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Sometimes the Score at Halftime DOES Matter

By Jeffrey Levine, Director of Retirement Education 
Follow Me on Twitter: @IRAGuru4EdSlott
 

On Sunday night we were treated to the first ever overtime in Superbowl history. It was a great game (with a lousy outcome – sorry, not a Pats fan). Of course, what most people will remember is that the Patriots finished off what may be the greatest comeback in sports history (that hurts to say), and that it was only the score at the end of the game that mattered. That may be true for the Superbowl, but it’s not always the case. As it turns out, sometimes the score at halftime does matter.

Take your tax return for instance. Yes, believe it or not, there is a halftime for your tax return. Just take a look at a 1040. It’s a two page form, and at the bottom of the first page (and also at the top of the second page) you’ve reached “halftime.” Halftime, on your tax return gets a special name, adjusted gross income, or AGI for short. 

When it comes to benefits or additional costs tied to your “income,” in the overwhelming majority of situations, it’s your AGI, or some variation thereof (known as modified adjusted gross income, or MAGI) that matters. Just consider the following list that shows a mere fraction of the items that are tied to AGI/MAGI:

-       How much of your Social Security benefits are taxable

-       How much you pay for Medicare Part B/D premiums

-       Whether or not you’re subject to the 3.8% healthcare surtax

-       Whether or not you can contribute to a Roth IRA

-       The amount your medical expenses must exceed in order to be deductible

-       Just about every personal income tax credit in the books

So why is this important? Because you have to understand that while you may be entitled to a certain tax break or deduction, if it doesn’t reduce your AGI, it will do nothing to help you with something tied to your AGI. Consider the following:

Jack and Jill are married and are 72 years old. Their AGI is $50,000 before they take their RMD for the year. A charitable couple, the two have decided to give away Jack’s $4,000 RMD to charity. If they chose to do so via a qualified charitable distribution, they would not receive any charitable deduction, but the $4,000 RMD would never be added to the couples AGI. Thus, if Jack and Jill needed to remain under $51,000 of AGI to qualify for a hypothetical tax break, they’d still be in good shape.

Suppose, however, that instead of making a QCD, the couple deposited Jack’s $4,000 RMD into their joint bank account and then wrote charity a check. Would charity get the same $4,000? Yes. Would Jack and Jill be able to claim an itemized deduction of $4,000 for their charitable contribution? Of course!

Here’s the problem for Jack and Jill; charitable contributions are an itemized deduction, and when it comes to your tax return, itemized deductions are a “third quarter” item. They do nothing to change the score at halftime on your tax return, and unlike the Falcons 21-3 lead at halftime of the Superbowl, this halftime score actually matters. So now, Jack and Jill have AGI of $54,000 and that hypothetical tax break they would receive by staying under $51,000? It’s gone.

Charity got the same amount, but Jack and Jill lost, all because the score at halftime changed.

Just look at the first page of your tax return. There’s no place to subtract amounts given to charity as a deduction, nor mortgage interest nor real estate or state income taxes. Those are often the biggest deductions on a person’s return, but they do nothing to change your halftime AGI score. They will help lower your taxable income, but that happens on the second page of your 1040, and that may not be good enough.

So just remember, when it comes to your taxes, sometimes the score at halftime is all that matters. Now if only that were true for the Superbowl.

 

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Posted in: jeffrey levine, AGI, QCD, Tax, MAGI