What Are PEP and Pease and Will They Return?
Explore two key tax provisions that were suspended, not repealed. Understand how they impacted high-income earners and why they are set to return automatically.
Two former tax provisions, the Personal Exemption Phaseout (PEP) and the Pease limitation on itemized deductions, once reduced specific tax benefits for higher-income individuals as their income increased. Both were suspended by the Tax Cuts and Jobs Act of 2017 (TCJA) and are not currently in effect. While this suspension simplified tax calculations, their potential return remains a topic of discussion.
The Personal Exemption Phaseout (PEP) Explained
Before its suspension, the personal exemption allowed taxpayers to deduct a set amount from their income for themselves, their spouse, and each qualifying dependent. For tax year 2017, this amount was $4,050 per person. The Personal Exemption Phaseout (PEP) was designed to reduce and eventually eliminate this benefit for taxpayers once their adjusted gross income (AGI) surpassed certain levels.
The phaseout was calculated based on income thresholds that varied by filing status. In 2017, the last year it was active, the reduction began for married couples filing jointly with an AGI of $313,800 and for single filers at $261,500. For every $2,500 (or fraction thereof) that a taxpayer’s AGI exceeded this threshold, their total personal exemption deduction was reduced by 2%. This reduction continued until the exemption was completely eliminated.
To illustrate, consider a married couple with two children in 2017. They could claim four personal exemptions, totaling $16,200 (4 x $4,050). If their AGI was $350,000, it exceeded the $313,800 threshold by $36,200. Dividing this excess by $2,500 gives 14.48, which is rounded up to 15. The 2% reduction rate is multiplied by 15, resulting in a 30% reduction of their total exemption. Their personal exemption deduction would therefore be reduced by $4,860 ($16,200 x 30%), leaving them with a final deduction of $11,340.
The Pease Limitation on Itemized Deductions Explained
The Pease limitation functioned to reduce the value of most itemized deductions for high-income taxpayers. It did not eliminate deductions but rather capped the total amount that could be claimed. This limitation applied to common deductions such as state and local taxes, home mortgage interest, and charitable contributions. Certain deductions were exempt, including medical expenses, investment interest expenses, and casualty or theft losses.
The Pease limitation was calculated based on the lesser of two amounts: 3% of the taxpayer’s AGI above a specific threshold, or 80% of the total itemized deductions subject to the limitation. In 2017, the AGI thresholds were the same as for PEP: $313,800 for married couples filing jointly and $261,500 for single filers.
For example, a single taxpayer in 2017 with an AGI of $361,500 would be $100,000 over the $261,500 threshold. If they had $50,000 in itemized deductions subject to the limitation, their reduction would be calculated. The first test is 3% of the excess AGI, which is $3,000 (3% of $100,000). The second test is 80% of their applicable deductions, which is $40,000 (80% of $50,000). The taxpayer would have to reduce their itemized deductions by the lesser of these two figures, which is $3,000, resulting in an allowable deduction of $47,000.
Suspension by the Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act of 2017 (TCJA) suspended both the PEP and Pease limitations starting with the 2018 tax year. The law altered the landscape of deductions, making the phaseouts temporarily irrelevant as part of a broader modification of the tax code.
The suspension of PEP was a direct consequence of the TCJA’s elimination of personal and dependency exemptions. Since the exemption was removed from the tax code, there was no longer a deduction to phase out. In its place, the TCJA increased the standard deduction and expanded the Child Tax Credit.
Similarly, the Pease limitation was made inactive by other TCJA changes. The law introduced a new $10,000 cap on the deduction for state and local taxes (SALT), which had been a large itemized deduction for many. This cap, along with the higher standard deduction, reduced the number of taxpayers who chose to itemize.
Current Status and Potential Reinstatement
Most of the TCJA’s provisions affecting individual taxpayers, including the elimination of personal exemptions and the suspension of the PEP and Pease limitations, are temporary. These provisions are scheduled to expire at the end of 2025 under a “sunset” provision.
If Congress does not pass new legislation, the tax code is set to revert to its pre-TCJA structure on January 1, 2026. This means personal exemptions would return, reinstating the Personal Exemption Phaseout. Likewise, the Pease limitation on itemized deductions would also come back into effect for high-income filers.
The income thresholds and exemption amounts would likely be adjusted for inflation from their 2017 levels. The return of these provisions would mean that higher-income taxpayers would again face limitations on their deductions, increasing their taxable income compared to the current system.