Managing adjusted gross income for tax savings
By Steve Savant
The tax code uses adjusted gross income (AGI) to limit deductions, credits and exemptions on taxpayers the Treasury feels are gaining too many tax advantages from tax planning — the higher the AGI, the lower the benefits. Worse, each limitation uses different thresholds. Some even create something called modified adjusted gross income (MAGI). Phew, that's a mouthful!
In the case of determining how much Social Security income seniors will have taxed, the formula adds half the Social Security income and all the municipal bond interest to AGI to come up with the MAGI number. This can result in as much as 85 percent of all Social Security income being taxed. So much for Congress's promise several years ago that our Social Security income will never be taxed.
And here's a shocker: The government keeps telling us they are only going after rich people for taxes. Look what they are doing to our retired seniors.The MAGI threshold, where they start to tax Social Security income, is $25,000 for singles and $34,000 for married couples. At $34,000 for singles and $44,000 for married couples, they start including 85 cents of every dollar over that limit. Consider that half of the Social Security income is included in the MAGI and you can see people hit these numbers pretty quickly. For example, a person making $24,000 a year of Social Security income would have $12,000 added to MAGI. That means they only need other income of $13,000 for singles and $22,000 for married couples before Social Security income starts to be taxed. They are certainly not rich by any standard; does this look like the $250,000 the administration is throwing out as the threshold to tax the rich? To be fair, both parties have been in power for many years and have not adjusted these thresholds.
One of the things insurance agents can do to help manage AGI is to redeploy the money invested in interest bearing assets and assets throwing off capital gains into annuities and life insurance. Because these assets do not generate annual form 1099 income until distributions are made, simply moving money into them from other taxable assets may reduce AGI. That may reduce taxation of Social Security income, increase deductions, exemptions and credits that can be used to reduce income taxation.
The capital asset issue may surprise you. Capital gains flow from schedule D, form 1040, to the front page of the form 1040 at the full value of the gain. It is not until later that the lower capital gains rate of 15 percent or less is computed. So, while a $100,000 capital gain may only be taxed at a 15 percent rate, the full $100,000 is included in AGI, and therefore impacts the taxpayers tax bracket and various other tax breaks. This is a subtle but important concept. One income tax planning opportunity resulting from an IRA to Roth IRA conversion often seems to be missed. While a lump sum conversion may cause AGI to be high for one year, in future years AGI will be reduced by the amount the taxpayer might have taken out from the IRA to live on. The accumulation of annual reductions in AGI, going forward, could have a favorable impact on income tax brackets, taxation of Social Security income and the limitations on deductions, credits and exemptions. Overall, this could be significant. And surprisingly, it could reduce the Medicare premiums seniors pay because our benevolent government now assesses premiums based on AGI.
Many believe the outrageous deficits our government has created will cause them to raise taxes in the future. If that is true, then the Roth concept would be better than the regular IRA. Add the AGI issue with the increasing rates benefit and maybe Roth conversion does make sense.