by Brenda Schafer MSA, CPA, CFP, EA
The Tax Institute at H&R Block

The WIIFM … ‘What’s in it for me’
Any time there’s a change in the tax law, everyone’s thinking “What’s in it for me?” It’s okay. It’s human nature. For some taxpayers the answer is “A lot of nothin’ again!” So what is it about tax breaks that make some of us big winners –and some of us –uh—not so much. (Like I’m gonna call any ya’ll “losers.”) Well, for one thing, some of you aren’t shelling out big money for college expenses, so the new education tax breaks won’t do you any good. Some of you aren’t in the market for an expensive energy efficient furnace or fancy schmancy windows for the house. There are those of you who are paying for college or who are going green at home who still won’t benefit from these tax breaks. Who are they? They’re the ones whose income is too high to qualify for the deduction or credit.

Phaseout vs. Cliff Test
There are two flavors of income ineligibility – (1) a “phaseout,” which most of you have probably heard of and
(2) a “cliff test.” A phaseout is by far the most common. In a phaseout, once a specified amount of income (earned income, AGI, modified AGI, etc) climbs above a certain amount, the amount of deduction or credit that you’re eligible to claim starts to decline until it reaches zero. That’s what’s known as being “within or beyond the phaseout range.” Some tax breaks start phasing out earlier than others and some phase out more quickly than others.

A cliff test, on the other hand, is exactly that, a cliff. You get the full benefit of a certain tax break until your specified income reaches a certain dollar amount. One dollar over that amount, and you’re out, or at least in another eligibility bucket. The saver’s credit is an example of a tax credit with income eligibility subject to a cliff test. A single taxpayer with AGI of $16,500 or less can get a saver’s credit of up to 50% of eligible retirement contributions up to $1,000 ($2,000 x 50%). If that same taxpayer had an AGI of $16,501, his max credit would be 20% of his eligible contribution amount up to a max of $400 ($2,000 x 20%). Crazy, isn’t it?

So what’s the deal with phaseouts and cliff tests? Congress uses these mechanisms to target the benefit of a tax provision to taxpayers in certain income brackets. Limiting eligibility for a tax break also makes the provision less expensive to implement, because it limits the number of taxpayers who can claim it.