The difference between above-the-line and itemized deductions.
If you want to make the greatest impact on your tax return, then it’s important to understand the difference between above-the-line and itemized tax deductions.
Above-the-line deductions are the most valuable and have an immediate impact on your taxable income. If you are leveraging these deductions, then you know that they will play a prominent role in your tax return.
Itemized deductions can be claimed only if they are greater than the standard deduction ($12,400 for single filers and $24,800 for married filers in 2020). That “if” makes itemized deductions less valuable, yet these are often the deductions many focus on most.
Here are some examples of the most common deductions.
Common Above-The-Line Deductions
Retirement Plan Contributions
If your employer offers a 401(k), 403(b), or 457 Plan, then all of your contributions to these plans are fully deductible up to the plan limits. If your employer doesn’t offer a plan, then Traditional IRA contributions are fully deductible. Here’s how it works.
Mary makes $100,000 a year and contributes $10,000 to her 401(k) plan, which reduces her taxable income to $90,000. If she contributes $20,000, then her taxable income is only $80,000.
Similarly, if you are self-employed, then you can consider using a solo 401(k) or SEP IRA to maximize your retirement and tax savings.
Depending on your income, you may also be able to deduct Traditional IRA contributions for a non-working spouse.
Health Savings Account (HSA) Contributions
If you are enrolled in a high deductible health plan (HDHP), then you can make contributions to an HSA that are fully deductible up to the plan limits. In 2020, single filers can contribute $3,550, and married filers can contribute $7,100.
If you are 55 or older, then you can make a catch-up contribution of an additional $1,000 to the limit that applies to you.
HSAs are arguably the strongest savings tool because these dollars can also be invested and grow tax-free for future medical expenses. For that reason, a HSA is a great complement or alternative to Long-Term Care insurance.
If you were divorced during or before 2018, then all maintenance payments required by the divorce decree are fully deductible to the paying spouse. Maintenance payments are then taxable to the receiving spouse.
Child support payments, however, are separate from maintenance and not tax-deductible.
If you were divorced in 2019 or later, then maintenance payments are not tax-deductible to the paying spouse and are tax-free to the receiving spouse, which may lead to smaller payments for the receiving spouse.
Student Loan Interest
Student loans are a common topic that impacts students and parents. Depending on your income, you can deduct up to $2,500 per year in interest paid on qualified student loans. In order to qualify in 2020, single filers must have an income of less than $85,000, while the limit for married filers is $170,000.
This deduction also applies to parents who may have taken out loans (Parent PLUS loan) to help a child with education expenses.
Common Itemized Deductions
Mortgage Interest & Points
In the majority of cases, the qualified mortgage interest that you pay on your mortgage is tax-deductible, but your original balance cannot exceed the below thresholds to qualify.
Mortgage was taken before December 15, 2017
- Single = $500,000 or less
- Married = $1,000,000 or less
Mortgage was taken after December 15, 2017
- Single = $375,000
- Married = $750,000
Also, if you paid any mortgage points, then this cost is a tax-deductible item on your tax return. When you pay mortgage points, you are essentially buying down your interest rate. You agree to pay a sizeable upfront fee in order to have an interest rate lower than the current market rate.
State and Local Taxes (“SALT”)
This deduction applies mainly to state income and property taxes.
Prior to the Tax Cuts and Jobs Act (TCJA), there was not a cap on state income and property tax deductions. For example, if you paid $10,000 in state income taxes and $10,000 in property taxes, then the full $20,000 was tax-deductible.
After TCJA, these taxes are still deductible but up to a maximum of $10,000. Using the same example from above, you would still pay $20,000 in combined taxes, but only $10,000 is tax-deductible.
The cap on SALT coupled with the significant increase in the standard deduction has resulted in fewer taxpayers claiming their itemized deductions.
If you contribute cash, check, or other items of value to a qualified organization, like a 501(c)(3), and you have a record of the contribution and value, then the contribution may be tax-deductible.
It’s worth noting that if you receive a benefit from the contribution, like merchandise, goods, services, or admission to an event, then you can’t claim a full deduction. You need to subtract the value of the benefit received from your contribution to determine how much is deductible.
While donations are an itemized deduction, there are strategic ways to get you over the standard deduction, like using a Donor Advised Fund, and get the most out of your donations.
Medical and Dental Expenses
While medical and dental expenses are eligible as itemized deductions, these expenses are not common deductions due to the limits because you can deduct only the expenses that exceed 7.5% of your adjusted gross income. For example, if your AGI is $100,000 and your medical expenses are $10,000, then you can only deduct $2,500 of those expenses because the first $7,500 (7.5%) is not tax-deductible.
Prioritize above-the-line deductions and think strategically when making decisions and elections that impact your itemized deductions to maximize your tax savings.
Your tax return contains a lot of valuable information that can change how you manage your tax exposure year to year. Sit down with your advisor and/or CPA to understand what’s driving your return and where you can make changes to maximize your keep.
We offer a free custom tax report that you can review on your own or with a professional that highlights your key tax rates and your best tax savings opportunities.
Frank Iozzo, CPWA®
President, Private Wealth Advisor
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