Telling Tips is a series of articles from local experts to help you save money, make better decisions and plan for a better future.
What do you think is the most important figure on your tax return?
a) Your refund?
b) Your wages?
c) Your adjusted or modified adjusted gross income?
d) Your taxable income?
Many concentrate upon the refund, ignoring everything that went into computing that figure. Many feel that the taxable income, the figure used to compute your income tax, is the most important. Others assume it’s the wages from working.
In truth, it’s your adjusted gross income (AGI) and your modified adjusted gross income (MAGI). Why? These are the jumping off points to determine your eligibility for many of your tax benefits.
What is the Adjusted Gross Income?
Adjusted Gross Income is your total gross income minus adjustments. Having this as low as possible will allow you more tax benefits, and therefore a lower tax bill.
The first step is to determine your gross income. Gross income is all of your income, including wages and salary, interest and dividends, rents and royalties, business income, alimony received, pensions and annuities, partnership income, state and local income tax refunds, capital gains and losses, jury duty pay, unemployment insurance. In other words, all income from whatever source, including income from accounts you have in other countries. (Not included here is public assistance, or income on tax exempt bonds.)
Secondly, you subtract various deductions, generally called “above the line” deductions. These include moving expenses, alimony you pay, educator expenses, early withdrawal penalties on savings accounts, 50 percent of the self-employment tax, self-employed health insurance, student loan interest, college tuition and fees, and IRA contributions. (The standard and itemized deductions are considered later, and therefore not subtracted at this time.)
After determining your gross income, and then deducting your expenses, you arrive at your Adjusted Gross Income. Several adjustments on your “Itemized Deduction Schedule,” Schedule A, are based on this figure, like your medical deductible of seven and a half percent and your ‘Miscellaneous Itemized Deductible’ of two percent. But there is more.
You may have heard the term “Modified Adjusted Gross Income” (MAGI). Certain items have to be added back to the AJI to computer the MAGI. These items include the deduction you took for the traditional IRA, student loan interest, and college tuition and fees, The MAGI is usually higher than the AGI. The MAGI is the figure used to determine if you can contribute to a traditional IRA, how much to a Roth IRA, and the taxable Social Security benefits.
Here’s the point: a number of items are affected by your AGI or MAGI:
- The taxable vs. non-taxable interest on U.S. Savings Bonds when cashed in to pay for college
- The allowable amount of a rental real estate loss deduction
- The taxable portion of your Social Security or Railroad retirement benefits
- Your deductible contribution to the traditional IRA
- Your ability to contribute to the ROTH IRA
- The student loan interest deduction
- The deduction for college tuition and fees
- Medical expense deduction
- Charity contribution deduction
- Casualty and Theft loss deduction
- Job & Miscellaneous expenses
- Personal Exemptions
- The Alternative Minimum Tax (AMT) computation
And more… including the credits for: child and dependent care; elderly or disabled; retirement savings, child tax credit; adoption tax credit; and the earned income credit.
Get the point? Each of the above has its own threshold. Oh, and don’t forget Social Security. An extra $1,000 of AGI can cost you 28 percent of this benefit.
So what can you do? Reduce your AGI:
- Maximize your contributions to your pension and other deferred plans, including the IRA
- Participate in your medical and dependent care flexible plan at work
- Review your investments, and sell those losers
- Consider US Savings bonds
- Pay medical expenses before year-end
- Make an extra mortgage payment in December
- Give a little more to charity
Call your tax preparer for advice. August is the slowest month of the year. Bother him/her. It’s your money you will be saving.
Have a good week.
Quip: “If you sell your soul to the Devil, do you need a receipt for tax purposes?”
Joseph Reisman, of Joseph S. Reisman & Associates, has been serving tax prep and business accounting expertise from his Coney Island Avenue office for more than 25 years. Check out the firm’s website.