Reinstate personal exemption phaseout and limitation on itemized deductions

High-income taxpayers face phaseouts of their personal exemptions and itemized deductions as their income exceeds specified levels. The 2001 tax act scheduled a gradual elimination of the phaseouts beginning in 2006 with complete elimination in 2010. Under current law, the phaseouts revert to their previous levels after 2010. The president proposes to eliminate the phaseouts and then reinstate them for high-income taxpayers in 2011.

In its full form, the personal exemption phaseout (PEP) reduces the value of each personal exemption from its full value ($3,650 in 2009 and indexed for inflation) by 2 percent for each $2,500 or part thereof above specified income thresholds that depend on filing status. Personal exemptions are thus fully phased out over a $122,500 (see phaseout table).

In 2009, the reduction is limited to one-third of its full value so the minimum value of personal exemptions is two-thirds of $3,650, or $2,433.

The limitation on itemized deductions—known as Pease after the congressman who introduced it—cuts itemized deductions by 3 percent of adjusted gross income above specified thresholds but not by more than 80 percent. The income threshold—$166,800 in 2009 ($83,400 for married couples filing separately)—is indexed for inflation. As is the case for PEP, the 2009 reduction is limited to one-third of its full amount so taxpayers cannot lose more than 26.7 percent of their itemized deductions - 1/3 of 80 percent.

The president proposes to restore both PEP and Pease in full in 2011. The threshold for the phaseouts would begin at 2009 levels of $250,000 for couples⁶ and $200,000 for other taxpayers, with both values indexed for inflation. TPC estimates tat 2011 thresholds would be $254,850 and $203,850 for couples and others, respectively. Personal exemptions would thus phase out for couples with income between $254,850 and $377,350 and for others with income between $203,850 and $326,350.⁷ Taxpayers would have their itemized deductions reduced in 2011 by 3 percent of their income over $203,850 (for single filers; the threshold would be $254,850 for couples filing jointly⁸) but not by more than 80 percent. Both phaseouts would increase marginal tax rates for taxpayers in the affected income ranges.

Footnotes

6. PEP would start at $125,000 for couples filing separately.

7. The values for married couples filing separately would be half those for joint filers.

8. The proposal does not say what the Pease thresholds would be for heads of household or for married couples filing separately. The current threshold for heads of household is the average of the thresholds for singles and married couples filing jointly; that for married couples filing separately is half that for couples filing jointly. If the same relationships applied to the 2010 budget proposals, the 2011 thresholds for heads of household and married filing separately would be $229,350 and $127,425, respectively.

Additional Resources
Tax Policy Briefing Book: Income Tax Issues: How do phaseouts of tax provisions affect taxpayers?
Press Resources: Limitation on Itemized Deductions
Press Resources: Personal Exemption Phaseout
Description of Revenue Provisions Contained in the President’s Fiscal Year 2010 Budget Proposal; Part One: Individual Income Tax and Estate and Gift Tax Provisions (JCS-2-09), Joint Committee on Taxation, September 2009, pp 70-73