by Kay Bell

Above-The-Line Deductions: More Than a Dozen Ways to Cut Your Taxes

What do teachers, divorcees and people paying off student loans have in common?  Tax breaks without itemizing.

These filers, along with other taxpayers who fit into special categories, might be able to claim at least one of the dozen-plus deductions found directly on Form 1040.  There's no Schedule A to complete, with its percentage-of-income thresholds and deduction phase-outs.  Officially, these breaks are identified as adjustments to your income.  But they are popularly referred to as above-the-line deductions because you subtract them on page one of your 1040, just above the page's last line (number 36 on the 2004 return) where you enter your adjusted gross income (AGI).

Taking these deductions will reduce your AGI, which in most cases directly cuts your overall tax bill because figuring your AGI is the first step in arriving at your final taxable income amount.  The less taxable income, the less you'll owe the Internal Revenue Service.

While you don't have to hassle with Schedule A, a few above-the-line tax breaks do require you to fill out another IRS form or worksheet.  Still, that's a relatively small time commitment to shave some dollars off your tax bill.

Here are this tax season's above-the-line deductions, in the order they're found on Form 1040 (lines 23 through 35).  They could help you chip away at your taxable income.

  1. Educator expenses.  With this deduction, teachers and other public and private school system employees can subtract up to $250 they spent on classroom supplies.  This tax break had expired, but lawmakers revived it for the 2004 and 2005 tax years.  The amount is relatively small, but because it's an above-the-line deduction, more taxpayers should be able to claim at least some of their school-related expenditures.  Previously, educators could claim such costs only if they included them as miscellaneous itemized deductions on Schedule A.  Even then, they're of no tax use unless all the filer's allowable sundry costs total more than 2 percent of adjusted gross income.
  2. Certain business expenses:  Unreimbursed business expenses also usually appear on Schedule A as a miscellaneous deduction.  But some taxpayers get to claim their work-related costs as above-the-line deductions without worrying about a percentage threshold; they are military reservists, performing artists and fee-basis government officials.  Although this collection sounds more like the cast of an avant-garde foreign-language film than related taxpayers, lawmakers have deemed that anyone who falls into one of these categories deserves special tax treatment.  National Guard and reserve members who traveled more than 100 miles last year in connection with their service can deduct those costs here.  So can performing artists who meet IRS guidelines, as can state or local government officials who were paid, in whole or part, a fee to do their jobs.  If you are in one of these three fields, tally your out-of-pocket costs here.  You will have to fill out Form 2106 or 2106-EZ.  The Form 2106 instruction book has more details on just who is eligible for this tax break.
  3. IRA deduction:  If your company doesn't offer a retirement plan, you might be eligible to contribute up to $3,000 for the 2004 tax year to a traditional individual retirement account and subtract that full amount from your income.  The amount goes to $3,500 if you're 50 or older.  Even if you have a company pension plan or 401(k), the Internal Revenue Service has increased the earnings limits -- as much as $74,999 for married couples filing jointly who each have a pension plan at work; $54,999 for single filers -- so that more people are able to take at least a portion of this tax break.
  4. Student loan interest:  Up to $2,500 of the interest you paid on a qualified student loan can be subtracted here.  The loan can be for you, your spouse or a dependent.  Even better, you're no longer limited to deducting interest paid during the first 60 months of the loan, so longer-term college loans should be a bit more tax valuable.
  5. Tuition and fees deduction:  If you're eligible to claim this deduction, you could reduce your taxable income by up to $4,000 ($1,000 more than last year's deduction).  There are income limits on who can claim this tax break, and remember that it is for tuition and fees, not room and board or other educational expenses, that you paid for yourself, your spouse or a dependent.  Also, the deduction is not available if you use the Hope or Lifetime Learning tax credits to pay school costs for the same student.  And the tuition and fee amounts that you use to figure this deduction must be reduced by any tax-advantaged distributions you got from a Coverdell education savings account or state tuition program.
  6. Health savings account deduction:  A health savings account (HSA) is a medical coverage plan that works much like an IRA.  Eligible participants put money into an HSA where it grows tax free and withdrawals can be made to pay medical, dental and vision care costs not covered under a corresponding high-deductible health care policy.  These accounts became available to eligible taxpayers for the first time last year, and HSA holders can deduct (within IRS limits) their annual contributions; for 2004 tax purposes, that includes money contributed last year, as well as deposits to the account as late as this April 15.  The maximum possible above-the-line HSA deduction on 2004 returns is $2,600 ($5,150 if the account is for family coverage).  Fill out Form 8889 to determine the exact amount you can claim here.
  7. Moving expenses:  If you relocated for job reasons, some of your expenses can be deducted here.  You will, however, also have to fill out Form 3903.
  8. Self-employment tax:  If you're self-employed, you still have to pay Social Security and Medicare taxes, both the amount collected from you as an employee and you as an employer.  But you get to deduct half of those payments here.
  9. Self-employed health insurance:  As an entrepreneur, you now can deduct 100 percent of health insurance premiums you paid for yourself, your spouse and dependents.  Don't forget to count what you paid toward long-term care policies.  You get a partial break here, too.
  10. Self-employed retirement plans:  If you have a self-employment pension plan, such as a Keogh or a SEP-IRA, deduct any contribution amounts here.
  11. Penalty on early withdrawal of savings:  On this line, the IRS gives you a break when someone else slaps your hand!  If you cashed in a certificate of deposit and paid an early-withdrawal penalty, you'll find the amount on the 1099-INT or 1099-OID that the account manager has sent you.  The IRS lets you subtract that charge from your income.
  12. Alimony paid:  Divorced filers get a chance to recoup alimony payments here.  Be sure to include the Social Security number of your ex-spouse, so the IRS can make sure he or she reports the payments as income.  Without the recipient's tax ID number on your return, the deduction could be disallowed.

