Determining Adjusted Gross Income on Your Tax Return
You Don't Have to Itemize to Claim These Tax Deductions
Not all tax deductions must be itemized in order to be claimed. Itemizing is time-consuming, often complicated, and not always in everyone's best interests. According to the Tax Foundation, almost 70 percent of taxpayers claim the standard deduction instead, which is often a higher amount than the cumulative total of everything the taxpayer has spent all year on tax-deductible items.
Adjustments to income are a different story. Sometimes called "above the line" deductions, you can enter them on the first page of your tax return before you decide whether or not to itemize or claim the standard deduction for your filing status.
The Most Commonly Claimed Adjustments to Income
For 2018, the 1040 tax return is the size of a postcard, and your adjusted gross income (AGI) is figured on line 7. Deductions go on line 8.
Line 9 accounts for the new TCJA qualified business income deduction. Your taxable income shows up on line 10 after you subtract lines 8 and 9 from 7.
Line 11 is where your tax due amount goes. You will need to follow instructions and attach the new Schedule 2.
The child tax credit and/or the new family credit for other dependents go on line 12 along with other non-refundable credits after completing, you got it, another schedule, this time Schedule 3*.
Then there's addition and subtraction and Schedules 4* and 5* to get to the amount of tax you paid throughout the year and the amount you still owe or are due as a refund. In several cases (noted by *) the entries will come after you complete related schedules.
Here's an overview of what the six new schedules cover. You can click the schedule titles to look at the PDF versions.
The current Form 1040 asked you to report certain added earnings on line 21. This includes (but is not limited to) most prizes and awards and all gambling winnings and earnings from an activity not engaged in for profit, such as money you made on your hobby. Now those amounts will go on line 21 of the new Schedule 1.
This new schedule also asks you to enter a business income (the existing Schedule C or C-EZ is still required); capital gains or losses (Schedule D in certain cases is still required); alimony received (this will change in 2019 under the new tax law); unemployment compensation; farm income (Schedule F still applies); earnings from rental real estate, royalties, partnerships, S corporations and trusts (to be detailed on Schedule E); and taxable refunds, credits or offsets of state and local income taxes.
That new 1040 line also is also where you'll report your adjustments to income. These amounts previously were known as above-the-line deductions because of their placement on page 1 of Form 1040 (and some on 1040A) just above those form's final page one line that showed your adjusted gross income. We tax scribes will have to come up with a new catch-all description for at least the next few years.
Regardless of what they're called, these adjustments/deductions include most of the old standbys: educator expenses; costs incurred by military reservists, performing artists and fee-based government officials (details still go on Form 2106); Health Savings Accounts, aka HSAs (Form 8889 still required); moving expenses but only if you're in the armed forced (Form 3903 still required); several self-employment related costs (retirement plan contributions, health insurance premiums and half of self-employment tax reported on Schedule SE); savings withdrawal penalty amount; student loan interest; traditional IRA deduction; and, for the 2018 tax year, alimony paid.
This short schedule is the core of our tax system, the tax due on your income. On the old, 2017 tax year Form 1040, this info went on line 44. On the new form, it will go on line 11 after you do the Schedule 2 calculations. As you do now, this could be as simple as looking at the IRS-provided tax table or going through worksheets depending on the tax treatment of your types of income.
All tax credits are better than tax deductions because they reduce your tax bill dollar-for-dollar. But some credits are worth more. Refundable credits could, as their name says, get you a refund if you don't owe any tax. Non-refundable tax credits, however, also are just like their name sounds. They can reduce your tax bill to zero, but you won't get a refund. Still, not a bad deal. If you can claim nonrefundable credits, you'll now do so on Schedule 3.
Here's where you'll report, as the schedule says, other taxes you owe. They include self-employment tax, some Social Security and Medicare taxes, household employment taxes, and retirement plan taxes.
The big items on this schedule are the estimated tax you paid and the amount you sent Uncle Sam when you got an extension to file. There's also the Obamacare premium tax credit, which people who use to purchase health care coverage on state exchanges or the federal marketplace. There also are lots of lines that are "reserved" for future entries.
