Tax Tips: Determining Adjusted Gross Income
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[For tax preparation options and discounts for military families and veterans, see theMilitary.com Tax Prep section.]
A scene from 1981's Raiders of the Lost Ark describes the proper staff height from which a jeweled medallion affixed on top and placed in a map room at a specific time of day will reveal where the Ark of the Covenant is hidden. Markings on one side of the medallion prescribes a "six Kadan height" but then the other side calls to subtract "one Kadan" to build the correct staff height. Six Kadan equates to Gross Income; one Kadan refers to exclusions and deductions made to calculate Adjusted Gross Income (AGI) – the actual amount of income reported to the IRS.
- Gross Income Exclusions
- Above the Line Income Deductions (Adjustments)
= Adjusted Gross Income (AGI)
AGI determination is a crucial, intermediate step to determining taxable income. Allowable reductions in AGI (Above the Line deductions) can have a compounding effect on post-AGI deductions and increases the availability of other tax credits.
Part 1 defined Gross Income as the aggregated income from all sources, minus allowable exclusions, with some common sources of household income including all W-2s; State / Local Tax Refunds; Investment Interest and Dividend Income (1099-INT / 1099-DIV); Rental Income (Schedule E); Mutual Fund and Stock Sales (1099B); IRA and Pension Income (1099R); and Social Security Income. Compensation for active service in a combat zone (with specific limits for commissioned officers) is excluded from Gross Income as well as BAH, other living, travel, and specific moving allowances. However, compensation in a combat zone is included in determining the tax-deductible portion of Traditional IRA contributions.
A key Gross Income exclusion available to all service members and employees with defined contribution retirement plans are elective deferrals into Thrift Savings Plans, 401Ks, 403Bs, and 457Bs.
Above the Line deductions are available regardless of whether the taxpayer claims itemized deductions or uses the standard deduction ($12,600 Married Filing Jointly / $6,300 Single / $9,250 Head of Household). There are many deductions available, but some pertinent to service members include the following:
All deductions attributable to a trade or business. Some myth busting is in order. The IRS has ruled employment in the Armed Forces a trade or business. Military personnel are able to deduct unreimbursed expenses such as meals and tips, lodging, transportation, car expenses, business telephone calls, laundry / dry cleaning of uniforms, dues / subscriptions, and education. However, it requires taking itemized deductions over the standard deduction (not necessarily advantageous) and deducted expenses are limited to only those exceeding 2% of AGI. It does not reduce AGI itself(1); for example, a military member reporting $50,000 in AGI and claiming $1,100 in unreimbursed expenses could only deduct $100.
There is an exception for Reservists traveling more than 100 miles away from home to perform duties. Expenses are an Above the Line deduction and are available even if taking the standard deduction. It is limited to the regular Federal per diem rate (lodging, meals, and incidental expenses), the standard mileage rate plus any parking fees, ferry fees, and tolls.(2)
Deductions attributable to rental property. Expenses from rental property income reported on Schedule E directly reduces AGI up to the amount of income received. Excess expenses can be carried over to the subsequent tax year against rental income, and subject to special rules, against other types of income.(3)
Losses from a home sale. Only losses associated with property used in a trade or business and investment property are deductible and are subject to special rules.(4) Selling a rental property at a loss may be deductible; selling your primary residence at a loss is not.
Moving Expenses. Unreimbursed moving expenses are deductible.
Traditional IRA Contributions. Review Block 13 of your household W-2s. The full deduction is allowed in all cases if you and your spouse are not covered by a retirement plan. Otherwise, the full deduction is limited to annual incomes below $59,000 (Single) and $95,000 (Married Filing Jointly) with deduction phase out between $59,000-$69,000 (Single) and $95,000-$115,000 (Married filing jointly).(5)
Qualified Higher Education Expenses. Includes tuition and fees paid for the attendance of the taxpayer, spouse, and dependents at a post-secondary institution offering credit toward a degree or other recognized education credential.(6) Single taxpayers under $65,000 AGI and Married Filing Jointly households under $130,000 AGI can claim a $4,000 deduction; Single between $65,000-$80,000 and Married Filing Jointly between $130,000-$160,000 can claim $2,000.(7)
Deductible interest payments on qualified education loans. Deductible and reported on a 1098-E.
Lowering AGI through Gross Income exclusion and above the line deductions affects reported taxable income and other deductions / credits further down in tax filing preparation. A key takeaway is how pre-tax contributions such as TSP, 401K, and related retirement savings plans not only help in long term savings, but lower the current year tax bill.
Todd Severance is a 1992 graduate of the U.S. Naval Academy with an MBA from the University of Arizona. He is a naval officer (Selected Reserve) with nearly 15 years active-duty experience. Todd is pursuing his Certified Financial Planner and is a business consultant with Echelon Group in Boise, Idaho.
Echelon Group provides Employee Benefits, Retirement Plans, Investment Management; Financial Planning and additional services to companies, its employees, and individuals.