshold (2% for each $1,250 for married taxpayers filing separately).

Limits in Action
These AGI-based limits can be very expensive for high-income taxpayers. Consider the following example:

Joe and Jane are married and have four dependent children. In 2016, they expect to have an AGI of $1 million and will be in the top tax bracket (39.6%). Without the AGI-based exemption phase-out, their $24,300 of personal exemptions ($4,050 × 6) would save them $9,623 in taxes ($24,30

0 × 39.6%). But because personal exemptions are completely phased out, they’ll lose that tax benefit.
The AGI-based itemized deduction reduction can also be costly. Joe and Jane could lose the benefit of as much as $20,661 [3% × ($1 million − $311,300)] of their itemized deductions subject to the reduction — at a tax cost as high as $8,182 ($20,661 × 39.6%).

These two AGI-based provisions combined could increase their tax by $17,805.

Year-End Tips
If your AGI is close to the applicable threshold, AGI-reduction strategies — such as contributing to a retirement plan or HSA — may allow you to stay under it. If that is not possible, consider the reduced tax benefit of the affected deductions before implementing strategies to accelerate deductible expenses into 2016. If you expect to be under the threshold in 2017, you may be better off deferring certain deductible expenses to next year.

Contact your advisor for more details on these and other income-based limits and help assessing whether you’re likely to be affected by them or more tips for reducing their impact.