By Amy Feldman
NEW YORK Jan 15 The big numbers under
discussion following the American Taxpayer Relief Act of 2012
have been $400,000, the income level where new marginal rates
kick in for singles, and $450,000, for married couples filing
But two limitations on tax breaks for high-income earners
are returning at much lower income thresholds, amounting to
something of a stealth increase. And there are few ways to get
Even if you think you are not rich enough to worry about
higher taxes under the new agreement, these two haircuts may
affect you because PEP and Pease, as they are called, come into
play at $250,000 for singles and $300,000 for married couples.
Combined, the two rules effectively raise taxes on the
affluent without increasing marginal tax rates. Both had been
temporarily eliminated by the Bush tax cuts and do not apply to
your 2012 taxes. They are back for 2013, though, as part of the
tax agreement reached in the fiscal cliff negotiations at
You may tear your hair out trying to sort through the
details, but there is one reason to count your blessings: If not
for the fiscal-cliff deal, the income thresholds would have been
far lower (Pease at $89,075 for singles and $178,150 for married
couples, and PEP at $178,150 for singles and $267,200 for
And that means millions of taxpayers do not need to worry
HOW PEP AND PEASE WORK
PEP, the personal exemption phase-out, lowers each personal
exemption that taxpayers are allowed to take for themselves and
their dependents by 2 percent for each $2,500 of household
income above the threshold.
For the 2013 tax year, the personal exemption will be
$3,900. So for each $2,500 step-up, you would lose $78 of each
For example, a couple making $350,000 would have two
exemptions and would be $50,000 over the threshold. So they
would lose $3,120 of their total $7,800 in exemptions. A family
of four at the same income level would have four exemptions
totaling $15,600 but would lose $6,140 of that due to PEP.
But some taxpayers at that level will end up owing the
Alternative Minimum Tax where those exemptions are not valid.
"Planning around PEP is counterproductive because of the
interaction with the Alternative Minimum Tax," says Bill
Fleming, managing director at PwC's private company services
practice. "It's all about Pease."
The Pease limitation on itemized deductions dates back to
1990 and is named for the late U.S. Representative Don Pease of
Ohio. Along with PEP, it was phased out by the Bush tax cuts,
disappearing completely in 2010.
Under the new Pease rules, many popular Schedule B
deductions like mortgage interest, state and local taxes, and
charitable contributions will get shaved down. The haircut is 3
percent of the amount your income is over the threshold of
$250,000 for singles or $300,000 for married couples. (Pease
does not apply to medical expenses or casualty and theft
To understand how these new rules will affect you, figure
out how much you will exceed the income limit and then calculate
3 percent of that amount.
For the couple making $350,000 in adjusted gross income, 3
percent of the $50,000 that they are over the limit is $1,500.
If the couple has $60,000 of itemized deductions, they would
only be able to claim $58,500. The higher the overage,
obviously, the greater the impact on the deductions allowed.
Remember: This will not actually cost you $1,500, in that
example, but would increase your taxable income by $1,500. For
many affluent taxpayers, "it's not a huge number," says PwC's
Fleming. "If you make millions, it's a big number."
WORKAROUNDS ARE FEW
Can you plan around PEP and Pease? It is not so easy, since
first you need to know your adjusted gross income - something
very few people think about until they do their tax returns
because there are so many moving pieces.
Kaye Thomas, author of the tax-planning site Fairmark, notes
that adjusted gross income includes capital gains, so selling
securities or other assets can trigger the restrictions. Pay
careful attention this year if you plan to sell your business or
If you suspect that you will be close to the threshold
limitation, you could try to lower your income by deferring it
or prepaying expenses at year-end. You could also put off taking
individual retirement account distributions above the required