Qualifying for Tax Breaks by Controlling Your Adjusted Gross Income

Mike Piper The Oblivious Investor writes: As we discussed a few weeks ago with regard to the Retirement Savings Contribution Credit, if you’re careful to pay attention to the applicable income limits (and how your income compares to those limits), you may be able to adjust your retirement account contributions slightly and in the process either make yourself eligible for the credit or increase the percentage used to calculate the credit.

As a few readers correctly pointed out, similar planning can be used to qualify for other tax breaks as well. (To which I would add that it can also be used to avoid being subject to certain negative tax provisions.)

For example, whether you are eligible for (or subject to) each of the following tax provisions depends (in part) on your adjusted gross income (i.e., your taxable income before subtracting your exemptions and standard or itemized deductions) or your modified adjusted gross income:

• The Lifetime Learning Credit,
• The American Opportunity Credit,
• The student loan interest deduction,
• The earned income credit,
• The child and dependent care credit*,
• The Affordable Care Act credit for health insurance purchased on one of the new exchanges,
• The personal exemption phaseout,
• The “Pease” limitation on itemized deductions, and
• The 3.8% tax on net investment income.

Admittedly, given that each of these tax provisions has its own income limit, it’s quite cumbersome to keep them all memorized such that you can always tell whether you’re close to qualifying for any other tax breaks.

For uses like this, tax software can be super helpful. You can simply try modifying your most recent return by bumping up pre-tax contributions of some sort (e.g. 401(k) or HSA contributions) by a few different amounts to see what happens with each change. Do any new tax credits or deductions appear? Or does anything else interesting happen, such as having some of your long-term capital gains or qualified dividends fall into a lower tax range such that they go from being taxed at 15% to not being taxed at all? (The catch, of course, with such experimentation is that tax software for the 2012 tax year will not account for tax provisions that are new in 2013.)

A Point of Caution

When trying to qualify for a given tax break, it’s important to check whether eligibility depends on your adjusted gross income (AGI) or your modified adjusted gross income (MAGI). Your modified adjusted gross income is your adjusted gross income, with a certain deduction (or a few deductions) added back in. But which deductions are added back in when calculating MAGI varies depending on which tax break we’re talking about. In other words, there are several different definitions for modified adjusted gross income.

The reason this is important is that you would not want, for example, to try to qualify for a given tax break by increasing your traditional IRA contributions if the tax break you’re trying to qualify for uses a definition of MAGI in which traditional IRA contributions are added back into AGI.

*Your eligibility for this credit is not actually a function of your AGI. Rather, theamount of the credit is a function of your AGI.