Decreasing your AGI is, for many people, a red herring. There are many extremely valuable AGI-increasing tax strategies which should be considered instead. These include intentionally realizing gains, Roth contributions, and Roth conversions. All of these strategies offer long term tax savings, especially when implemented each year, for the average tax payer.
That being said, there are scenarios where lowering your AGI as an exception this year can produce such significant savings that it is worth deviating from your previous strategy for one or two years. To that end, I have compiled these lists.
Why You’d Want To Lower Your AGI
- Lower Taxable Income. AGI is the first stop on the way to taxable income, so lowering AGI will lower your taxable income.
- Increase Itemized Deductions. The Medical Expense Deduction and the Misc Investment Expense Deduction (which is how you can deduct an advisor’s management fee) are both reduced by a percentage of your AGI. If these are significant deductions for you, lowering your AGI can help lower your tax bill by effectively lowering your taxable income twice, one above the AGI line and one below.
- Decrease Phase-outs / Increase Exemptions. If you’ve been hit with phase-outs of your Itemized Deductions and Exemptions but remain close to or in the phase-out range, lowering your AGI may be able to bring back some of those valuable reductions, helping your tax bill twice.
- Lower Medicare Premiums. The Medicare premium surcharge is based on AGI. If you’re close to a surcharge line, lowering your AGI might be able to shave a few dollars off your monthly premium.
- Decrease Alternative Minimum Tax (AMT). AMT is not based on AGI, but depending on what you do to reduce your AGI, you may be able to move out of (or sadly into) AMT.
- Increase Financial Aid. Income (as assessed by your AGI) is counted five times more than your assets when assessing financial aid for you or your children. Lowering your AGI starting two years prior to the year you apply for aid can increase your chances of receiving grants significantly.
- Do More Roth Conversion. If you’re trying to squeeze as much Roth conversion into one calendar year (say, the year before RMDs start), then lowering other parts of your AGI this year can help lower your tax bill on the conversion now.
- Qualify for Welfare or Subsidies. A lot of welfare programs are based on AGI, including Affordable Care Act subsidies. Lowering your AGI may be able to move you into state or federal benefits.
How to Lower Your AGI
- Take Advantage of Employer Benefits and Retirement Salary Deferrals. Deferring your employee income into a pre-tax employer-sponsored retirement plan makes that income not even show up on your tax return. It is pulled out before it gets to the wages line, lowering your AGI dollar-for-dollar.
- Deductible Contributions. There are a few above-the-line deductions (where “the line” is AGI) that as a result lower your AGI. Among then are Health Savings Account, Traditional IRA, and SIMPLE or SEP-IRA contributions.
- Tax-Loss Harvesting. Harvesting a net capital loss can reduce your AGI by $3,000 each year.
- Qualified Charitable Distributions (QCDs). After age 70 1/2, you can donate your required minimum distribution (RMD) to charity directly as a QCD and, in doing so, have it not even appear on your Taxable IRA Distributions line.
- Modify State Tax Payment. A quirk of the tax code is that taxable refunds are included in AGI while the deduction for state taxes paid is a below-the-line deduction in Itemized Deductions. As a result, setting your state tax withholding more accurately and not overpaying your state tax bill lowers your AGI.
- Slow Down Student Loan Repayment. The slower you pay off your student loans, the more of your payment is interest which can be deducted above-the-line. Also, the more money you can have growing in your investment account (see “How Quickly Should I Pay My Student Loans?“)
- Pay Your Family. If you own your business, hire non-spousal family members. This puts income on their tax return and takes it off your tax return. This will decrease your AGI by increasing their AGI.
- Take a Sabbatical. Some jobs allow for your to take a year or less of unpaid leave before returning to your position. If you and your retirement can afford it, this is an easy and fun way to lower your AGI.
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