In a NutshellTo take certain big-ticket tax deductions, you have to itemize your deductions on your federal income tax return, rather than take the standard deduction. But above-the-line deductions are adjustments to income that you can make — if you’re eligible for them — whether you itemize deductions or take the standard deduction. Tax deductions reduce your taxable income, which in turn can reduce the amount of tax you owe.
Think you have to itemize to take advantage of tax deductions? Think again. Above-the-line tax deductions can help lower your tax bill without the extra paperwork of itemizing deductions.
Above-the-line deductions reduce your income before you apply the standard deduction or itemize deductions on your federal income tax return. Making these adjustments helps you arrive at your adjusted gross income. AGI is the foundation for determining your taxable income, tax bracket and tax rate.
Let’s look at some things to know about above-the-line adjustments and how they can affect your tax return.
- What are above-the-line deductions?
- Why is this important?
- What are some above-the-line deductions?
- How could this affect my taxes?
The IRS looks at your level of income to decide which tax credits and deductions you qualify for, and your marginal tax rate.
But it’s not your gross income — meaning all the income you receive in a year that’s not tax-exempt — that the IRS goes by. Instead, it uses your adjusted gross income as a starting point for calculating your tax rate, tax bracket and eligibility for certain deductions and credits.
After you calculate your AGI, you’ll determine your taxable income either by taking the standard deduction or itemizing deductions (like the medical expense deduction).
On the 1040 form, it used to be that AGI was calculated in its own section and separated from the rest of the form by a line. After tax reform, above-the-line deductions are included on the 1040 Schedule 1 form.
Even though the forms have changed and there’s no actual line, the adjustments you make to your gross income to calculate your AGI are still referred to as above-the-line deductions — and other deductions you apply to your AGI are considered below-the-line deductions.
When it comes to figuring out which tax credits and below-the-line deductions you qualify for, the IRS uses your AGI and possibly your modified adjusted gross income, or MAGI, depending on the deduction. Your MAGI is your AGI with some adjustments added back in.
Because your above-the-line deductions help set the stage for your eligibility for other tax breaks, it’s essential to know what these adjustments are and how you can maximize their value each year.
It’s especially important if you’re a high-income earner whose AGI or MAGI means you might be phased out of eligibility for certain tax deductions and credits.
The tax code provides above-the-line deductions for all kinds of taxpayers. Here are some common ones.
Student loan interest deduction
Eligible student loan borrowers can claim an adjustment of the amount they paid in student loan interest during the year, up to a cap amount (which was $2,500 for the 2019 tax year). The deduction may be reduced or even eliminated entirely based on your MAGI and filing status.
If you qualify as an eligible educator, you may be able to deduct up to $250 worth of qualified and unreimbursed work-related expenses. Educator expenses can include professional-development courses, books, supplies, equipment and classroom materials.
Health savings account contributions
If you have a single-person high-deductible health plan, or HDHP, you can contribute up to $3,500 to a health savings account and deduct it from your gross income. If you’re on a family HDHP, you can contribute up to $7,000 and take the deduction above the line.
If you’re a small-business owner and paid self-employment taxes — a tax that consists of Social Security and Medicare taxes — you can deduct the employer-equivalent portion of the taxes you’ve paid during the year.
You can also deduct any contributions you make to SEP IRA, SIMPLE IRA and qualified retirement plans for yourself and your employees. Plus you can deduct health insurance and other insurance premiums you paid for yourself, your spouse and qualifying dependents.
If you make alimony payments to a spouse or former spouse, you may be able to deduct them as an adjustment to your gross income.
Note that the divorce or separation agreement must have been executed before 2018. Also, keep in mind that if you make any modifications to an earlier agreement after 2019 and the revision expressly states that it repeals the tax break, you’ll no longer be able to take this above-the-line deduction.
Individual retirement arrangement contributions
You can contribute up to $6,000 annually ($7,000 if you’re 50 or older) to an individual retirement arrangement, or IRA, though your limit can vary based on your age and income.
For traditional IRA contributions, you can claim a deduction for some or all of your contributions. The amount you can take as an adjustment depends on your MAGI and whether you have an employer-sponsored retirement plan.
Like all tax deductions, above-the-line deductions reduce the amount of income subject to federal income tax. Reducing your taxable income could ultimately lower your tax obligation. The more you know about the different adjustments available, the easier it will be to create a strategy to maximize their value.
As your income grows, maximizing your above-the-line deductions along the way can help hold down your tax bill.
Because above-the-line deductions are key to calculating your AGI, take some time to find out which ones you qualify for and how you can maximize the adjustments you can take to your gross income.