In the early part of December each year we focus on year-end tax planning of our clients. The reality is, however, that December is too late to implement some really effective strategies—that planning should begin in January. One of the more effective tax planning strategies for taxpayers of all income levels is to manage their Adjusted Gross Income (AGI). AGI is the bottom number of Page 1 of your Form 1040 tax return. Why is managing your AGI important? Many items in your tax return are dependent on or limited by AGI. For example:
Expenses for Medical Expenses, Casualty Losses and Miscellaneous Itemized Deductions are only deductible to the extent they exceed a certain AGI threshold.
The amount of Social Security Income that is taxable is dependent on the total level of income.
The ability to claim Itemized Deductions and Personal Exemptions is phased out for taxpayers with higher levels of AGI.
The amount of one’s Medicare premiums is increased at certain AGI levels.
The ability to claim some passive losses is dependent on AGI.
Other tax items, such as IRA contribution limits, child care credits and the exclusion of savings bond interest for higher education expense have limitations when AGI exceeds a certain threshold.
How can one manage their AGI?
Where business or rental income is involved, it is sometimes possible to accelerate or defer the recognition of income. The timing of the payment of deductible expenses is also a factor.
Make a deductible retirement plan contribution.
Participate in a 401(k) plan or a “cafeteria” plan at work.
For those over 70-1/2 who have a traditional IRA, it is possible to direct an IRA distribution, including a Required Minimum Distribution (RMD), directly to charity, avoiding the IRA distribution being included in AGI. This is an added bonus for those who claim the Standard Deduction, effectively providing a charitable contribution deduction where it is not otherwise available. The contributions must be made directly from the IRA trustee to the charity, the charitable contribution acknowledgement rules must be followed, and it must be from a traditional IRA. Where the distribution might come from another type of account, such as a SEP, SIMPLE or 401(k), that account must first be rolled over (usually tax free) into a traditional IRA.
Given the results of the recent federal elections, it is safe to assume that there will be some changes in the tax law in 2017. How those changes will finally look is anybody’s guess at this stage, but one proposal is to increase the standard deduction from $6,350 to $15,000 for single individuals, and from $12,700 to $30,000 for married couples. This could make using IRA distributions for charitable contributions a significant tax planning strategy for qualified individuals.
Talk to us to see if managing your AGI is an effective strategy for you. If it is, the earlier in the year it is implemented the more effective it will be. I, for example, will fund my 2017 Church pledge through my RMD.