Determining Adjustments to Income on Your Tax Return
You Don't Have to Itemize to Claim These Tax Deductions
Itemizing is time-consuming, complicated, and not always in everyone's best interests, but not all tax deductions must be itemized in order to be claimed. The Tax Foundation, a leading independent tax policy nonprofit in the U.S., indicates that 13.7% of taxpayers are expected to itemize on their 2019 tax returns when they file them in 2020, claiming the standard deduction instead.
The Tax Cuts and Jobs Act (TCJA) nearly doubled standard deductions when it went into effect in 2018. As a result, this deduction is often more than the cumulative total of everything the taxpayer has spent all year on tax-deductible expenditures. Most, therefore, claim the standard deduction instead.
Adjustments to income, sometimes called "above the line" deductions, are different. You can enter them on your tax return before you decide whether to itemize or claim the standard deduction. Adjustments to income come off your gross total income and result in your adjusted gross income (AGI).
Eligibility for a good many other deductions and tax credits depends on your AGI. The higher it is, the less likely you are to qualify.
The Calculations on Your Tax Return
Your AGI appears on line 8b of the 2019 Form 1040, the return you'll file in 2020. The standard deduction or the total of your itemized deductions appear on line 9.
The 2019 tax return is different from the one that was used for the 2018 tax year. The IRS has redesigned the Form 1040 twice, once in 2018 and again in 2019. These lines correspond only with the 2019 return.
Line 10 accounts for the TCJA qualified business income deduction. Your taxable income shows up on line 11b after you subtract line 11a from line 8b.
Line 12a is where your tax due amount goes. You must complete and attach Schedule 2 and enter the total on line 12a. Add this to your tax and enter the result on line 12b.
The child tax credit and/or the family credit for other dependents go on line 13a. Line 13b is for other non-refundable credits you can claim.
The Numbered Schedules
Three numbered schedules must accompany your tax return if any of them apply to your financial situation and your tax return. Their corresponding information is then entered on your return itself, and in most cases helps determine your AGI.
These numbered schedules were introduced when the Form 1040 was first redesigned in 2018. There were six of them in that tax year. They're numerical, while those still in effect from before 2018 are identified by letters, such as Schedule A that lists your itemized deductions. There are only three numbered Schedules for the 2019 tax year as a result of that year's revised Form 1040.
Schedule 1 Affects Your AGI
Form 1040 asks you to report some added earnings on line 7a. This includes but isn't limited to:
- Business income or loss as calculated on Schedule C
- Rents royalty income as calculated on Schedule E
- Farm income or loss as calculated on Schedule F
- Unemployment compensation
- "Other Income," which can include prizes and awards, gambling winnings, and earnings from an activity not engaged in for profit, such as money you made on your hobby.
The total of all these sources of income is arrived at on line 9 of Schedule 1 and transfers to Part I, line 7a of the 2019 Form 1040. The schedule also asks you to enter capital gains or losses, alimony received by divorce decree or agreement entered into before 2019, and taxable refunds, credits, or offsets of state and local income taxes.
Your adjustments to income are calculated in Part II of Schedule 1. These are the amounts that were previously referred to as "above-the-line" deductions because they appeared on the first page of tax returns in use in 2017 and earlier years. They were entered just above those forms' final page one line that showed adjusted gross income.
These adjustments/deductions include:
- Educator expenses
- Costs incurred by military reservists, performing artists, and fee-based government officials
- Health savings accounts (HSAs)
- Moving expenses for members of the Armed Forces
- Several self-employment costs such as retirement plan contributions, health insurance premiums, and half the self-employment tax reported on Schedule SE
- Savings withdrawal penalty amounts
- Student loan interest
- The traditional IRA deduction
- Alimony paid pursuant to decrees dated 2018 or earlier
The total of all these deductions is subtracted from your gross income to arrive at your AGI on line 8b of your 2019 tax return. You can then subtract either the standard deduction or the total of your itemized deductions from your AGI. 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.
