I remember sitting in my tax class and hearing this question all the time. Here’s my best attempt at an explanation:

First off – your Adjusted Gross Income (AGI) is the most important number in determining your taxes.

Did you have tuition expenses you were hoping to get back from Uncle Sam? Did you hire a nanny to babysit your kids and want to get some of that money back through the Child-Care tax credit?

A lower AGI means a better chance of being able to answer yes to these and other questions that will lower your taxes.

For example, the government will help you pay your expenses for a babysitter or a nanny.

If your AGI is below $15,000 – the government will help pay 35% of your child-care expenses. If your AGI is above $43,000 – the government will help pay 20% of your child-care expenses. If your AGI is between $15,000 and $43,000 – the government will help you pay somewhere between 20% and 35%. (See here for complete eligibility requirements)

Now that we’ve seen one way AGI is used, let’s go back to the difference between Deductions for AGI and Deductions from AGI.

Let’s consider the story of two taxpayers – Angela and Bob. Angela and Bob both made $43,000 in 2008. Both Angela and Bob spent $3,000 on a babysitter. So far they are the same. Here is where things get different: Angela has a $5,000 deduction for AGI (unrelated to child-care), and Bob has a $5,000 deduction from AGI (also unrelated to child-care).

Angela’s AGI is $38,000 (income of $43,000 minus the $5,000 Deduction for AGI) and Bob’s AGI is still $43,000 (the Deduction from AGI doesn’t change his AGI). The government will give Angela more money back for the babysitter. Why – because she has a lower AGI.

In general, you want a Deduction for AGI instead of a Deduction from AGI. The IRS decides what expenses are a Deduction for AGI, a Deduction from AGI, or neither. The more you are able to take advantage of Deductions for AGI, the more you will be able to legally reduce the amount of taxes you pay – no matter what your income is.

What effect do mortgage payments have on my income tax?

If you borrowed money to buy the home you live in, you might be able to deduct some of your mortgage payments.   If you have a standard mortgage, you pay back the original amount you borrowed (the principal) plus a little more for the privilege of paying it back over time (interest).

You can deduct these interest payments from your taxes.   Mortgage interest is a deduction from AGI.   If all of your deductions from AGI are more than the standard deduction, your mortgage payments will reduce your income taxes.

For complete eligibility requirements and instructions on deducting mortgage interest, download this.

More Links

NYTimes Economix Blog – Killing (or Maiming) a Sacred Cow: Home Mortgage Deductions

Fast Company -Why You Can’t Afford Tax Ignorance