Above the line tax
Deductions are worth more than
Below the line ones

What is the line?

Adjusted gross income. AGI for short.

This year, 2022, you’ll find this number on line 11 of your Federal Form 1040. It tends to move around from year to year as these forms get format updates.

You’re also going to encounter the abbreviation MAGI a lot. No, it does not mean Make America Go Insane. It stands for Modified Adjusted Gross Income. For most people, all this means is AGI plus any tax exempt interest from municipal bonds. In 2022, you’ll find this number on line 2a of your Federal Form 1040.

A deduction that applies before your adjusted gross income gets calculated is more valuable than a below-the-line deduction for a couple of reasons.

Reason #1: Tax thresholds.

A tax threshold is the point at which you cross into a new bracket of ordinary income or capital gains, or expose yourself to Net Investment Income Tax, Additional Medicare Tax, IRMAA surcharges on Medicare B and D premiums, and on.

An above-the-line deduction directly reduces your AGI. This means it can comprehensively reduce your exposure to taxes by directly reducing taxable income. It buffers you from exposure to higher tax thresholds, and, therefore, higher taxes. It can also open up tax advantages like being able to contribute to a Roth IRA. Lastly, a lower AGI can potentially qualify a taxpayer for tax credits.

Most important takeaway: The lower the AGI, the better.

Reason #2: Bypass the standard deduction.

You don’t have to itemize deductions to be able to use an above-the-line deduction. The standard deduction applies after the calculation for Adjusted Gross Income.

When the standard deduction doubled in 2018, many personal deductions were lost. Move across the country for work? Not a deduction anymore. Damage to your home not covered by insurance? Not a deduction anymore. The list goes on.

The standard deduction for the 2021 tax year is $25,100. Assume for a moment that there was no such thing as an above-the-line deduction and all deductions were below-the-line. Now let’s say a married couple in their 40s each contributed the maximum to Traditional IRAs in 2021 ($6,000 each = $12,000). This same couple also makes the maximum contribution to a Health Savings Account ($7,200) for a total contribution to these accounts of $19,200.

With our double standard deduction, none of these contributions would be deductible. You would have to have an additional $5,900 of deductions before you could itemize and claim a deduction for these account contributions.

Fortunately, that is not the case. We have above-the-line deductions so that every dollar you contribute to a deductible account avoids inclusion as taxable income.

To maximize deductions, first look at all of the possible above-the-line deductions and see which ones you can use. Then use them.

If you’re looking down the road and making a tax plan, learn about the above-the-line deductions you can’t use right now. Can you make any changes that could let you take advantage of these gifts from the IRS?

Happy deducting!