Tax deductions reduce your tax liability and fall into two categories, above-the-line and below-the-line.
“The line” for the purposes of this discussion is your adjusted gross income (AGI). Above-the-line deductions reduce your AGI. An example would be a contribution to a traditional IRA. This can be an advantage because a lower AGI may enable you to qualify for certain other tax benefits, like thresholds for calculating certain itemized deductions, as well as non-tax benefits, like student loan repayment calculations.
You can take above-the-line deductions whether you itemize or not.
Below the line deductions refers to deductions you can take after calculating your AGI. These are primarily itemized deductions. They’re calculated on Schedule A, then transferred to Form 1040 and deducted from your AGI. They generally have the same effect of lowering your taxable income, but they don’t reduce your AGI.
We’re going to discuss both sets of deductions below.
Once again, above-the-line deductions can be taken whether or not you itemize on Schedule A. They’re entered on Form 1040, Schedule 1, Additional Income and Adjustments to Income, then transferred to Form 1040 itself just before calculating your income tax liability.
The most common above-the-line deductions include the following:
Health savings account (HSA) deduction
An HSA is a tax-sheltered account you can set up to pay medical expenses. Contributions are allowed up to $3,850 per year for an individual, and $7,750 for a family. For those 55 and older, the contribution limit increases by $1,000.
These are something like IRAs for medical expenses. Not only are your contributions tax-deductible, but any income you earn on your savings is also tax-deferred. The funds can be withdrawn for any qualified medical expense, without being subject to income tax. Any money not spent in the current tax year can be carried forward indefinitely.
This is an excellent workaround strategy if you have significant medical expenses, but aren’t able to write them off as an itemized deduction.
If you’re a qualified teacher, you can deduct up to $250, or $500 if you’re married filing jointly and you’re both teachers. Educator expenses include costs for books, supplies, computer equipment, and other necessary expenses. Naturally, you can only deduct these expenses if they’re not reimbursed by your employer.
Certain business expenses of reservists, performing artists, and fee-basis government officials
As an Armed Forces reservist, you can claim a deduction for amounts due to traveling more than 100 miles from home. The travel must be related to your reserve activities.
Fee-basis state or local government officials can include amounts paid for expenses incurred in connection with your assignments.
Qualified performing artists can include expenses related to their craft. Your adjusted gross income must be $16,000 or less before subtracting the expenses in connection with being a performing artist.
Moving expenses for active members of the Armed Forces
Active members of the Armed Forces can take an above-the-line provision for moving expenses if they incur expenses for a move due to reassignment.
If you make a contribution to a traditional IRA, it may be tax deductible and reported as an above-the-line deduction. However, contributions may be limited or ineligible for deduction if you are covered by an employer-sponsored retirement plan.
Note: Roth IRA contributions are never tax-deductible.
Self-employed SEP, SIMPLE, and qualified plans
There are enhanced retirement plans available for the self-employed that allow you to deduct an even larger amount than you can under a traditional IRA. For example, under a SEP IRA, you can deduct 25% of your business income, up to $58,000 per year. It’s deductible as an above the line deduction.
Deductible part of self-employment tax
If you’re self-employed, you’ll be required to pay the self-employment tax. Employees pay half of the FICA tax due and the employer pays the other half, for a total of 15.3% of wages. However, when you are self-employed you have to pay both halves.
Therefore, the IRS allows you to deduct half the tax against your income for federal income tax purposes as an above the line deduction.
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Self-employed health insurance deduction
If you’re self-employed person, and you pay health insurance premiums, they can’t be taken as a business expense on your Schedule C. But they can be deducted as an above-the-line deduction. You can deduct the full amount of premiums paid for health insurance and long-term care insurance, as long as the combined amount doesn’t exceed the net income from your business.
Penalty on early withdrawal of savings
If you pay a penalty for early withdrawal of a savings instrument, like a certificate of deposit, it can be deducted as an above-the-line deduction. This will have the net effect of reducing the taxability of any interest income earned on the certificate.
There was a major change with the tax status of alimony in the new tax law. Beginning in 2019, alimony will no longer be tax deductible if it’s pursuant to divorce decrees executed after December 31, 2018.
However, if you pay alimony as a result of a divorce decree executed no later than December 31, 2018, it’s still tax-deductible as an above the line deduction.
Student loan interest deduction
If you have student loans, you can deduct up to $2,500 in interest as an above-the-line tax deduction.
