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AGI and Allowable Deductions

May 19, 2019

When we use the terms “above-the-line” and “below-the-line,” what does the “line” refer to? The answer is simple: the line is the demarcation between your adjusted gross income and taxable income. Your adjusted gross income (or AGI) is your gross income less any adjustments (or deductions) you claim. Your AGI is the figure you use to compute your taxable income. And your taxable income is the figure you use to ultimately determine your tax liability. Taxpayers should always aim to make their AGI as low as possible. 

We’ve pointed out on several occasions that tax avoidance is the legal minimization of one’s tax burden. There is no offsetting legal principle that holds that a taxpayer must pay as much tax as is theoretically possible. In fact, there is a very real attitude that minimizing one’s tax liability is both wise and ethical. When we minimize our tax liability through legitimate means, we are exercising sound money management principles. We are demonstrating that we desire to stretch our earnings as much as possible. Lawful tax avoidance stems from principles which should be promoted throughout our entire society.

Modified AGI

In addition to AGI, taxpayers should also be aware of the modified AGI, or MAGI. Modified AGI is essentially just a taxpayer’s AGI, increased by certain items. MAGI is an important concept because it can also affect a person’s eligibility for various tax credits. What’s more, modified AGI is also used in the computation of the Medicare investment surtax, which we’ve discussed before.  

To Minimize Taxes, Maximize Deductions

The distinction between above-the-line and below-the-line deductions is highly useful from a tax avoidance perspective. As we will explore in detail, above-the-line deductions can have a benefit beyond their face value. Taxpayers who wish to pay as little tax as possible should maximize their above-the-line deductions in all instances. In this post, we will discuss the distinction between these different types of deductions. We will also highlight the benefits of above-the-line deductions.  

The Distinction Between Above-the-Line and Below-the-Line 

An above-the-line deduction, also referred to as an “adjustment to income,” directly reduces your AGI. In other words, this type of deduction reduces the amount used to compute your tax. This means that an adjustment to income can be utilized regardless of whether you itemize your tax return. Itemized deductions are deductions taken to AGI, which occurs “below-the-line.” But adjustments to income literally offset your gross income above-the-line and go toward the computation of your AGI. Common examples of above-the-line deductions include alimony, traditional IRA contributions and student loan interest. Self-employed health insurance premiums, half of the self-employment tax, and qualified tuition also may be deducted above-the-line

Above-the-line deductions may have benefits which go beyond their face value. In other words, a $1,000 deduction above-the-line may have a new impact greater than $1,000. This is because a lower AGI will affect the application of other tax benefits and below-the-line deductions. Reducing your AGI may also reduce your taxable Social Security and retirement benefits. As an example, if you take an itemized deduction for job-related expenses, this deduction will be reduced by 2% of your AGI. Hence, a lower AGI will therefore translate into a higher deduction and lower tax liability. This is one way in which above-the-line deductions contribute beyond their face value. 

Below the Line Deductions to AGI

Below-the-line deductions are simply those take place after AGI. The average layperson is familiar with the most common below-the-line deductions. Business expenses for self-employed people and small business owners, child tax credits, the standard deduction. These are all examples of post-AGI calculation deductions. Unlike above-the-line deductions, below-the-line deductions always have a net impact which is the same as their face value. If a person takes a deduction below AGI for $1,000, then the net impact will be to lower taxable income by $1,000. 

Like below-the-line deductions, above-the-line deductions can be falsified. Many taxpayers run into trouble with the IRS for falsely taking below-the-line deductions, such as business expenses. The same thing can happen with above-the-line deductions. Above-the-line deductions are probably more likely to be scrutinized by the IRS because of their greater potential tax benefit. A taxpayer who claims an inordinate amount for an above-the-line deduction will add risk to his return. Taxpayers should be sure that they can substantiate all deductions, both above and below-the-line. 

Call Mackay, Caswell & Callahan For Tax Help

As we’ve seen, the distinction between these types of deductions is critical for optimizing your tax return. Taxpayers should take as many adjustments to their income as is legally possible to minimize their AGI. Lowering AGI will contribute toward ultimately minimizing taxable income. If you want to stay out of tax debt, one thing you can and should do is minimize your tax burden. The team at Mackay, Caswell & Callahan, P.C., is all-too-familiar with this issue. We know that back tax debt can be emotionally and psychologically crippling, and so taxpayers need to go the extra mile to avoid it. Utilizing good tax avoidance techniques is an important part of that process. If you still find yourself in tax trouble, though, you don’t have to fight the problem alone. Consider reaching out to one of our top New York City tax attorneys for help.

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