The Internal Revenue Code and state tax regulations are filled with complexities that can significantly impact your clients’ financial outcomes. While some provisions are straightforward, others create unexpected challenges that require careful planning and expertise.

The Progressive Tax System vs. Tax Cliffs

Most taxpayers understand the basic concept of tax brackets, though many mistakenly believe that earning more money means all their income will be taxed at a higher rate. As a tax professional, you know this isn’t true. The progressive tax system ensures that only additional income is taxed at higher rates, while previous earnings remain taxed at lower brackets.

However, there are notable exceptions to this progressive approach. In certain scenarios, earning just one additional dollar can trigger increased taxes or costs on previously earned income. These situations, known as “tax cliffs,” require special attention during tax planning to prevent costly surprises for clients.

Medicare IRMAA: A Federal Tax Cliff Example

One significant federal tax cliff appears in Medicare’s Income-Related Monthly Adjustment Amount (IRMAA). While this surcharge doesn’t appear directly on tax returns, it creates substantial additional costs for higher-income individuals. For the 2024 tax year (affecting Medicare costs in 2026), the threshold amounts for the lowest tier are:

• Married Filing Jointly: $212,000
• Single Filer: $106,000 

Exceeding these limits by even one dollar triggers an additional $1,052 per person in Medicare premiums. For married couples, this translates to $2,104 in increased annual costs — effectively creating a 210,400% tax rate on that single additional dollar.

New Jersey’s Pension Exclusion: A State-Level Tax Cliff 

New Jersey’s pension exclusion provides another compelling example of tax cliff effects. This provision offers tax relief to retirees by excluding certain pension income and IRA distributions from taxation. However, the system includes three critical breakpoints for married couples:

• First threshold: $100,000
• Second threshold: $125,000
• Final threshold: $150,000

Social Security benefits don’t count toward these thresholds, making the exclusion accessible to many retirees here in New Jersey. The most dramatic cliff occurs at the $150,000 threshold. A taxpayer with exactly $150,000 in income qualifies for a portion of the pension exclusion. However, earning just one additional dollar ($150,001) eliminates the entire exclusion, increasing state income taxes from $3,164 to $5,236 — a 207,200% effective tax rate on that single dollar.

Planning Implications for Tax Professionals

These examples illustrate why careful income planning is crucial for clients approaching these thresholds. When advising clients about Roth conversions, IRA distributions or other income-generating decisions, consider:

• The timing of income recognition
• Alternative income sources
• Multi-year planning strategies
• Coordination with other tax benefits and phase-outs

Remember, these examples represent just two of several potential tax cliffs in the current tax system. Maintaining awareness of these thresholds helps protect clients from “falling off the cliff” and suffering unexpected tax consequences. Offering this kind of analysis and guidance further showcases the value and impact of your professional tax planning services.