Blog Article

The Personal Exemption Phaseout

Lowell Parker

By Lowell Parker, Wealth Advisor CFP®
Published On 03/15/2016

The Personal Exemption Phaseout (PEP) is back. Physicians and other high-income earners need to consider its impact. Below you’ll find the general guidelines, an example of how it works and finally, creative ways in which you can help manage or negate its impact.

PEP phases out the personal exemption by 2% for each $2,500 that a person’s adjusted gross income (AGI) exceeds the threshold.

PEP for 2015

Filing Status  Phaseout Begins Phaseout Ends
Married Filing Jointly $309,900 $432,400
Head of Household $284,050 $406,550
Single $258,250 $380,750

Example: married filing jointly with two children

Personal exemption = $16,000. AGI= $360,000. AGI in excess of phaseout is $50,100/$2,500= 20.4, round up to 21. Multiply by 2% = 42% reduction on the initial exemption of $16,000. Reduction amount = $6,720. Personal exemption = $9,280.

If you are at the upper threshold of a $2,500 increment, take caution. A $100 increase in income could wipe out 2% of your personal exemptions.

Here’s how can you manage the impact.

Get your portfolio in shape

Realized gains in your investment accounts are included in your AGI and will impact the PEP. If your portfolio is in need of restructuring (in turn realization of gains) due to poor management and misallocation, there’s no time like the present to get it in shape. The benefits of a well-structured portfolio are more valuable than the personal exemption. And, if your income is going to stay the same, the net impact of the PEP will be the same whether you realize all the gains in year one, or, for example, over a two to three year period. That said, if your income is going to be significantly less next year, consider holding off.

Distribute your income elsewhere

IRA distributions are considered income. If your income is getting close to the phaseout, distribute elsewhere – a taxable brokerage account, for instance.

Consider your dividends

If your income is constant and your investment accounts distribute a significant amount of distributions, consider the following options:

  • Locate the dividend paying assets in your tax sheltered accounts,
  • Retool the investment strategy in your non-tax deferred accounts to minimize dividend-paying investments. PEP aside, asset location can be an extremely valuable tool for high-income earners.

Make the most of your deductions

Take advantage of your 401(k), 401(k) over 50 catch up, IRA, and Health Savings Account (HSA). Also consider your student loan interest, which is important for younger physicians who are still carrying the debt.

Manage your distributions

If you are in a partnership, manage distributions more effectively in high-income years.

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Lowell Parker

By Lowell Parker, Wealth Advisor CFP®

Lowell developed a passion for finance in high school, after some hard lessons learned. Now as a Wealth Advisor, he appreciates the opportunity to help his clients articulate, achieve, and expand on their financial and associated life goals. He particularly enjoys working with mid-career technology professionals.

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