Your adjusted gross income matters more than you might realize on your income taxes because it sets the threshold for certain deductions, such as the medical expenses deduction, and determines -- or is the starting point for determining -- your eligibility to claim other deductions and credits, such as the American opportunity credit and the retirement savings credit. Certain IRA contributions can reduce your AGI.
The deduction for traditional IRA contributions is classified as an adjustment to income, which means that it will reduce your adjusted gross income. The deduction is a dollar-for-dollar reduction. For example, if you contribute $5,000 and qualify to deduct the entire contribution, your adjusted gross income drops by $5,000.
Only contributions to a traditional IRA are ever deductible. If you're not married and not covered by an employer plan, such as a 401(k), your contributions are always fully deductible. If you are married, your contributions are guaranteed to be deductible, and therefore guaranteed to reduce your adjusted gross income, only if neither you nor your spouse participates in an employer-sponsored retirement plan. Roth IRA contributions will never reduce your adjusted gross income because the contributions are made with after-tax dollars.
If you or your spouse participates in an employer-sponsored plan, you can't deduct your traditional IRA contributions if your modified adjusted gross income exceeds the annual limits. The Internal Revenue Service sets different limits for each filing status and updates them annually. For example, in 2012, if you are single and covered by an employer plan, you can't deduct any of your traditional IRA contribution -- and therefore can't use it to lower your AGI -- if your modified adjusted gross income exceeds $68,000.
Both traditional and Roth IRA contributions can qualify you to claim the retirement savings credit, which directly reduces your tax liability. To qualify, your modified adjusted gross income must fall below the limits for your filing status, you must be over 18 years old and you can't be a full-time student. However, it won't lower your adjusted gross income because it is a credit rather than a deduction.
- Internal Revenue Service: Publication 590 -- Individual Retirement Arrangements (IRAs)
- Internal Revenue Service: Topic 450 -- Adjustments to Income
- Internal Revenue Service: 2012 IRA Contribution and Deduction Limits - Effect of Modified AGI on Deductible Contributions If You ARE Covered by a Retirement Plan at Work
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