The Journey Of Your Tax Refund

Once again, we find ourselves approaching tax time. That time when we are either excited to get back some of our hard-earned money, or disappointed to see that we owe even more than we’ve already paid. As we do our taxes, most of us have our eye on that one number, either the amount we owe Uncle Sam or what we have coming from him.
Folks, I agree that final number is really important, but this week I want to talk to you about a whole bunch of numbers scattered throughout your 1040 that can matter a whole lot to you as well.
As Ralph Waldo Emerson famously noted, “It’s not the destination, it’s the journey.” I know, no one looks fondly upon the journey of doing their taxes, but through this journey a very important number is calculated—some argue a number even more critical than the total tax owed or refunded. That number is found on line 37, Adjusted Gross Income, or AGI.
The AGI calculation is relatively straightforward. It is equal to the total income reported that is subject to income tax, including income from employment, self-employment and alimony, interest and dividends paid, capital gains recognized (potentially offset by losses) and distributions from IRAs; less certain specified deductions including contributions to retirement plans, student loan interest paid, moving expenses, self-employment tax, and other eligible “adjustments.”
As simple as it may seem to explain, that number has some hefty consequences. You see, if you are collecting governmental benefits, your AGI can determine how much of your Social Security benefits are taxable, how much you pay for Medicare Part B/D premiums, the minimum required level of medical expenses necessary for itemized deductions, as well as whether you are subject to the 3.8 percent Obamacare surtax. It can also affect whether or not you can contribute to a Roth IRA and whether or not you are eligible for certain personal income tax credits.
Also, items that fall “below” line 37 (technically, on page 2), Schedule A deductions such as charitable donations, medical deductions, mortgage interest and property taxes, all of which can help to lower your overall taxable income, get phased out if your AGI is above certain limits.
The goal should be to keep your AGI as low as you can, making you eligible for as many of those deductions as possible. So, how can you do that?
Charitable contributions are one way, but only if done correctly. If you simply write checks for those gifts, they are considered “below the line” deductions that do not lower AGI.
However, gifting directly from an IRA can lower your AGI in certain circumstances. The IRS allows us to withdraw up to $100,000 a year from an IRA, tax-free, to donate to a qualified charity. And if performed correctly, this donation can be counted toward that dreaded taxable required minimum distribution that must come out of your IRA every year after age 70 1⁄2. There are, however, strict rules that must be followed; for example, the distribution must go directly to the charity from the IRA, so please make sure you consult with a qualified retirement specialist.
A few weeks back, my colleague Susan Roman wrote a fabulous column, thoughtfully explaining the differences between tax-exempt Roth IRAs and tax-deferred Traditional IRAs. (If you missed it, go to www.www.cutter-copy.dev/all-iras-are-not-created-equal). One benefit to Roth IRAs, with respect to AGI, is that distributions don’t even show up on Page One, thereby not raising AGI. So, by planning ahead and funding Roth IRAs, to the extent possible, distributions that may be necessary to supplement fixed income will not increase AGI.
Keep in mind, conversions from a Traditional IRA to a Roth IRA will raise that income figure for that taxable year, so if considering a conversion, be very aware of the potential tax consequence. Again, I encourage you to consult with a qualified retirement specialist if you are considering this.
Oftentimes, the potential to reduce your AGI is based not just in how you file, but how you manage your finances throughout the year. This highlights the importance of having an advanced tax plan and finding ways to create “above the line” deductions every day of the year, not just on the day you sit down to file.
Folks, as I already mentioned, the journey of filing taxes might not be fun, but what you do on that journey can drastically increase your enjoyment when you reach your destination. Keeping an eye on your AGI, and planning how to best manage and lower it, can make that final number a lot more manageable.