Let's take a quick form detour here.  What if you don't want to or need to use the long Form 1040?  You still get a chance to reduce your income if you file Form 1040A instead.  Four of these above-the-line adjustments -- educator expenses, IRA contributions, student loan interest and the tuition and fees deduction -- also can be claimed on lines 16 through 19 of that slightly shorter tax return.

A Few More Adjustments

Now back to the long 1040.  We're out of designated adjustment lines as we reach the bottom of page 1, so that's the end of the nonitemizing tax breaks, right?  Wrong.

Although line 35 simply instructs you to "add lines 23 through 34a," tax geeks who take a closer look at the form's instructions will find even more possible ways to whittle away at their incomes.

Sure, several of these adjustments, such as reforestation amortization or contributions by certain chaplains to tax-sheltered annuities, are for relatively limited tax situations.  A couple, however, have a slightly wider tax audience.

Did you contribute to an Archer medical savings account?  This is a health care program provided by some small businesses and also used by some self-employed workers.  You can deduct a portion of these medical care contributions (fill out Form 8853 to determine the amount) on line 35.  Write the amount on the dotted line and identify it by writing "MSA" next to it.

Another tax break that has grown in popularity is the $2,000 deduction for the purchase of a clean-fuel vehicle; for most taxpayers, this applies to hybrid autos.  If you bought one of the cars that the IRS has designated as eligible for this tax break, simply enter the deduction amount directly on dotted line 35 and write "Clean Fuel."

Be sure to add all these specially annotated line 35 amounts to the deductions claimed on the preceding 12 income adjustment lines.  This final number goes on the far right section of line 35. Once entered there, it's subtracted from the total income amount you entered on line 22.  The result on line 36: your adjusted gross income.

You can find other possible line 35 income adjustments on pages 31 of the 1040 instruction book.  Not many taxpayers will find these helpful, but check them out just to be sure.  They might just pay off for you.

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