The income phaseout could reduce or eliminate new deductions on the 2025 federal tax return, such as the senior citizen deduction, overtime pay, tips and auto loan interest.
Average tax refund expected to be even higher in 2026, according to IRS data
Tax season is here, and new data from the Internal Revenue Service shows the average tax bill will be even higher this year.
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- New tax credits for overtime, tips, seniors and car loan interest don’t disappear immediately when your income crosses the line.
- Some deductions, such as those for those over 65, will be completely phased out sooner than some people imagine.
Perhaps you’re wondering why you didn’t get an additional refund from the new tax credit for seniors? Or were you somehow ineligible for other new federal income tax benefits on tips, overtime pay, or car loan interest?
Thanks to these new deductions, millions of people are receiving larger tax refunds this year, while others are receiving far less cash than they imagined. One possible reason?
If you earn too much overall, you may only get a partial credit or no credit for these new tax breaks on your 2025 federal income tax return. These tax breaks also apply for the 2026, 2027, and 2028 tax years, so it’s important to understand how the Earned Income Graduation Works with these credits.
Tax experts say the phaseout threshold is not currently indexed to inflation.
The four major tax breaks that are part of the One Big Beautiful Bill Act (deductions for tip income, overtime pay, new car loan interest, and enhanced deductions for those 65 and older) are all packed with complex rules and limitations, including income thresholds. Even though the One Big Beautiful Bill was signed into law by President Donald Trump on July 4, these tax cuts are retroactive to sometime in 2025.
Oddly enough, each of these tax credits has different income limits, which can add to the confusion.
The way deductions are phased out based on income is also not always the same. For example, experts note that car loan interest deductions and senior citizen deductions end much faster than tip income and overtime deductions once a taxpayer exceeds a certain income threshold.
“One of the biggest misconceptions is the idea of an income ‘cliff,'” says April Walker, senior manager of tax and ethics at the American Institute of Certified Public Accountants.
But your deductions don’t automatically fall off a cliff.
“The new tax credits for overtime, tips, seniors and auto loan interest don’t disappear all at once once your income crosses a certain line,” Walker said. “But that is exactly what many taxpayers are thinking, and it is causing unnecessary anxiety.”
Instead, the amount allowed as a deduction will be phased out as your income increases, she said. “Even if you exceed the limit by a small amount, your deductible will be reduced by a small amount, not by a few thousand dollars,” Walker said.
We’re not just talking about wages. Your income may also be higher due to investment income or taxable income deductions from your regular 401(k) plan. Combining income could unexpectedly push taxpayers into the phase-out range.
And, said Mark Luscombe, principal analyst at Wolters Kluwer Tax & Accounting in Riverwoods, Illinois, “you might also be surprised by how quickly the deduction has phased out since it started.”
“In general, these phase-outs tend to be faster than other tax code provisions,” Luscombe said.
Here’s an overview of how the income phase-out works for each of the four deductions required by the new Schedule 1-A.
Mechanism in which overtime deductions will be phased out
The annual deduction limit for overtime pay on your federal income tax return is $12,500 for singles and $25,000 for married couples filing jointly.
The overtime deduction begins to decrease when a taxpayer’s modified adjusted gross income for that tax year exceeds $150,000 for unmarried individuals and $300,000 for married couples filing jointly. If a married couple files separately, they will not receive the deduction.
The OT deduction is phased out at a rate of $100 for every $1,000 above the threshold. This is similar to the phasing out of tip income.
If an unmarried taxpayer’s modified adjusted gross income reaches $275,000, the OT deduction is no longer available at all.
For married couples filing jointly, the deduction is completely eliminated once their modified adjusted gross income reaches $550,000.
Carl Breedlove, principal tax research analyst at H&R Block, gave one example. Assume that John, who is unmarried, has a modified adjusted gross income of $170,000 and earns $10,000 in deductible overtime.
Given his income, he is considering deducting $8,000 in overtime pay from his taxable income.
reason? His modified adjusted gross income is $20,000 above the single person threshold of $150,000.
$20,000 divided by $1,000 equals 20. 20 times $100 reduces John’s eligible overtime income of $10,000 by $2,000.
What is modified adjusted gross income? Basically, it is calculated by adding income to adjusted gross income.
Schedule 1-A re-adds income from Puerto Rico that we excluded from AGI, as well as income related to certain U.S. nationals from Form 2555 related to foreign housing and foreign earned income, and income related to tax relief from Form 4563 to exclude income from bona fide residents of American Samoa.
Enhanced elderly deduction system
A new temporary “senior bonus” will allow many taxpayers age 65 and older to deduct up to $6,000 of income on their federal returns. If both spouses are 65 or older, up to $12,000 can be deducted from their income.
If a married couple file separately, they will not receive the enhanced elderly deduction.
