Tax Deductions: Above-the-Line, Standard, Itemized, and Miscellaneous

TFB — Wed, 18 Feb 2009 14:59:50 +0000

I wrote about tax credits last week. This time let’s look at tax deductions. First a recap of the difference between a tax credit and a tax deduction:

A tax credit directly reduces your tax dollar for dollar. If you are supposed to pay $5,000 in tax, a $500 tax credit reduces your tax to $4,500.

A tax deduction reduces your taxable income, which indirectly reduces your tax. If you are supposed to pay $5,000 in tax, a $500 tax deduction reduces your taxable income by $500 which then reduces your tax by only $500 * 15% = $75 if you are in the 15% marginal tax bracket.

Therefore a $100 tax credit is worth a lot more than a $100 tax deduction.

Within tax deductions, there are above-the-line deductions, standard deduction, and itemized deductions.

Above-the-line deductions are officially known as adjustments to income. The “line” refers to the last line on page 1 of your Form 1040 or Form 1040A, which is labeled adjusted gross income (AGI).

That AGI is the magic number that determines eligibility for many tax breaks. Above-the-line deductions reduce that magic number. They can be taken even if you use the standard deduction and not itemize your deductions. An above-the-line deduction also passes through AMT, whereas some of the other deductions are disallowed under AMT.

Therefore a $100 above-the-line tax deduction is better than a $100 below-the-line deduction. The new tax deduction for sales tax when you buy a new car is an above-the-line deduction.

I think most people already know the difference between standard deduction and itemized deductions. So I’m not going to waste your time. I do want to point out just because an expense is tax deductible, it doesn’t mean you can actually take the deduction.

I know it sounds weird but it’s true. It took me a while to figure out many exciting deductions are only deductions in theory. Most people can’t really take them. This is because some deductions must first clear a floor before they can be deducted.

For example medical expenses are tax deductible, but you can only deduct the portion which exceeds 7.5% of your AGI. For many people that means zero.

Theft losses are also tax deductible, but only the portion which exceeds 10% of your AGI. That’s a very high hurdle.

Safe deposit box rental fees and tax preparation fees are also theoretically tax deductible, but few people can actually deduct them because them fall into a bucket called miscellaneous deductions, which are subject to a floor of 2% of AGI. All your miscellaneous deductions added together must exceed 2% of your AGI before you can deduct anything.

For example, suppose your AGI is $80,000, 2% of your AGI is $1,600. If you have $1,700 in all miscellaneous deductions, you can only deduct $100. If you have $1,500 in all miscellaneous deductions, you can’t deduct anything.

Therefore most miscellaneous deductions are practically useless.

The following table lists some of the tax deductions (as of 2008 tax year) in alphabetical order. I’m not enumerating miscellaneous deductions here because there are simply too many. All the links point to the official IRS web site for that topic. Every tax deduction has a unique set of qualification rules. Out of 19 tax deductions listed here, 11 are above-the-line; the other eight are itemized deductions.

Tax Deduction	Above-the-Line?
Alimony Paid	Yes
Casualty and Theft Losses	No, 10% AGI floor
Charitable donations	No
Educator Expenses	Yes
Health Savings Account	Yes
Investment Interest	No
Medical and Dental Expenses	No, 7.5% AGI floor
Miscellaneous Expenses	No, 2% AGI floor
Mortgage Interest and Points	No
Mortgage Insurance Premiums	No
Moving Expenses	Yes
Property Tax	No
Qualified Performing Artists	Yes
Self-Employment Health Insurance	Yes
Self-Employment Retirement Plan Contributions	Yes
1/2 of Self-Employment Tax	Yes
State Income Tax or Sales Tax	No
Student Loan Interest	Yes
Traditional IRA Contributions	Yes
Tuition and Fees	Yes

Isn’t it a mess or what?

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Software picked, likely related articles at The Finance Buff:

Tax Breaks In Stimulus Bill for Buying a Home Or a New Car

TFB — Thu, 05 Feb 2009 15:14:07 +0000

[Update on Feb. 18, 2009: American Recovery and Reinvestment Act of 2009 was signed into law on Feb. 17, 2009. This post is updated with the latest info from what's in the law. Please also read the follow-up post for other tax provisions in this law.]

[Update on Nov. 29, 2009: Worker, Homeownership, and Business Assistance Act of 2009 extended homebuyer tax credit both by time and by eligibility.]

1. $8,000 tax credit for buying a home. The new stimulus law will give up to $8,000 tax credit to first-time homebuyers. Unlike the previous $7,500 tax credit for first-time homebuyers, which has to be paid back in 15 years, this is a true tax credit as long as you hold the home for 3 years. The credit is still limited to people with an AGI under $75k (single) or $150k (married filing jointly). This tax credit is refundable, which means it’s not limited to your federal income tax liability. The qualifying purchase dates are between Jan. 1, 2009 and Nov. 30, 2009. So it’s not retroactive for purchases in 2008.

Worker, Homeownership, and Business Assistance Act of 2009 further extended homebuyer tax credit by time and income eligibility. The time for making a purchase was extended to April 30, 2010. For homes purchased on or after Nov. 7, 2009, the eligible income level is raised. The law also added a new $6,500 tax credit to existing homeowners who lived in their current home for at least five years out of the previous eight years.

Bought When?	By Whom?	Tax Break
Before 4/9/2008	anybody	None
4/9/2008 – 12/31/2008	first-time homebuyer; AGI under $75k/$150k (phase out to $95k/$170k); buy a primary residence	$7,500 interest-free loan over 15 years
1/1/2009 – 11/6/2009	first-time homebuyer; AGI under $75k/$150k (phase out to $95k/$170k); buy a primary residence	$8,000 tax credit
11/7/2009 – 4/30/2010	first-time homebuyer; AGI under $125k/$225k (phase out to $145k/$245k); buy a primary residence	$8,000 tax credit
11/7/2009 – 4/30/2010	existing homeowner; AGI under $125k/$225k (phase out to $145k/$245k); buy a primary residence	$6,500 tax credit

Source: CCH Tax Briefing. Full text of American Recovery and Reinvestment Act of 2009 and Worker, Homeownership, and Business Assistance Act of 2009.

2. Tax deduction for buying a new car. The stimulus law also gives a tax deduction for sales tax if you buy a new car (not a used car). To qualify for the tax deductions, you must buy a new car under $49,500 between the date the law is signed and 12/31/2009. There’s also an AGI limit of $125k (single) or $250k (married filing jointly), and a phase-out range of $10k. You can take advantage of this whether you itemize your deductions or use the standard deduction.

Bought When?	By Whom?	Tax Break
Before 2/17/2009	anybody	None
2/17/2009 – 12/31/2009	AGI under $125k/$250k (phase out to $135k/$260k); buy a new car under $49,500	tax deduction for sales tax

Source: CCH Tax Briefing. Full text of American Recovery and Reinvestment Act of 2009.

Patience is greatly rewarded by our government. If you bought your home or car too soon, you get no tax break or you only get a small break. If you waited, not only you get a better price, you also get a much bigger tax break. It makes you wonder if even bigger tax breaks are coming down the road. If I were in the market for a home or a new car, I would not proceed until I know I won’t miss out on a significant tax break.

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Software picked, likely related articles at The Finance Buff:

The Finance Buff » tax deduction

Tax Deductions: Above-the-Line, Standard, Itemized, and Miscellaneous

Tax Breaks In Stimulus Bill for Buying a Home Or a New Car