Calculating MAGI Under the Tax Cut and Jobs Act

Transcription

1 Calculating MAGI Under the Tax Cut and Jobs Act Presented on October 17, 2018 By I. Richard Gershon Professor of Law University of Mississippi School of Law I. What is MAGI and What is it Used For? MAGI is Modified Adjusted Gross Income. It is the IRS s attempt to calculate the expendable resources to determine whether that taxpayer qualifies for certain income-tested deductions and programs. For example: The IRS uses the MAGI to determine eligibility for the tax deduction for tuition and fees. Thus, as of 2018 a single or head-of-household filer covered by a retirement plan at work is not eligible to take an IRA deduction if they had a MAGI of $73,000 or higher. The limit is $121,000 for married couples filing jointly. The taxpayer cannot take a deduction for tuition and fees if they have a MAGI of $80,000 or higher as a single or head-of-household filer, or $160,000 if married and filing jointly. 1

2 MAGI is used to determine eligibility for premium tax credits and other savings for Marketplace health insurance plans and for Medicaid and the Children's Health Insurance Program (CHIP). MAGI is adjusted gross income (AGI) plus these, if any: untaxed foreign income, non-taxable Social Security benefits, and tax-exempt interest. II. Calculating AGI To calculate MAGI we must first calculate Adjusted Gross Income. Adjusted Gross Income is define by IRC 62 as Gross Income minus certain adjustments. IRC 61 defines Gross Income as income from whatever source derived. Accordingly, Gross Income includes, among other things, salaries, wages, tips, gains from dealings in property, IRA distributions, income from businesses, certain distributions of Social Security. 26 CFR sates that gross income also includes treasure trove, or found money, and illegal source income. Release of indebtedness, other than in bankruptcy or insolvency is treated as income, as well (IRC 108). Gross income does not include items such as insurance paid by reason of death of an insured (IRC 101), gifts or inheritances (IRC 102), and damages for personal injury or sickness (IRC 104). It also does not include tax-exempt income this will be important when we calculate MAGI. 2

3 Once we have determined Gross Income, we can then calculate AGI. The adjustments under IRC 62 include expenses incurred by the owner of a business, including SEP contributions. They also include IRA contributions, and student loan interest. III. IMPORTANT CHANGE TO AGI CALCULATION MADE BY THE TAX CUTS AND JOBS ACT. Yes, I put that in all caps for a reason! The Tax Cuts and Jobs Act of 2017 (TCJA) made important changes that affect the calculation of AGI, and therefore MAGI. The TCJA made major changes to two above the line deductions used to calculate AGI: 1. Moving expenses. The deduction for work-related moving expenses is suspended for , except for active-duty members of the Armed Forces (and their spouses or dependents) who move because of a military order that calls for a permanent change of station. (For , the exclusion from gross income and wages for qualified moving expense reimbursements is also suspended, again except for active-duty members of the Armed Forces who move pursuant to a military order.) 2. Alimony payments. For divorce agreements executed (or, in some cases, modified) after December 31, 2018, alimony payments won t be deductible and will be excluded from the recipient s taxable income. Because the recipient spouse would typically pay income taxes at a rate lower than that of the paying spouse, the overall tax bite will likely be larger under this new tax treatment. This change is permanent. More on this change, infra. 3

4 IV. Now, Let s Calculate MAGI Once we have determined the taxpayer s AGI we can calculate MAGI. MAGI is equal to AGI with the following additions: Non-taxable Social Security benefits (Line 20a minus 20b on a Form 1040) Tax-exempt interest (Line on 8b on a Form 1040) Foreign earned income & housing expenses for Americans living abroad (Form 2555) Gambling losses that are deductible under 26 USC 165(d) to the extent of gambling winnings are added back to determine MAGI! Each of these additions represents expendable resources available to the taxpayer, even though those resources are not subject to Federal Income Taxation. Note that items such as gifts and inheritances are not included in MAGI, even though they, too, are available resources. Note that gambling losses are added back to MAGI, even though they are partially deductible under IRC 165(d). The rationale behind adding gambling losses back to AGI to calculate MAGI is that a taxpayer who loses money gambling clearly had that money as an expendable resource. Thus, it should be included in MAGI for purposes of certain income-based deductions and federal program qualifications. For Medicaid Qualification: From MAGI subtract the following for purposes of Medicaid eligibility: Scholarships, awards, or fellowship grants used for education purposes and not for living expenses. 4

5 Certain American Indian and Alaska Native income derived from distributions, payments, ownership interests, real property usage rights, and student financial assistance An amount received as a lump sum is counted as income only in the month received. And that is really all there is to MAGI. It s not MAGIC!!!! V. Notable Changes Made By TCJA A. Alimony and Moving Expense Deductions As mentioned in IV., supra., the TCJA repealed the deductions for moving expenses, and for alimony for divorces finalized after 12/31/2018. Because moving expenses and alimony payments will no longer be deductible in calculating AGI, they will also be included in MAGI. I am especially concerned about the repeal of the alimony deduction, because MAGI is designed to reflect available/spendable income of the taxpayer in determining income-based qualification. Alimony paid is not a discretionary expense (unlike wagering losses). Furthermore, removing the deduction for alimony will have a negative impact on both the payor and the payee, because the deduction enabled the payor to lower their net cost, while increasing the payee s benefit. Finally, and most importantly, alimony will no longer be included in the gross income of the payee. That means that alimony will not be included in the Gross Income, the Adjusted Gross Income, or the Modified Adjusted Gross Income of the recipient. I put that in bold, because alimony received is clearly an expendable resource of the payee. Consider a person who has no 5