This schedule isn't noted on the new Form 1040, but you'll need it if, as its name indicates, you have a foreign address or want to let someone else talk to the IRS about information on your tax return.
Other Adjustments to Income
Other above-the-line deductions depend on the particular details of your life, such as your vocation and your marital status.
- Classroom expenses for teachers and educators: This one is only good for $250, or $500 if you're married, filing a joint return and both you and your spouse are educators. Still, every deduction helps. According to the IRS, you must be "a kindergarten through grade 12 teacher, instructor, counselor, principal or aide for at least 900 hours a school year in a school that provides elementary or secondary education as determined under state law." You can take an above-the-line deduction for unreimbursed work-related expenses you incur during the tax year, if you qualify.
- Alimony paid: No, you don't have to pay taxes on the portion of your income that you must give your ex each month, but you have to provide your ex's Social Security number on your tax return. Your ex is taxed on this income instead. Certain rules apply, such as that the alimony must be provided for in a court order. If you just give your ex money out of the goodness of your heart, it doesn't count.
- Moving expenses: You can deduct many expenses associated with moving, but only if you have to move for job-related reasons, not simply because you'd like a change of scenery.
- Deduction for half the self-employment tax: If you're self-employed, you're hit with the burden of having to pay 100 percent of your Social Security and Medicare taxes. Your employer would pick up half this tab if you worked for someone else. But the IRS effectively gives that other half back to you on line 27 of your 1040. You still have to pay the tax, but you get credit for it.
- Self-employment health insurance: If you worked for someone else, you would have to itemize to claim a deduction for what you spend on health insurance premiums, and that deduction is subject to some rules and limitations. But you can deduct 100 percent of what you spend on premiums if you work for yourself. The policy can cover you, your spouse and your dependents.
- Qualified performing artists and other professions: This adjustment to income applies to only a select few certain artists, as well as to reservists and some fee-basis government officials.
- Domestic production activities deduction: This covers businesses in certain industries.
Adjustments to Income Lower Alternative Minimum Tax
The total of all these deductions is subtracted from your total income to arrive your adjusted gross income on line 37 of your 1040 tax return. You can later subtract either the standard deduction or itemized deductions from your AGI on the second page, as well as any personal exemptions. The result tells you your total taxable income, the figure that's used to calculate your federal income tax liability—how much you may owe the IRS or the amount of a tax refund you can expect.
Here's more good news: Adjustments to income are not added back when calculating the alternative minimum tax should you be subject to the AMT. This is because the alternative minimum tax is an alternate method of calculating the federal income tax liability, and this alternate method starts with adjusted gross income. Adjustments reduce adjusted gross income so by extension they can lower the alternative minimum tax.
Increasing Adjustments Increases Other Deductions and Credits
Some itemized tax deductions are limited by a person's adjusted gross income. For example, medical expenses can be deducted only to the extent that they exceed 7.5 percent of your adjusted gross income as of 2018. That number is set to rise to 10 percent for 2019.
Let's say Tom has adjusted gross income of $50,000 for the year. Let's also suppose that Tom has medical expenses totaling $6,000 for the year. Tom can deduct his medical expenses to the extent that they exceed 7.5 percent of his AGI, or $3,750. His medical expenses of $6,000 exceed this threshold by $2,250 so Tom can potentially deduct $2,250 out of his $6,000 in medical expenses as an itemized deduction on Schedule A in this scenario.
Now let's say that Tom also contributes $1,000 to a traditional individual retirement account in that same tax year. These contributions are an adjustment to income, so this reduces Tom's AGI by $1,000.
Now his adjusted gross income is only $49,000. Instead of a threshold of $3,750 (7.5 percent of $50,000) for calculating his medical expenses deduction, he has a threshold of $3,675. As a result, Tom can deduct an additional $75 in medical expenses for a total of $2,325 instead of $2,250.
Increasing adjustments can also increase certain tax credits that are based on your adjusted gross income, and it can decrease other taxes because some surtaxes are calculated based on a person's adjusted gross income. For example, the 3.8 percent net investment income tax is based in part on a person's modified adjusted gross income. Reducing adjusted gross income can, therefore, decrease the net investment income tax.