But tax experts say some seniors may be surprised to find out they can’t claim deductions of up to $6,000 or $12,000. How much tax you save depends largely on the amount of deductions you can claim based on your income.
Once the deduction begins to phase out for unmarried seniors with modified adjusted gross income of $75,000 and joint filers of $150,000, high-income seniors will receive a smaller tax cut or no tax cut at all. If a married couple files separately, they will not receive the deduction.
The enhanced senior tax deduction will phase out at 6% per $1,000, or $60 per $1,000. It will be completely phased out at $175,000 for single filers and $250,000 for joint filers.
Income limits for tip deduction
Waitstaff, blackjack dealers, lounge singers and other recipients of eligible tip income may be able to claim a new deduction of up to $25,000 on tip income earned in 2025.
The deduction for tip income will begin to be reduced or phased out for unmarried taxpayers with modified adjusted gross incomes above $150,000 and married couples filing joint returns with modified adjusted gross incomes above $300,000. If a married couple files separately, they cannot claim the tip income deduction.
This deduction will eventually phase out at a rate of $100 for every $1,000 above the threshold.
The tax break on tip income completely phases out once adjusted gross income reaches $400,000 for single filers and $550,000 for married couples filing jointly.
If you’re married, remember that you’re looking at the couple’s modified adjusted gross income, not just the spouse receiving the tip income.
Why interest rates on car loans gradually decrease
Higher-income households are more likely to buy new cars, but many taxpayers may find themselves reaching the income threshold needed to qualify for a deduction for the interest paid on a new car loan.
Starting with their 2025 tax return, eligible new car buyers can take a new deduction of up to $10,000 in auto loan interest during a given tax year. New vehicles must be for personal use.
The new auto loan deduction will phase out by $200 for every $1,000 or portion thereof of modified adjusted gross income that exceeds $100,000 for single filers and $200,000 for joint filers.
Given this formula, many taxpayers end up missing out on up to $10,000 in deductions more than they expected. For unmarried taxpayers, spending $10 above the $100,000 threshold will reduce your auto loan deduction by $200.
“So technically, the upper end of the phaseout range would be $149,001 for single filers and $249,001 for joint filers,” Luscombe said.
Most simply, many tax websites will state that the auto loan interest deduction is no longer available when your modified adjusted gross income reaches $150,000 for single filers and $250,000 for joint filers.
Luscombe noted that the phrase “or a portion thereof” is used only for the auto loan interest deduction, not for the OT deduction, enhanced senior citizen deduction, or tip deduction.
Phase-out means that once your income reaches the phase-out threshold, you no longer qualify for the maximum tax reduction. However, if your income does not exceed the maximum income limits for claiming certain deductions, you may be eligible for some benefits.
What’s unusual: If a married couple files separately, they can’t claim deductions for overtime pay, tips, and the enhanced senior citizen deduction. But tax experts now say the rules are different when it comes to interest on new car loans.
“Taxpayers filing using the married couple’s separate filing status can claim the auto loan interest deduction as long as they meet the other requirements for the deduction,” said H&R Block’s Breedlove.
Breedlove acknowledged that some confusion exists because the auto loan deduction is not exactly the same as the other large deductions on Schedule 1-A.
Other limitations: The auto loan interest deduction only applies to new cars, not used cars or leases. New cars or trucks must undergo final assembly in the United States. That means it’s physically assembled at a factory in the U.S. before being shipped to dealers.
And, admittedly, the steps from when the deduction is reduced to when the deduction is completely eliminated can be very confusing.
“The phase-out is not intuitive,” said Tom Oseven, registered agent and director of tax content and government relations at the National Association of Tax Professionals.
In general, many taxpayers mistakenly believe that simply qualifying for a credit is not the same as receiving the full amount of the credit, such as the $6,000 maximum credit for adults age 65 and older.
H&R Block’s Breedlove noted that most tax software determines the phase-out for taxpayers, but they can also estimate deductions by doing their own calculations.
Oseven, who is based in Illinois, typically works with 500 to 600 clients from a wide range of income levels during tax season. As a result, he said, the impact of the phaseout was much more pronounced when filing returns, especially among retirees and upper-middle-income taxpayers.
“We are definitely seeing older adults phase out sooner than expected,” Oseven said.
In some cases, minimum distributions from 401(k)s and IRAs are increasing seniors’ incomes, Oseven said.
For example, someone who can only deduct $2,000 under the income-based enhanced senior tax deduction may only save $240 in taxes if they’re in the 12% marginal tax bracket.
In contrast, for someone in the 12% marginal tax bracket who can deduct the full $6,000 of the enhanced senior tax deduction, the tax savings would be $720.
Contact personal finance columnist Susan Tompol: stompor@freepress.com. follow himr X @tompor.
