Some deductions are better than others

"Above the line" deductions are better than those "below the line," because they reduce your AGI.

Robert D. Flach
by Robert D. Flach, MainStreet contributor

There are two types of tax deductions. “Above the line” deductions are claimed on Page 1 of Form 1040 and reduce Adjusted Gross Income. “Below the line” deductions are claimed on Page 2 of the 1040 and reduce Taxable Income. The “line” is your Adjusted Gross Income.

“Above the line” deductions are “more better” than “below the line” ones. Because these deductions reduce your AGI, they could also increase a multitude of other tax benefits that are “phased out” or disallowed altogether based on your AGI, or a “modified” AGI, and could also reduce the amount of taxable Social Security or Railroad Retirement benefits. An “above-the-line” deduction of $1,000 could actually reduce your net Taxable Income by more than $1,000.

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“Above the line” deductions include expenses that are claimed on Schedules C, D, E and F, and “Adjustments to Income” such as:

  • Alimony
  • Early withdrawal penalties for CDs and savings accounts
  • Educator expenses
  • Job-related moving expenses
  • Qualified tuition and fees
  • Self-employed deductions for health insurance premiums, half of the Self-Employment Tax and traditional retirement plan contributions
  • Student loan Interest
  • Traditional IRA contributions

“Below the line” deductions are the Standard Deduction or Itemized Deductions from Schedule A and Personal Exemptions. The tax benefit of a deduction claimed “below the line” is always limited to the amount of the actual deduction. A $1,000 “below the line” deduction will reduce your net taxable Income by only $1,000.

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Here is a tip: You can deduct as a miscellaneous itemized deduction the cost of preparing your tax returns. If the invoice is itemized you can allocate the tax preparation fee to Schedules A, C, E and F as per the itemization.

The invoice for preparing your 2011 tax returns totals $350, which is itemized as $150 for Form 1040 and Schedule A, $125 for Schedules C and SE and $75 for Schedule E. You can deduct $150 on your 2012 Schedule A, $125 on Schedule C and $75 on Schedule E.

By allocating the fee you have reduced your AGI by $200. If you claimed the entire fee on Schedule A you would have reduced your taxable income only. And it is possible that, because of the 2 percent of AGI exclusion that applies to miscellaneous deductions, you would get only a partial, or no, tax benefit from the fee.

So if your tax return includes multiple schedules, ask your tax pro to itemize your invoice.