CARL WATTS & ASSOCIATES

September 25, 2017

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Adjustments to Income
Keeping up with our newsletters, you already know that federal tax deductions are a way to decrease your taxable income and thus reduce the amount of tax you owe to the federal government. Tax credits, on the other hand, are a direct reduction of the tax due.


It is also well known that, depending on your personal circumstances, you can either take the standard tax deduction, or the itemized deduction.

With that in mind, it is important to understand that the standard or the itemized deductions are below-the-line deductions and that there are a number of above-the-line deductions also referred to as adjustments to income or as pre-tax deductions.

Adjustments to income are called above-the-line deductions because they appear on page one of Form 1040, above the line that reports your AGI. As a matter of fact, the very definition of AGI is gross income minus adjustments to income.

Above-the-line deductions are considered to be more advantageous than below-the-line ones because they can play an important role not only in how much you pay in taxes, but also in determining your itemized deduction amounts, the amount of various credits you will qualify for, and any earned income that you are entitled to.

You can take adjustments to income in addition to your standard deduction or itemized deductions and these deductions are not added back when calculating the alternative minimum tax.

Above-the-line deductions may also refer to expenses that are claimed on Schedule C (Business income); Schedule D (Capital gain or loss); Schedule E (Income from rental real estate, royalties, partnerships, S corporations, trusts; and Schedule F (Farm income). These above-the-line deductions are not included among the adjustments to income and may be taken into consideration when calculating the alternative minimum tax.

The reason behind the adjustments to income is, on one hand, the government’s awareness that some expenditures are necessary to be able to earn income (or earn more income), and on the other hand to create an incentive for people to be responsible with their money and plan ahead for certain eventualities (including health care expenses and retirement).


Here are the adjustments to income as they appear on your Form 1040:

Educator expenses deduction, which allows teachers and educators to deduct classroom supplies and other materials they paid with their own money.

Certain business expenses of reservists, performing artists, and fee-basis government officials. These professionals are entitled to deduct their out-of-pocket job-related expenses as an above-the-line tax break , provided they meet certain conditions.

Health savings account deduction. If you are an eligible individual who qualifies for an HSA, you can deduct your HSA contributions as an adjustment to income.

Moving expenses. If you relocate to start a new job, or to seek work in a new city, you may be able to deduct the cost of moving from one home to another.

Deductible part of self-employment tax. Employees are required to pay half of the 15.3% tax for both Social Security and Medicare and their employers pay the other half. Consequently, the self-employed are allowed to deduct half of the 15.3% as an adjustment to income.

Self-employed SEP, SIMPLE, and qualified plans.

Self-employed health insurance deduction.

Contributions to the SEP, SIMPLE, and qualified plans, as well as contributions to health insurance are again allowed as adjustments to income for the self-employed since these contributions are also excluded from employees taxable income.

Penalty on early withdrawal of savings. If you withdraw money from a certificate of deposit or other time-deposit savings account prior to your certificate maturing, you may incur a penalty for early withdrawal. You are allowed to deduct this penalty as reported to you on Form 1099-INT as an adjustment to income.

Alimony paid. If you pay alimony or separate maintenance to your ex- spouse, you can report the total amount of alimony you paid during the year as an adjustment to income.

IRA deduction. You can reduce your taxable income by contributing money to a traditional individual retirement account (IRA).


Student loan interest deduction. If you qualify, you can deduct interest on student loans paid into by yourself, by your spouse (if you file jointly), and for your dependents.

Tuition and fees. Just like with the student loan interest, you can deduct the cost of college tuition for yourself, your spouses, and your dependents.

Domestic production activities deduction. US-based businesses with certain qualified production activities can take a tax deduction of 3% from net income.

There are, of course, several incidental rules and limitations on most of these deductions that will be detailed in future newsletters. You may also need additional forms for some of these adjustments and you will need to keep receipts for various items claimed as well.

There are a few more adjustments that can be claimed on Form 1040 than on Form 1040A. Adjustments that are on both forms are: the educator expenses, IRA deductions, student loan interest, and the tuition and fees deduction.

You should also know that not all adjustments to income are named on Form 1040. Although line 36 simply instructs you to total your entries on all the previous adjustment lines, if you venture to take a closer look at Form 1040 instructions, you will discover that you can add here many more possible adjustments to income, even if some of them are for relatively limited tax situations.

Some of these adjustments to income include: attorney fees and other legal costs, jury duty pay if you gave the pay to your employer, and Archer MSA deduction.


Most of all, remember that, if you want to maximize your deductions, it is best to talk to a tax professional who can guide you to use deductions efficiently and legally.
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