I had a rather unpleasant surprise this tax season. Due to our Modified Adjusted Gross Income (MAGI) being too high, we weren’t able to claim the full American Opportunity Tax Credit (AOTC) for 2023. Before this, I had no idea what MAGI was, nor was I aware that we were anywhere near the cutoff. However, receiving only part of the credit has inspired me to research ways to reduce my tax bill for 2024.
What is your Modified Adjusted Gross Income?
Leave it to the IRS to make something complex that could be simple. First MAGI is not the same as your Adjusted Gross Income that’s reported on your tax forms. Instead, it’s a calculation of your AGI after adding back in certain deductions and tax-exempt interest income. (Search online for calculators to determine your MAGI).
Why should you care?
If you have a child in college, the AOTC is dependent on your MAGI being below a certain level. Additionally, your MAGI comes into play with a Roth IRA. To receive the full AOTC credit, the MAGI cutoff for married couples filing jointly is $160,000. To be able to contribute to a Roth IRA, the MAGI cutoff for married couples filing jointly is $228,000 (for 2023).
What can you do to lower your MAGI?
Obviously, if you’re making substantially more than these cutoff amounts, the chances of being able to reduce your income to be eligible for the AOTC or a Roth IRA may be limited. But if you’re like me, and you received a partial credit, you may be able make changes to your income to come in under the limit.
Increase your pre-tax contributions to retirement plans. One of the biggest changes you can make to your taxable income is to participate in a pre-tax retirement plan, like your company 401(k) or 403(b). This is an area where we were lacking in 2023; we participated in a Roth 403(b) since the company contributes a large amount to the pre-tax 403(b). However, given our tax rate and the fact that we fully expect to be at or below that rate in retirement, it makes more sense to participate in the pre-tax plan now and pay taxes later. Plus, it may be just enough to receive the full AOTC.
Participate in a Health Savings Account (HSA). As with pre-tax contributions to a retirement plan, contributions to a HSA can help reduce your taxable income, thereby reducing your MAGI. If you contribute through work, the amounts are withdrawn from your paycheck pre-tax. If you contribute on your own, your contributions are tax-deductible.
Keep an eye on investment earnings. One other area we maxed out on in 2023 was saving in a high-yield savings account (HYSA). We have been considering purchasing a home and didn’t want to have the down payment invested in the market, so there was a large amount earning 5% for most of the year. All of that income added to our tax bill.
But even if you aren’t saving in a HYSA, if you sell in-the-money stocks without selling losers (i.e., you don’t take advantage of tax-loss harvesting), you may see your MAGI increase as well.
Use flexible spending accounts. Many companies offer flexible spending accounts for health care or dependent care. While the amounts you can contribute to each are more limited than contributions to a pre-tax retirement plan, your contributions will be withdrawn from your paycheck before taxes are calculated.
Unfortunately, I didn’t pay close attention to the MAGI limits for the American Opportunity Tax Credit. And while we got the majority of the credit, it still irks me that we didn’t receive the full amount. I’m confident that taking the steps above will drop our MAGI enough to receive the full credit in 2024.
Photo by N. Voitkevich