Tax Cliffs: How $1 More Can Affect Your Tax Planning
Most tax planning scenarios fall under a gradual income system where incremental increases to income trigger minor tax consequences. Tax cliffs, however, follow a different set of rules where just one additional dollar of income beyond a certain threshold can result in one losing out on a tax deduction or a credit. It is a delicate balance in which you are either in or you are out with no in-between. Below are a few examples of major tax cliffs to be mindful of.
IRMAA (Income Related Monthly Adjustment Amount)
Medicare-covered individuals can find themselves paying more in premiums if one’s Modified Adjusted Gross Income (MAGI) crosses a certain threshold. While the additional premiums one would pay is based on a tiered system, IRMAA will be triggered once one crosses the income threshold by a single dollar. Below is a handy chart to understand how much more one would pay in premiums.
For example, a married couple with a MAGI over $174k (but under $218k), will end up paying $57.80 ($115.60 for both) more a month in Medicare premiums. On an annual basis this amounts to $1,387.20. More information on how IRMAA is designed and how MAGI is calculated can be found in our earlier blog here.
ACA Premium Subsidies
The ACA offers tax credits for individuals who buy health insurance via the marketplace. The goal of this credit is to subsidize the cost of the health insurance for individuals who may not be able to afford it. To be eligible for the credit, one’s MAGI must be between 100% - 400% of the federal poverty level. Additionally, depending on one’s household size, this threshold may be higher. For 2020, the chart below illustrates what these limits are
One single dollar above the 400% federal poverty level, will result in being ineligible for this credit, thus leaving you in a position to pay the full cost of insurance. For example, a household of 3 making with a single dollar of MAGI over $85,230 would be ineligible for the tax credit.
Retirement Savings Contribution Credit
In order to encourage saving for retirement, a tax credit is available for low-income individuals that contribute to their qualified retirement plans. Individuals that earn beyond a certain AGI threshold (for 2020: Married Filing Jointly – more than $65,000, Head of Household – more than $48,750, All Others: more than $32,500) will not be eligible for this tax credit.
NJ Pension Exclusion
Residents of New Jersey can qualify for an income exclusion on their state return if their income falls below certain thresholds. (Additionally, to be eligible for this income exclusion, one must be 62 or older.) Below is a helpful chart to understand the thresholds.
Going over any of these amounts will result in you losing this exclusion. Thankfully, for New Jersey purposes, Social Security is not considered income so this may help with planning around this exclusion. For example, if a married couple (both over the age of 62) were to have $99,000 of income and an additional $40,000 in Social Security benefits, they would still be eligible for the NJ exclusion, thus being able to exclude the $99,000 from the NJ state return.
Conclusion
Ultimately, the issue of tax cliffs comes down to income control. Not being mindful of these cliffs can cost you hundreds or thousands of dollars. It is strongly recommended that you consult with a tax advisor to project your income and help you tax advantage of these credits.
Weingarten Associates is an independent, fee-only Registered Investment Advisor in Lawrenceville, New Jersey serving Princeton, NJ as well as the Greater Mercer County/Bucks County region. We make a difference in the lives of our clients by providing them with exceptional financial planning, investment management, and tax advice.