Valuable Above the Line Deductions - The Broke Professional

Valuable Above the Line Deductions

Make off with the deductions you deserve

Not sure if you heard, but a new tax law went into effect for 2018. I wrote about some of the major changes here.

One of the goals of the new tax plan was to make the tax filing process easier and simpler. While the jury is still out on that, one thing we can count on is that more people will be taking the standard deduction instead of being able to itemize their deductions.

The main reason for this is the limitation on the State and Local Tax (SALT) deduction to $10,000. The SALT taxes comprise of a number of different types of taxes, but the main one that will affect most people is property tax.

This is especially a huge blow for those living in expensive cities such as San Francisco or New York, where property taxes alone can be $20,000, way over the $10,000 limit.

So with the hard limit placed on SALT and the doubling of the standard deduction, fewer people will be able to itemize their deductions. That’s definitely a bummer, but all is not lost.

Above the Line deductions to the rescue!

Walk the Line

Deductions taken above the line have always been valuable. The “line” refers to your Adjusted Gross Income (AGI). Many tax breaks and credits are calculated based on your AGI.

And most of them start phasing out if your AGI is too high. That’s why above the line deductions are so powerful. Not only do they reduce the income that you’re going to be taxed on, they can also make you eligible for even more tax perks.

For example, the American Opportunity Tax Credit is a nice credit for tuition and other education costs. You can get up to $2,500 off your tax bill. That’s powerful.

But if you’re a married couple in 2019 and your AGI is above $180,000, you cannot claim the credit. A big loss.

Another good example is a Roth IRA. They are awesome accounts that allow you to save tax free money for retirement. But if you’re a married couple that makes more than $203,000 in 2019, you can’t contribute to a Roth. Another big loss.

I hope you can see the importance of keeping your AGI as low as you can. Since most taxpayers will be using the standard deduction under the new tax law, above the line deductions become all the more valuable in reducing your tax bill.

Low Hanging Fruit

Here is the actual list of above the line deductions taken directly from tax form 1040:

These are the big juicy deductions to focus on. What jumps out to me is that there are two no brainer deductions that most people can take advantage of.

Health Savings Account deduction. HSA’s are one of the best accounts out there. And if you have a high deductible health plan, which many people do, you can contribute to one. You can reduce your AGI by contributing to one, and any investment growth is tax free as well.

If you’re employed, you can simply get the contributions taken out of your paycheck. Easy enough. If you’re self employed, just report your contributions on that line 25 to get your above the line deduction.

-IRA contribution. This is another nice deduction you can use to reduce your AGI. It’s important to note this deduction refers to Traditional IRA’s. Roth IRA contributions are not tax deductible.

For 2019, you can contribute a maximum of $6,000 to an IRA. This will beef up your retirement savings while reducing your taxable income. A true win-win.

If you’re employed and are offered access to a 401k, you can still contribute to your own Traditional IRA, but there are income limits. If your tax filing status is single and your income is more than $74,000, your contributions are not tax deductible. $123,000 is the limit if married.

But no need to fret. The contribution limit of a 401k plan in 2019 is $19,000. More than triple that of an IRA. That’s income that is not reported on your W2, effectively lowering your AGI. Take full advantage of this if you can.

Student loan debt is not something you want to keep around too long, but it’s nice you can get an above the line deduction for the interest paid. In fact, if you have some low interest loans (below 4% in my book) that don’t keep you up at night, it can make sense to keep some of it around.

The reason being that compound interest from investing is most powerful when you’re young. If you invest early and often while keeping low interest student debt that will give you a little deduction anyway, it can be a nice wealth boost. Just a thought.

If you’re self employed, you have a few more opportunities to get deductions. You can deduct your health insurance premiums and part of the self employment tax.

I’ve been paying COBRA premiums since I recently became self employed. COBRA is much more expensive than what I was paying for health insurance as an employee, so it’s nice that I will be able to deduct that on my tax return.

Take what you can get

Paying more taxes than you should isn’t patriotic. The government lets us take deductions for a reason, so take advantage of them. The two big ones everyone should try to take advantage of are HSA and Traditional IRA contributions.

Almost everyone should be able to contribute to these. And they have the compound effect of increasing your retirement savings and reducing your AGI, possibly opening the door for even more tax credits. Can’t think of a more slam dunk way to increase your wealth.

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Comments

  1. http://Jake says

    “If you’re employed and are offered access to a 401k, you technically can’t contribute to an IRA.”

    Wait, what? Is this new or am I misunderstanding it. I thought you can contribute money to both an IRA and 401k… Isn’t the usual pattern to contribute to the 401k up to the employer match then switch to the IRA and max that before heading back to the 401k to finish maxing that out??

    • Hey Jake thanks for bringing that to my attention. What I meant to write is that if you are offered access to a 401k you usually can’t contribute to a Traditional IRA. Well you can you just can’t make a tax deductible contribution. I will change that. Some people can but most professionals make too much of an income to have a 401k and be able to contribute to a traditional IRA as well.

      You can still contribute to a Roth IRA though even with a pretty high income. Thanks for the comment.

      • http://Jake says

        Ahh, ok. I’ve never hit that income limit so I forgot about it. A good thing to keep in mind. Thanks for the article!

  2. http://Dan%20Alletto says

    If you are interested in a Roth IRA you have to weigh the benefits of reducing your AGI with a traditional IRA vs the tax free growth of a Roth. You can only contribute $6,000 to a combination of both, so you can’t get the full benefit of both. There are online calculators to help make a decision about what is best for your situation. The one I liked was from bankrate, https://www.bankrate.com/calculators/retirement/roth-traditional-ira-calculator.aspx . It showed that if I did a Roth vs Traditional, I will make about $80,000 more after taxes with a Roth vs Traditional. The traditional IRA may get your AGI down now, but in the long run, you make more on tax free growth in a Roth.

    • Hey Dan. That’s a good point. Those calculators are good but they are looking at it form purely the tax angle, while there are other benefits to each account. For example, you can withdraw Roth contributions tax and penalty free as long as you have had the account for at least 5 years. Some people value that. Can’t do that with a Traditional. But if you are able to lower your AGI by contributing to a Traditional, you may be eligible for other tax credits as mentioned in the post. So there are other factors at work.

      And the big variables are where you will be income wise in the future and where the tax rates will be. We can have a reasonable guess on where our income will be in 10 years, but can;t be sure. Same goes for tax law. What I like to do is be “tax diversified”. Meaning have some retirement funds in pre tax and some in after tax. You can put $3,000 in your Roth and $3,000 in your Traditional. This also provides more flexibility in the future when it’s time to withdraw from the accounts. Lots to consider!

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