In CPA lingo, we often refer to an item of income or expense as “above the line” or “below the line”. The “line” is the number on the last line of the first page of your Form 1040 (US Individual Income Tax Return) and is your Adjusted Gross Income, or “AGI”. It is the net difference of your “Total Income” about halfway down on page 1 and the adjustments to your income in the lower section of page 1, hence the title “Adjusted” Gross Income. Anything below that line does not affect your AGI, but it may be affected by
A few areas having an AGI that is too high
will cost you are:
· Your personal exemptions
· Up to 3% of your itemized deductions
· The ability to contribute directly to a Roth IRA
· The ability to deduct contributions to Traditional IRAs (TIRAs)
· The ability to contribute to Education Savings Accounts (ESAs)
· Financial aid for higher education
· The deduction for education loan interest
· Higher taxes on Social Security
· Higher Medicare premiums
The above are all relevant, depending upon the stage at which you’ve reached in your career. In medical school, a low AGI could help qualify you for government-based aid. In residency and fellowship, AGI could affect your student loan interest deduction and your IRA contribution deductions. As an established attending, lowering your AGI can increase your itemized deductions and personal exemptions. And, of course, AGI still matters in retirement as you face Medicare premiums and Social Security taxation.
Some things not affected by AGI are:
· The ability to deduct contributions to an HSA (Health Savings Account)
· The exclusion of the first $250k per spouse in qualified home sale gains
· Qualified plan contributions to 401ks, 403bs, 457s, etc.
And here are a few strategies that will help reduce your AGI:
· Classify payments to your ex-spouse as alimony rather than child support (this must be handled in the divorce decree).
· Take some of your retirement distributions from a Roth IRA rather than a 401k or TIRA
· Strategically time taxable Roth conversions for years your income is low
· Classify expenses as business (above the line) rather than personal (below the line) when appropriate. An example is supporting a local event in return for advertising. By misclassifying as a donation (very common) rather than advertising, you are taking a deduction on Schedule A (below the line) rather than as a reduction in business profits (above the line).
· Segregate mortgage interest and real estate taxes on rental property and farm businesses (above the line) from personal interest and taxes (below the line).
· Deduct part of the cost of tax preparation from moonlighting and rental income (above the line) rather than 100% on Schedule A, where it is not only below the line, but wasted on high-income professionals.
· Use section 179 to take a larger depreciation deduction when it will help reduce your AGI the most (this means planning ahead for necessary
equipment purchases, especially as you near year-end).
· Reimbursing yourself through your business under an accountable plan (your business will deduct your reimbursement when paid and it won’t be taxable to you!)
· Contributing to a SEP, SIMPLE IRA, or SOLO-401k plan.
· Contributing to an HSA or buying self-employed health insurance
Once you get used to thinking in terms of the effect on AGI, I’m sure you’ll find other ways to reduce it. AGI is the primary number the IRS refers to when granting and removing tax benefits, so the effect on AGI should always be considered when you are making a financial decision that could impact your taxes.