What is a 'Phase Out'

A phase-out in the financial world refers to the gradual reduction of a tax credit that a taxpayer is eligible for as their income approaches the limit to qualify for that credit. A specified income range determines who qualifies for a specific tax credit. The lower income is eligible for the maximum amount, and the higher income is eligible for the minimal amount. Taxpayer's income that exceeds the upper limit is ineligible for the credit.

BREAKING DOWN 'Phase Out'

A phase-out applies to several credits recognized by the Internal Revenue Service (IRS). It refers to tax credits designed to benefit low-to-middle income households. Since it targets taxpayers in a specific income bracket, it "phases out" or shrinks beyond a specified income threshold, before disappearing altogether.  

Which Credits Phase Out?

For the tax year 2018, the federal Child Tax Credit begins to phase out for married taxpayers filing jointly when their modified adjusted gross income (MAGI) reaches $400,000 ( $110,000 for the tax year 2017). If their MAGI falls below this number, they may claim the full $400,000. If it falls above this limit, the credit gradually reduces until the reaching the income limit. For the tax year 2018, the income limit is $440,000. If the couple filing jointly makes a MAGI beyond that limit, they can't claim the Child Tax Credit. 

The phase-out also applies to the Saver's Credit, formerly known as the Retirement Savings Contributions Credit. This credit was designed to help low-to-middle income Americans saving for retirement through qualified plans, like a 401(k) and Individual Retirement Accounts (IRA). 

The most a taxpayer may get in the form of a nonrefundable Saver's Credit is 50% of the first $2,000 worth of contributions for the year, or $1,000. To be eligible for the maximum credit, Adjusted Gross Income (AGI), as a single tax filer, needs to be $19,000 or less for the tax year 2018 ($18,500 or less for the tax year 2017). 

After these thresholds, the credit begins to "phase out." Taxpayers earning more may claim a smaller percentage of their contributions to the funds. For the tax year 2018, a single filer with an AGI above $31,500 can't claim the credit ($31,000 for the tax year 2017). 

The Student Loan Interest Credit also undergoes a phase-out. This credit aims to reduce the tax bills for low-to-middle income taxpayers paying off eligible student loans. Qualifying taxpayers may deduct from their tax bill the amount they paid in student loan interest. The maximum tax credit they may receive is $2,500. 

To deduct all the student loan interest below the maximum, the MAGI must be $65,000 or less if filing single (the same as for tax year 2017). The student loan credit begins to phase out beyond this point, allowing less of the student loan interest paid deduction. The maximum MAGI for deducting any student loan interest is $80,000 if filing single (the same as for tax year 2017).

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