CARL WATTS & ASSOCIATES

August 05, 2013

www.carlwatts.com
office@carlwatts.com
Washington DC
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These are certainly the most important figures on your tax return and, if ever you felt confused or even intimidated by these acronyms, it is high time we clarify what they mean and how they influence your taxes.

Gross Income (GI) is the sum of your revenue for a given year and it includes: wages, salaries, tips , taxable interest, dividends, taxable refunds, credits, or offsets of state and local income taxes, alimony received, business income (or loss), capital gain (or losses), other gain or losses, income from retirement accounts, rental real estate, royalties, partnerships, S corporations, trusts, etc. income, farm income, unemployment compensation, taxable social security benefits and certain other kinds of income.

All these sources of income make up lines 7 to 21 on your 1040 Form.

Your Adjusted Gross Income (AGI) is calculated by deducting certain adjustments from your total GI. These adjustments make up lines 23 to 35 on your 1040 Form and include: IRA and self-employed retirement plan contributions, alimony payments, self-employed health insurance payments, one-half of any self-employment taxes paid, health savings account deductions, penalties on the early withdrawal of savings, educator expenses, student loan interest, moving expenses, tuition and fees, deductions for domestic production activities, certain business expenses of performing artists, reservists, and fee-basis government officials.

Your AGI affects the amount you can claim for the dependent care credit, credits for the elderly or permanently disabled, the adoption credit, the child tax credit, the Hope & Lifetime Learning credits, and the earned income credit.

Many deductions phase out or disappear altogether if you have an AGI above certain limits.

  • Total itemized deductions. The re-instituted phase-out limitation on itemized deductions cuts the amount of deductions you can take by 3% of AGI above the specified thresholds but you cannot lose more than 80% of the affected itemized deductions.

For the 2013 tax year, the Pease Limitation applies to single filers earning more than $250,000 and married couples filing jointly who earn more than $300,000. The rule caps deductions on mortgage interest, state income tax, property tax and charitable donations for taxpayers who are above the income threshold.

The limitation does not apply to deductible medical expenses, deductions for investment interest, casualty and theft losses and gambling losses. If you’re subject to the Alternative Minimum Tax, the Pease limitations don’t apply.

  • The fiscal cliff deal also reduced the personal exemption phaseout limit for high-income earners. Known as PEP, the limit on exemptions applies to taxpayers at the same income thresholds as Pease. What the limit does is reduces personal exemptions for affected taxpayers by two percent for every $2,500 of income above the threshold. For the 2013 tax year, the personal exemption is $3,900.
  • Miscellaneous itemized deductions. You can claim the amount of expenses that is more than 2% of your adjusted gross income.
  • Mortgage insurance premiums. Unless you are subject to the overall limit on itemized deductions, you can deduct all of the interest you paid during the year on mortgages secured by your main home or second home
  • Charitable contributions. In general, contributions to charitable organizations may be deducted up to 50% of your AGI computed without regard to net operating loss carrybacks.  Contributions to certain private foundations, veterans organizations, fraternal societies, and cemetery organizations are limited to 30% of AGI.
  • Medical deduction allowance. Beginning Jan. 1, 2013, you can claim deductions for medical expenses not covered by your health insurance when they reach 10% of your AGI. This change affects your 2013 tax return that you will file in 2014.
GI, AGI, and MAGI
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There is a temporary exemption from Jan. 1, 2013 to Dec. 31, 2016 for individuals age 65 and older and their spouses. If you or your spouses are 65 years or older or turned 65 during the tax year you are allowed to deduct unreimbursed medical care expenses that exceed 7.5% of your AGI. The threshold remains at 7.5% of AGI for those taxpayers until Dec. 31, 2016.

Your Modified Adjusted Gross Income (MAGI) is calculated by adding back some deductions to your AGI.

The definition of MAGI varies according to the purpose for which the related calculation is being used. These modified versions of AGI may add certain items to AGI that were excluded in computing both GI and AGI. According to the IRS, common additions include:

  • Student loan interest;
  • One-half of self-employment tax;
  • Qualified tuition expenses;
  • Tuition and fees deduction;
  • Passive loss or passive income;
  • IRA contributions, taxable social security payments;
  • The exclusion for income from U.S. savings bonds;
  • The exclusion under 137 for adoption expenses;
  • Rental losses;
  • Any overall loss from a publicly traded partnership.

For many taxpayers, AGI and MAGI will be the same, or at least very close. They differ only if you have one or more items from the above list to add to your AGI, and some of them are quite rare and obscure.

MAGI is used by the IRS to determine if a taxpayer is eligible to use certain deductions, credits, or retirement plans, like American Opportunity Tax Credit, Lifetime Learning Tax Credit, Student Loan Interest Deduction, Tuition and Fees Deduction, and the Earned Income Credit..

Your MAGI is the benchmark for determining how much of a deduction you can take on IRA contributions when you file taxes.

Also, MAGI is used to determine whether your Social Security benefits are taxable or not.

The Social Security Administration uses MAGI to determine the cost of Medicare premiums for Part B and Part D for higher-income beneficiaries.

Bottom line, you need to know the difference between AGI and MAGI for different IRS forms you may need to fill out; it is very important to read the instructions to the forms carefully in order to find the correct description of MAGI for whatever situation you are encountering.