The money you earn is not necessarily one-to-one with the money you pay taxes on. The IRS provides taxpayers with several means to reduce their tax liability through so-called tax deductions on their income tax return or Form 1040. Of these, there are two kinds:
- Above-the-line tax deductions, also known as adjustments to income and;
- Below-the-line tax deductions are more frequently known as the standard deduction or various itemized deductions.
All tax deductions serve to reduce the income the IRS recognizes as taxable. Low-income taxpayers may even entirely forego paying taxes on their income when all deductions and tax credits are accounted for. However, deductions are essential for every taxpayer.
Not only will deductions reduce the amount of tax you owe, but your adjusted gross income (AGI) – your income after above the line deductions but before below-the-line deductions – is typically what the IRS uses to calculate eligibility for various tax breaks, such as the Earned Income Tax Credit, and per-eligible dependent Child Tax Credit.
For example, when the IRS notes that all head of household filers with one eligible dependent and an AGI of more than $46,560 no longer qualify for an EITC, that doesn’t mean earning anything north of that amount completely disqualifies you. Your AGI may be substantially lower than your gross income.
What is an Above the Line Deduction?
The IRS refers to above-the-line deductions as adjustments to income. To reiterate, they are deductions everyone qualifies for to determine their AGI, which is used as a basis for eligibility for several tax credits and other tax benefits.
However, qualifying for an above-the-line deduction is not a given. Your adjusted gross income may be close to your total income if none of the IRS deductions are valid. This can massively affect your eligibility for certain tax breaks, including itemized deductions.
Itemizing medical expenditure is a typical case where income adjustments matter. If, for example, you earned $100,000 in a given year and chose to itemize your medical expenses of exactly $7,500, you would not benefit from this itemized deduction because you can only deduct medical expenses that exceed 7.5 percent of your annual adjusted income.
But if above-the-line adjustments amount to $20,000, your AGI becomes $80,000, and your 7.5 percent threshold is reduced to $6,000 – meaning of the $7,500 you spent in medical bills, $1,500 can be deducted from your taxes.
We’ve mentioned the Earned Income Tax Credit and the Child Tax Credit, but other tax credits also depend on your adjusted gross income.
While the IRS does what it can to identify taxpayer mistakes, it might not necessarily feel incentivized to look too hard when you miss out on above-the-line deductions. Be sure to take every advantage you can! Thoroughly review your Form 1040 to ensure that you’ve taken note of every deduction applicable to you and your tax account.
Above the Line Deductions vs. Below the Line Deductions
Because above-the-line deductions translate into your adjusted gross income, they are considered above the line. Meanwhile, below-the-line deductions do not affect the IRS’ perception of your annual taxable income, but they do reduce your tax liability. In other words, the IRS does not continue to discount your earnings for the purposes of establishing income eligibility but will reduce what you owe in taxes based on your chosen deductions.
Below the line deductions are either one standard deduction (a flat amount all taxpayers are entitled to), or multiple itemized deductions.
Taxpayers who opt out of the standard deduction can choose to itemize instead. It can be more efficient to itemize, particularly if you qualify for several deductions. Serious expenses are usually a safe bet, but it’s a good idea to consult a tax pro to have your tax return professionally reviewed before you choose to opt out of your standard deduction.
This is especially important if you haven’t kept up with how the standard deduction has changed over the years. One of the significant changes of the Tax Cuts and Jobs Act of 2017 that affected people all over the country was the massive boost it gave the standard deduction while removing certain itemized deductions.
Another benefit of the standard deduction over the itemized deduction is that the IRS is less likely to give your tax return a second, more thorough look. Itemizing a lot can draw the IRS’ attention – even if you did not make any mistakes on your itemized deductions, a thorough look might reveal a mistake somewhere else in your return, resulting in a penalty. Again – professional tax preparation services can be a great boon if your tax account warrants itemized deductions.
Common Above the Line Deductions
Above-the-line deductions can drastically alter your income in the eyes of the IRS, provided you’re eligible. Here are a few standard above-the-line deductions that many people might qualify for.
- Educator Expenses – teachers and other educators can claim a deduction of up to $250 a year on supplies and other essentials procured out of pocket, whether it’s pencils, notebooks, geometry kits, and so on.
- Self-Employment Deductions include three separate deductions, each of which can be valuable for self-employed taxpayers. One is half of your self-employment tax (your personal contributions to Medicare and Social Security). Another is contributions made to a self-employment retirement plan. Finally, premiums are paid on health insurance.
- Alimony – to claim a deduction for alimony payments, you must include the Social Security Number of the person you divorced and the date your marriage was dissolved.
- IRA Deduction is a deduction for investments made into a retirement fund. There is a limit on how much of your investment you can deduct.
- Student Loan Interest – paid student loan interest, not the payments themselves, is deductible.
Get Professional Tax Help From Rush Tax Resolution
Taxes are neither fun nor necessarily simple – especially if you qualify for several different deductions. If you want to make the most out of your taxes, you will want to be thorough with your tax return, which can result in a greater risk for errors and potentially costly penalties.
Skip the worries and get to the benefits with professional tax prep services. Rush Tax Resolution can help you maximize your tax return and minimize your tax liability. Contact us to learn more today.