In a previous article, we reviewed what you need to know about your “Gross Estate.” An understanding of this concept is important when it comes to estate planning for the Federal estate tax and gift tax systems, as well as tax planning strategies that can benefit you from year to year.
What is My Adjusted Gross Income?
Another concept we wish to review is your “Adjusted Gross Income” or “AGI.” You have likely heard these terms many times while preparing your annual tax returns. However, your adjusted gross income is also a very important consideration for your estate plan. It impacts your ultimate taxable income, and thus your income tax liabilities. Therefore, it is also important towards realization of your short-term and long-term financial goals.
How to Calculate Your AGI
From a strictly tax-preparation perspective, your gross income is all receipts for the tax year, including:
• Salary
• Self-Employment Earnings
• 1099 Income (Investment Dividends and/or Retirement Income)
• Earned Interest on Taxable Accounts
When determining your final adjusted gross income, you are allowed certain credits and deductions to offset this amount. Possible credits and deductions include:
• Self-Employment Business Expenses
• Earned Income Tax Credit
• Dependent Credits
• Mortgage Interest
• State and Local Taxes
• Charitable Contributions
• Personal Gifts
Charitable contributions and certain personal gifts should be considered on an annual basis to reduce taxable income for the year and protect your estate assets in the future. [Please read my previous article on “How to Take Advantage of Non-Taxable Gifts” for more information.]
To calculate your adjusted gross income, you take your total gross income and subtract allowed tax credits and deductions. This determines your AGI, which is essentially your final taxable income for the tax year.
Tax-Deferred or Tax-Avoided Income and Investments
Certain income is not considered immediately taxable if it is invested into a tax-deferred retirement account such as an IRA or a 401(k). Other income can avoid taxation completely, such as income on a ROTH IRA or gains from investments in an Opportunity Fund (which has invested in an Opportunity Zone).
You will want to talk with your tax advisor for more specifics about what you can and cannot deduct as you prepare your tax return for any given year.
Adjusted Gross Income and Your Estate Plan
Now, I want to look at adjusted gross income from an estate planning perspective. How will understanding your AGI affect your important life planning and estate planning decisions?
Estate Tax Liabilities
Taxes (income and estate) are generally calculated based on a bracket system. The greater your wealth, the greater your possible estate tax. And the greater your income, the greater your possible income tax.
If you have (or may have) a taxable estate, your income (and increased wealth) may cause you to have (or have a greater) estate tax liability. While this is technically a “good problem” to have, certain planning strategies are available to reduce or eliminate this risk while simultaneously redirecting tax-sheltered income passed on to family and other loved ones.
Personal Gifts, Charitable Contributions, and Trusts
As part of your estate planning, you will want to consider implementing personal gift-giving, increased charitable contributions, and possibly the formation of a trust to reduce your annual tax liabilities, as well as those of your heirs when your final estate is transferred upon your death. For example, by your gifting income producing assets, you can remove this tax liability (and the resulting increased value of your estate). At the same time, you can create income and wealth for the recipient of your gift.
Knowing your adjusted gross income and calculating what it will be before the end of any calendar year can be a very beneficial process for wealthy individuals worried about their tax liabilities. You can then take proactive steps to reduce your future taxable income, while protecting your family and increasing their wealth.
As you develop and refine your estate plan, adjusted gross income is just one of many financial concepts to understand and utilize for more effective planning. For help with all your life planning needs, contact me today.
