Every year, the Internal Revenue Service (IRS) allows taxpayers to reduce their tax bills by claiming deductions. Deductions help lower your taxable income, enabling you to pay less in taxes. Above-the-line deductions are especially beneficial — they lower your adjusted gross income (AGI).
Your AGI is what the IRS uses to determine whether you can get other tax deductions. If your AGI Is high, either of these two can happen:
you probably won’t write off as many deductions as the taxpayers with lower AGIs
the IRS can prohibit you from writing off other deductions
That’s why claiming above-the-line deductions is crucial – it can help open doors for other more-valuable tax breaks.
Here’s everything you need to know about above-the-line deductions...
An above-the-line deduction is an amount that may be deducted from gross income on the first page of your tax return before you figure out your adjusted gross income (AGI). This means that above-the-line deductions can reduce your taxable income and ultimately reduce the amount of taxes owed.
Adjusted gross income is the amount of income you have left after certain specific deductions are subtracted. These include alimony paid, contributions to certain individual retirement accounts (IRAs) and other qualified retirement plans, self-employed health insurance premiums, student loan interest, half the self-employment taxes you pay, moving expenses for a job change, or work-related education that qualifies as a work-related expense, and some educator expenses.
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Above-the-line deduction vs. below-the-line deductions: What’s the difference?
Above-the-line deductions are everything you can deduct before adjusted gross income, while below-the-line deductions are everything you can deduct after adjusted gross income.
For example, you can subtract your contributions to a traditional IRA, self-employed SEP or SIMPLE IRA, and health savings account from your gross income before you calculate adjusted gross income.
So, let's say your gross income is $35,000, your total contribution to a traditional IRA was $5,000 and you are using the standard deduction. Your adjusted gross income would be calculated as follows:
Gross income - contributions = Adjusted Gross Income
$35,000 - 5,000 = $30,000
After you figure out your AGI, you can then claim below-the-line deductions. For example, if your adjusted gross income is $60,000 and you paid $2,500 in interest on a student loan or qualified mortgage interest, then you would subtract this amount from $60,000. Your new adjusted gross income would be $57,500.
It's important to remember that above-the-line deductions can only reduce your AGI on the front page of your tax return, but below-the-line deductions can reduce your taxable income.
You can take an above-the-line deduction whether or not you itemize deductions on your tax return.
A list of above-the-line tax deductions
Here's a comprehensive list of above-the-line deductions you can claim to lower your tax bill:
Teachers – both in the public and private sector – can deduct up to $250 for educator expenses. And married couples who are both teachers can write off a maximum of $500.
The following are eligible for this deduction:
Aides working at least 900 hours during school years
Expenses include the purchase of books, supplies, equipment (computer, software, paper, etc.), other property used in the classroom, computer equipment (hardware/software), and supplementary materials used by students.
If you move due to a change in your job or business location, the costs of your move are deductible as an adjustment to income. You can deduct any reasonable cost of moving household goods and traveling from your old home to your new home.
But there’s a catch, though: you can only deduct moving expenses for a job if you meet the distance and time tests.
Distance test: You must work at least 50 miles farther from your old home than your old job was from your old home. If you had no previous workplace, your new workplace must be at least 50 miles from your old home.
Time test: After the move, you must work at your new job for at least 39 weeks during the first 12 months immediately following your arrival in the general area of your new workplace.
Also, you can't deduct moving expenses for a move back to your former home.
Generally, alimony or separate maintenance payments made under a divorce or separation instrument may be deductible by the payer and must be included in income by the payee.
If you receive alimony, include the amount received in your income.
If you pay alimony, you can claim the amount of alimony paid as an above-the-line deduction against your income.
Health Savings Account (HSA) contributions
If you're enrolled in a high deductible health plan (HDHP), then you can contribute to an HSA and reduce your taxable income by the amount contributed. For 2022, an individual with self-only HDHP coverage can contribute up to $3,650 to an HSA account (a slight increase from $3,600 in 2021). And those with family HDHP coverage can contribute up to $7,300 ( an increase from $7,200 in 2021).
Those aged 55 or older can make an additional catch-up contribution of $1,000 for self-only HDHP coverage and $2,000 for family HDHP coverage.
Your contribution remains in your account until you use it. You can withdraw the money at any time to pay or reimburse qualified medical expenses you incur. If you withdraw money from your HSA for any other reason, the amount you withdraw will be taxable and it may also be subject to a penalty.
You can deduct the amount you pay in interest on student loans for yourself, your spouse, or your dependent. Your loan must have been taken out solely to pay qualified education expenses.
So, who is a dependent? Your dependent is either a qualifying child or a qualifying relative.
Qualifying expenses are the total costs of attending an eligible educational institution, including graduate school. These include tuition, books, fees, supplies, and equipment that were required for enrollment or attendance at the educational institution.
50% of self-employment taxes
When you're a full-time employee, both you and your employee pay FICA, which is the federal insurance contributions tax (FICA) -- Social Security and Medicare. The IRS automatically deducts Social Security and Medicare payments from your wage throughout the year.
But when you're self-employed, you're required to pay both halves of Social Security and Medicare taxes. Luckily, though, because you can't have half of your self-employment taxes deducted from your paychecks, the IRS allows you to claim a deduction equal to 50% of your Social Security and Medicare taxes. So if you incurred $5,000 in self-employment tax, the IRS will give you a $2,500 credit for this expense.
You can deduct the amount you contribute to your IRA, Roth IRA, SEP-IRA, SIMPLE IRA plan, or simplified employee pension (SEP) plan during the tax year 2022 if you meet certain conditions. For 2022, your maximum deductible contribution is $6,000 ($7,000 if you're age 50 or older).
Health insurance premiums
You can deduct 100% of health insurance premiums if you are self-employed or have a net profit from self-employment.
You can deduct health insurance premiums paid for yourself, your spouse, and your dependents even if you do not claim itemized deductions on Form 1040.
As a small business owner, understanding the various IRS-required forms for subcontractors is absolutely essential to remain compliant. This guide will let you know all about creating 1099 forms and what types of forms you may need..