Year-End Tax Planning: Who Should Try To Reduce AGI For 2010?
There is a great deal of uncertainty over which income tax rates will apply for 2011.
Unless Congress acts, virtually everyone will be subject to higher rates starting next year, but few expect that this “doomsday scenario” will become reality.
Congress may leave the current rate structure unchanged for everyone for 2011, or it may increase rates for “higher income individuals.” This uncertain state of affairs leaves many in a quandary about year-end tax planning moves.
This article considers when it would be wise to reduce Adjusted Gross Income, or AGI, for 2010, for example by deferring income till next year.
Who should try to reduce AGI for 2010?
Numerous tax breaks are reduced or eliminated if a taxpayer's AGI, or modified AGI (MAGI), exceeds specified thresholds.
As year-end nears, taxpayers who do not anticipate being subject to higher rates next year should consider reducing their 2010 AGI by deferring taxable income into 2011, or by accelerating deductions, if doing so will keep their income level for the current tax year below the relevant phase-out thresholds (or will mitigate the effect of the phaseouts).
The following are some tax breaks whose availability is limited by AGI (or MAGI). Some of these breaks may themselves be made less available in 2011 as a result of the sunset provisions.
(1) A nondeductible Roth IRA contribution can be made of up to $5,000 (up to $6,000 if age 50 or older). For joint returns, the allowable contributions to a Roth IRA phase out for MAGI between $167,000 and $177,000. For singles and heads of household it phases out for MAGI between $105,000 and $120,000. For married taxpayers filing separate returns, the allowable contribution phases out for MAGI between $0 and $10,000.
(2) The AGI phaseout for making deductible contributions to traditional IRAs by active participants in an employer-sponsored retirement plan begins at $89,000 of MAGI for joint filers and the deduction is phased out completely at $109,000 of MAGI. For singles or heads of household, the phaseout begins at $56,000 of MAGI and is complete at $66,000. For married filing separate returns, the otherwise allowable contribution phases out for MAGI between $0 and $10,000.
(3) If one isn't an active plan participant but his spouse is, the nonparticipant spouse isn't subject to the traditional IRA deduction phaseout range, but can make full deductible contributions to a traditional IRA as long as the couple's combined MAGI doesn't exceed $167,000. The deduction is phased out where the combined MAGI is between $167,000 and $177,000.
(4) Taxpayers are allowed a $1,000 child tax credit for each qualifying child under age 17. The amount of the credit allowable is reduced by $50 for each $1,000 (or part of a $1,000) of MAGI above $110,000 for joint filers, $75,000 for single filers, and $55,000 for marrieds filing separately.
Observation:
Pegging the phaseout in $50 increments means that for some a $1 increase in AGI can trigger a $50 increase in tax liability.
(5) Qualifying taxpayers may claim an American Opportunity Tax Credit of up to $2,500 per student. Also, there's a Lifetime Learning Credit of up to $2,000 per qualifying taxpayer. The credits are for higher education expenses paid by taxpayers for themselves, their spouses and their dependents.
The American Opportunity Tax Credit is reduced at MAGI between $160,000 to $180,000 on joint returns, and between $80,000 and $90,000 on other returns. The Lifetime Learning credit phases out for taxpayers with MAGI of $100,000 to $120,000 on joint returns, and between $50,000 to $60,000 on other returns.
(6) Individuals may take a deduction for up to $2,500 of interest on qualified education loans, but the amount deductible is reduced at MAGI between $120,000 and $150,000 on joint returns, and between $60,000 and $75,000 on other returns.
(7) The adoption assistance/adoption credit begins to phase out when MAGI exceeds $182,520 and are gone at $222,520 of MAGI. The total expenses that may be taken as a credit for all tax years for the adoption of a child by the taxpayer is limited to $13,170. The per-child exclusion for employer-provided adoption assistance also is limited to $13,170.
(8) For qualifying purchases of principal residences in the U.S. before Oct. 1, 2010, eligible first-time homebuyers may claim a refundable tax credit equal to the lesser of 10% of the purchase price of a principal residence or $8,000. This credit phases out for individual taxpayers with MAGI between $125,000 and $145,000 ($225,000 and $245,000 for joint filers) for the year of purchase.
There are other items of income, deduction, credit, and exclusion that are affected by levels of AGI or MAGI. Key items affected are: miscellaneous itemized deductions; Social Security benefits taxation; medical expense deduction; and nonbusiness casualty loss deductions.
Should some increase AGI in 2010?
On the other hand, for taxpayers who do anticipate being subject to higher rates next year the best bet might be to take the opposite tack: accelerate as much income as possible to take advantage of today's rates even if some tax breaks are reduced because of the effect of increased AGI on phase-out thresholds.
Comparative calculations would of course have to be made to see just how much the advantage of lower rates might be offset by the loss of tax breaks.
Also, for 2010, neither itemized deductions nor personal exemptions are phased out at higher levels of AGI. However, under the sunsets, for 2011, most itemized deductions of higher-income taxpayers will be reduced by 3% of AGI above an inflation-adjusted figure, and a higher-income taxpayer's personal exemptions are phased out when AGI exceeds an inflation-adjusted threshold. If the sunset provisions go into effect, this could be a reason for affected taxpayers to accelerate income to 2010 from 2011.
Others who should consider deferring income.
Income deferral also may aid those in the following situations:
- Retirement, unemployment, or a business slowdown will result in a drop into a lower tax bracket next year.
- A child next year will escape the kiddie tax and be in a lower bracket than his parents.
- A change from single to head-of-household status will occur in 2011 so that more income will be taxed at a lower rate.
In two weeks, we’ll discuss how to reduce AGI for those who would benefit.
