Your adjusted gross income (AGI), which is your gross income minus deductions such as retirement contributions and other adjustments, is one of the most important numbers in your entire tax return. It’s used to determine limits on many types of deductions, credits, and tax rates, as well as a variety of tax benefits.
By reducing your AGI, you can increase your itemized deductions, including medical expenses, which are reduced by 10 percent of your AGI (7.5 percent if you or your spouse is age 65 or over); miscellaneous deductions, which are reduced by 2 percent of your AGI and include costs such as unreimbursed employee expenses and tax preparation fees; and casualty losses, which are reduced by 10 percent of your AGI plus $100.
What are some strategies for reducing your AGI so that you can responsibly reduce your taxes?
Reduce your income
Do you operate a profitable business and report it on a Schedule C? In that case, make sure you deduct all ordinary and necessary expenses. According to the IRS, “ordinary expenses” are common and accepted in your trade or business and “necessary expenses” are helpful and appropriate for your trade or business.
Do you have rental property? Be meticulous about documenting your costs to operate the property, including expenses such as taxes, maintenance, and insurance.
Are you expecting substantial capital gains this year? Sell off some of your underperforming investments or securities to absorb those gains. You will be able to deduct up to $3,000 of capital losses in excess of capital gains.
Increase your above-the-line expenses (adjustments to income)
So-called “above-the-line deductions” can reduce your income before your AGI—“the line”—is calculated. On Form 1040, these deductions can include retirement contributions, health insurance deductions, and student loan interest deductions, among other things.
The above-the-line expenses that the average person has most control over are related to retirement.
If you’re self-employed, for example, you can make deductions related to certain retirement plans on line 28. Retirement plans for self-employed individuals allow as much as $52,000 for contributions to SEP-IRAs and 401(k) plans. There are lower limits for other plans. And line 32 allows up to $5,500 ($6,500 if age 50 or older) for deductible IRA contributions for employees.
Line 36 holds special secrets: Scroll down on this page in the IRS instructions to find nine deductions that don’t appear anywhere else. They include repayment of unemployment benefits, deductions related to not-for-profit rental activities, and more. Most of the other lines are self-explanatory, but you can also look up the details in Publication 17.
Bear in mind that when you manage to reduce your AGI as much as legally possible, you also reduce the impact of the Alternative Minimum Tax (AMT). Therefore, it’s worth delving even further into the details of lines 24 through 36 on your Form 1040.
Reducing your AGI can help you pay fewer taxes, but it can also be confusing. Consider enlisting the help of a tax professional to help ensure you maximize your savings.
Eva Rosenberg, EA is the publisher of TaxMama.com ®, where your tax questions are answered. She is the author of several books and ebooks, including Small Business Taxes Made Easy. Eva teaches terrific courses that might help individuals and small businesses at CPE Link.