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Below the Line Deductions
Once again, below-the-line deductions are primarily itemized deductions you include on Schedule A. Typically, it only makes sense to itemize deductions if they exceed the amount of your standard deduction.
Medical and Dental Expenses
If you’re able to itemize your deductions, medical and dental expenses may be partially deductible. I’m saying partial because a limitation applies to the amount of the deduction.
First, you’ll need to tally up all your medical and dental expenses. You can deduct anything over 7.5% of your adjusted gross income. So for example if you earn $100,000 you’ll be able to deduct any medical expenses over $7,500.
Fortunately, there’s a long list of medical and dental expenses that can be deducted. These include fees paid to medical professionals, payments for inpatient hospital care or residential nursing home care, acupuncture treatments, inpatient treatment for alcohol or drug addiction, or participation in a smoking cessation program; payments to participate in a weight loss program (certain qualifications are required), payments for insulin, false teeth, reading or prescription glasses, contact lenses, hearing aids, crutches, wheelchairs, and payment for medically related transportation. Each of these expenses will need to be reduced by any insurance reimbursement received.
As well, you can deduct payments for premiums paid for health insurance and qualified long-term care insurance that you pay directly to the carrier, over.
Taxes You Paid
You can deduct payments for state and local income taxes or state and local income taxes, but you can’t deduct both. You can also deduct state and local real estate and property taxes. Collectively, these taxes are referred to as SALT deductions.
Like the medical and dental expenses deduction, a limitation applies here as well. The combination of all taxes paid is only deductible up to a total of $10,000 ($5,000 for single filers). Beyond that threshold, your taxes paid to state and local governments are not deductible.
Interest You Paid
Though the line item on Schedule A appears as Interest You Paid, the only deductible forms of interest are mortgage interest and investment interest.
You can deduct interest paid on mortgage indebtedness on your primary and secondary homes only. Interest can be deducted on a mortgage used to buy your home, a second mortgage, a home equity loan, or a home equity line of credit (HELOC).
There are deduction limits here as well. If you incurred the mortgage indebtedness no later than December 14, 2017, interest can be deducted on loan amounts up to $1 million. However, interest on loans acquired after that date is deductible only up to $750,000. Excess interest paid will not be tax-deductible.
Investment interest includes interest paid on money borrowed to purchase taxable investments. A major category in this connection is margin interest paid for a brokerage account. Investment interest can be deducted up to the amount of your net taxable investment income for the year. Any interest not deductible in the current year can be carried forward to the next tax year.
Gifts to Charities
You can deduct charitable contributions, and there are generally no limits. However, any contribution of $300 or more for single filers or more than $600 for married couples filing jointly requires written evidence. As well, non-cash contributions over $600 require that you also attach IRS Form 8283. You can deduct up to 60% of your AGI.
How To Calculate It: Valuing Your Non-Cash Donations Come Tax Time
Casualties and Theft Losses
You can only deduct casualty and theft losses on personal property as an itemized deduction unless you were a victim of a federally declared disaster. You can only take these deductions if they were not reimbursed by insurance or other means. Also, the total of your losses must be more than 10% of your AGI and only the amount above this limit is deductible.
Theft losses include losses from embezzlement, extortion, robbery, fraud or misrepresentation, burglary, blackmail, and kidnapping for ransom.
Any losses sustained must be reduced by any insurance reimbursement you receive.
Other Itemized Deductions
These are deductions you report on Line 16 of Schedule A, and are basically permissible deductions not listed above. They include the following deductions:
- Gambling losses, to the extent of gambling winnings.
- Casualty and theft losses of income producing property.
- Federal estate tax on income in respect of a decedent.
- A deduction for amortizable bond premium.
- An ordinary loss attributed to a contingent payment debt instrument or inflation index debt instrument (like TIPS bonds).
- A deduction for repayment of amounts under a claim of rights if over $3,000.
- Certain unrecovered investments in pensions.
- Impairment related work expenses of a disabled person.
Learn more: Federal Income Tax Brackets and Standard Deductions
Of course, this isn’t a full list of every deduction available. So understanding your available deductions throughout the year is an important part of tax planning. If you keep good records during the year you can ensure that you remember, and can document, each of your deductions. Plus it saves time and stress if you have a system for keeping track of the deductions you qualify for.
If you aren’t sure if you qualify for a deduction speak to a tax professional. No reason to overpay your taxes!