6 other revenue except alimony. That person will have zero GI, zero AGI, and accordingly zero MAGI. That would be true, even if the alimony was a large amount like $1 million!!! That cannot be what Congress intended, and I would bet that such alimony will eventually be included in MAGI calculations for years beyond B. Tax Brackets and Standard Deduction Under TCJA, The top rates of 37% for 2018 take effect at $500,000 and $600,000, respectively. The brackets will continue to be adjusted for inflation. In 2017 the top rate was 39.6%. NOTE: the TCJA calls for annual inflation adjustments to be calculated using the chained consumer price index (also known as C-CPI-U). This will increase tax bracket thresholds at a slower rate than is the case with the consumer price index previously used. C-CPI-U also will apply to the standard deduction, certain exemptions and other figures. The change could potentially push taxpayers into higher tax brackets more quickly and make various breaks worth less over time. The law adopts the C-CPI-U on a permanent basis. For , the TCJA suspends personal exemptions but roughly doubles the standard deduction amounts to $12,000 for singles and separate filers, $18,000 for heads of households, and $24,000 for joint filers. The standard deduction amounts will be adjusted for inflation beginning in For some taxpayers, the increased standard deduction could compensate for the elimination of the exemptions, and perhaps even provide some additional tax savings. But for those with many dependents or who itemize deductions, these changes might 6

7 result in a higher tax bill depending in part on the extent to which they can benefit from the family tax credits. The threshold for itemized deductions is increased because of the higher standard deduction. C. Tax Credit TCJA also makes the child credit available to more families than in the past. Under the new law, the credit doesn t begin to phase out until adjusted gross income exceeds $400,000 for married couples or $200,000 for all other filers, compared with the 2017 phaseout thresholds of $110,000 and $75,000. The thresholds won t be indexed for inflation, though, meaning the credit will lose value over time. The TCJA also includes, beginning in 2018, a $500 nonrefundable credit for qualifying dependents other than qualifying children (for example, a taxpayer s 17-year-old child or elderly parent). These provisions all expire after D. Changes to Itemized Deductions State and local tax deduction. The deduction for state and local taxes had been proposed for elimination under tax reform. It survived but has been scaled back substantially. For , taxpayers can claim a deduction of no more than $10,000 for the aggregate of state and local property taxes and either income or sales taxes. 7

8 Mortgage interest deduction. The TCJA tightens limits on the deduction for home mortgage interest. For , it generally allows a taxpayer to deduct interest only on mortgage debt of up to $750,000. However, the limit remains at $1 million for mortgage debt incurred before December 15, 2017, which will significantly reduce the number of taxpayers affected. Home equity interest deduction. The new law suspends the deduction for interest on home equity debt for However, home equity debt interest might still be deductible if the funds are used for a purpose where interest otherwise may be deductible, such as for home-improvement, investment or business purposes. The rules are complex and the new law is still being interpreted. Medical expense deduction. Qualified medical expenses are deductible only to the extent they exceed the applicable AGI threshold. The TCJA reduces the threshold from 10% of AGI to 7.5% for all taxpayers for both regular and AMT purposes in 2017 and Charitable contribution deduction. For , the limit on the deduction for cash donations to public charities is raised to 60% of AGI from 50%. However, charitable deductions for payments made in exchange for college athletic event seating rights are eliminated. E. The Alternative (Parallel Universe) Minimum Tax The AMT is a separate tax system that limits some deductions, disallows others and treats certain income items differently. The top AMT rate of 28% is lower than the top 8

9 regular income tax rate, but it typically applies to a higher taxable income base. If AMT liability exceeds regular tax liability, taxpayer must pay the AMT. The TCJA temporarily reduces the number of taxpayers who will to pay the AMT by increasing both the AMT exemption amount (to $109,400 for married couples, $70,300 for singles and heads of households, and $54,700 for separate filers) and the AMT exemption phaseout thresholds (to $1 million for married couples and $500,000 for all other taxpayers other than estates and trusts). These amounts apply for 2018 and will be annually adjusted for inflation until the provision expires after F. The Kiddie Tax One popular tax planning technique is to transfer investments or other incomeproducing assets to family members in lower tax brackets to take advantage of their lower rates. The kiddie tax makes this difficult to do. Under pre-tcja law, when the kiddie tax applies, all but a small portion of a child s unearned income is taxed at the parents marginal rate (if higher), defeating the purpose of income shifting. The kiddie tax generally applies to children age 18 or younger, as well as to full-time students age 19 to 23 (with some exceptions). The TCJA makes the kiddie tax even harsher by taxing a child s unearned income according to the tax brackets used for trusts and estates, which are taxed at the highest marginal rate (37% for 2018) once 2018 taxable income reaches $12,500. In contrast, for a married couple filing jointly, the highest rate doesn t kick in until their 9

10 2018 taxable income tops $600,000. In other words, in many cases, children s unearned income will be taxed at higher rates than their parents income. G. Roth IRA s TCJA prohibits taxpayers who convert a pretax traditional IRA into a post-tax Roth IRA from later reversing the conversion. H. 529 Plans 529 plans can be used to save for primary and secondary education at private schools. I. Wealth Transfer Taxes TCJA raised the exemption for estates of taxpayers dying in 2018 to $11.18 million. Essentially doubling the amount of wealth that can be transferred free of taxes in a person s lifetime and at death. Because of portability of the exemption between spouses, a married couple can transfer in excess of $22 million in TAXABLE wealth before incurring any wealth transfer tax liability. The annual gift exclusion for 2018 is $15,000 per donee. I am guaranteed to never owe a wealth transfer tax!!!! 10