Every year, millions of Americans keep careful track of their charitable contributions, mortgage interest, property taxes and various other expenses in an effort to clear the dollar threshold that will allow them to claim the larger amount of their aggregated itemized deductions instead of having to settle for the standard deduction. However, some deductions can be taken regardless of whether the taxpayer is able to itemize. Expenses in this category are known as above-the-line deductions, and this article examines those expenses that can be deducted by any taxpayer who pays them.
Breaking Down Your Taxable Income
The basic tax computation formula used in the U.S. has four main sets of parts that are broken down on the 1040. The formula is shown as follows:
All Sources of Taxable Income
= Gross Income
- Above-the-Line Deductions
= Adjusted Gross Income
Standard or Itemized Deductions
= Taxable Income
Tax Credits and Taxes Paid or Withheld
= Balance Due or Refund
What Are Above-the-Line Deductions?
Above-the-line deductions constitute those expenses that are deducted for AGI, while itemized deductions are deducted from this number. The "line" is the taxpayer's AGI, which is the bottom number on the front of the 1040. Above-the-line deductions are listed on the bottom half of the front of the 1040 and can be broken down as follows. Please note that all figures are as of 2010.
- Domestic Production Activities
Up to 6% of activities related to the domestic production of certain goods or services (such as engineering or architectural) may be deducted under certain conditions.
- Moving Expenses
The costs of transporting household goods from one residence to another are usually fully deductible, provided that they are not reimbursed by the taxpayer's employer. The move must be made for work or business reasons, and the taxpayer's new place of employment must be at least 50 miles further away from the taxpayer's previous residence than the previous workplace was from there.
- Retirement Plan Contributions
All contributions made to traditional IRAs and qualified plans such as 401(k), 403(b) and 457 plans are deductible. Taxpayers with incomes above a certain level who contribute to both a traditional IRA and a qualified plan are subject to a graduated phaseout reduction on the deductibility of their IRA contributions. This deduction is not available for contributions to Roth IRAs or retirement plans of any kind.
- HSA, MSA Contributions
All contributions to Health Savings Accounts and Archer Medical Savings Accounts are fully deductible. However, the taxpayer cannot have access to any kind of group policy coverage, including that offered by fraternal or professional organizations. The purchase of a qualified high-deductible health insurance policy is also required.
- Health Insurance premiums
The cost of premiums paid for individual health insurance policies (including high-deductible policies) are fully deductible for self-employed taxpayers. As with HSAs and MSAs, the taxpayer cannot have access to group health coverage of any kind.
- Self-Employed Business Expenses, SE Tax
Virtually any expense incurred in the operation of a sole proprietorship is deductible on Schedule C, such as rent, utilities, the cost of equipment and supplies, insurance, legal fees, employee salaries and contract labor. This also includes one-half of the self-employment tax that must be paid on this income. Although these expenses are not listed directly on the 1040 but are carried to the income section via the Schedule C, they are still considered to be above-the-line deductions because they are subtracted in order to determine adjusted gross income.
Payments made to a spouse pursuant to a divorce decree that are not classified as child support are usually counted as alimony. All payments of this type are deductible from gross income.
- Educator Expenses
These include unreimbursed qualified expenses of up to $250 ($500 for joint filers if both are in this category). Qualified expenses include teaching equipment, supplies, books and other ordinary expenses that are commonly associated with education. This deduction is available for education professionals who teach grades K-12 and work at least 900 hours during the year.
- Early Withdrawal Penalties
Any penalties paid for the early withdrawal of money from a CD or savings bond that is reported on Form 1099-INT or 1099-DIV can be deducted.
- Student Loan Interest
All interest paid on federally-subsidized student loans up to a certain amount is deductible, provided the taxpayer's income does not exceed $75,000 for single, head-of-household or qualifying widower filers or $150,000 for joint filers.
- Tuition and Fees
In some cases, it is more advantageous for taxpayers to deduct the costs of tuition, fees and other educational expenses paid to qualified educational institutions rather than claim one of the educational tax credits for them. Those who are unable to qualify for these credits for any reason can take this deduction instead as well.
Any or all of these deductions can be taken in addition to the itemized deductions for eligible taxpayers. Of course, there are also several incidental rules and limitations on most of these deductions that are not covered here. For more information on above-the-line deductions, read the instructions for the 1040 Form on the IRS website or consult your tax advisor.