Rules and limits apply to some of these adjustments to income. You can't always claim the full amount of what you spent on these expenses.
The adjustment to income for classroom expenses for teachers and educators is $250, or $500 if you're married, filing a joint return, and both you and your spouse are educators. According to the IRS, you must be a teacher, instructor, counselor, principal, or aide for students from kindergarten through grade 12. You must work at least 900 hours a year in a school that provides elementary or secondary education.
You can take an above-the-line deduction for unreimbursed work-related expenses up to these limits if you incur during the tax year if you qualify.
It used to be that you didn't have to pay taxes on the portion of your income that you contributed to your ex-spouse each month in the form of alimony, but that changed with the TCJA, effective 2019. Your ex-spouse was taxed on this income instead.
You must provide your ex's Social Security number on your tax return if you want to claim this adjustment for tax years prior to 2019. Certain rules apply, such as that the alimony must be provided for in a court order.
You could deduct many expenses associated with moving prior to 2018, but this changed with the TCJA as well. This adjustment to income is only available to servicemembers beginning in 2018.
Your move must be necessitated by a military order and be a permanent change of station. Moving expenses incurred by your spouse or dependents qualify as well.
Half the Self-Employment Tax
You must pay 100% of your Social Security and Medicare taxes if you're self-employed. This is referred to as the self-employment tax. Your employer would pick up half these taxes if you worked for someone else.
The IRS effectively gives that other half back to you, however, on line 14 of your Schedule 1. You still have to pay that half of the tax, but you get a credit for it.
Self-Employed Health Insurance
You would have to itemize to claim a deduction for what you spend on health insurance premiums if you worked for someone else, and that deduction is subject to some rules and limitations. But you can deduct 100% of what you spend on premiums if you work for yourself. The policy can cover you, your spouse, and your dependents.
Effect of AGI on the Alternative Minimum Tax
Adjustments to income are not added back when calculating the alternative minimum tax if you're subject to the AMT. This tax is an alternate method of calculating your federal income tax liability, and the calculation starts with adjusted gross income. Adjustments to income reduce your AGI, so by extension they can lower the alternative minimum tax as well.
Effect of AGI on Other Deductions and Credits
Some itemized tax deductions are limited by a taxpayer's AGI. For example, medical expenses can only be deducted to the extent that they exceed 7.5% of your adjusted gross income as of 2019 and 2020.
As an example, let's say Tom has an AGI of $50,000 for the 2019 year. He has qualifying medical expenses totaling $6,000 for the year. Tom can deduct his medical expenses to the extent that they exceed 7.5% of his AGI, or $3,750. His medical expenses of $6,000 exceed this threshold by $2,250, so Tom can deduct $2,250 out of his $6,000 in medical expenses as an itemized deduction on Schedule A in this scenario.
But 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.
His AGI, therefore, drops to $49,000. He has a threshold of $3,675, or 7.5% of $49,000, rather than $3,750 for calculating his medical expenses deduction. He can deduct an additional $75 in medical expenses for a total of $2,325 rather than $2,250.
Increasing adjustments can also increase certain tax credits that are based on your AGI, and it can decrease other taxes because some surtaxes are calculated based on AGIs. For example, the 3.8% 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.
Other Schedules for the 2019 Tax Year
You might have to deal with completing and submitted some additional numbered schedules as well, depending on your tax situation and the tax year for which you're filing.
Schedule 2: Taxes
Schedule 2 is a short form, but it's the core of our tax system. It's the tax due on your income. The total from this schedule is transferred to line 15 of the 2019 Form 1040 after you make Schedule 2 calculations. Most tax preparation software will take care of these calculations for you.
Schedule 3: Nonrefundable Credits
Tax credits are better than tax deductions because they reduce what you owe the IRS dollar for dollar, while deductions simply subtract from your taxable income. But some credits are worth more.
Refundable credits are first applied to the tax you owe to erase that obligation, then—as the name suggests—the IRS will send you any unused balance. Non-refundable tax credits can reduce your tax bill to zero, but you won't get a refund. The IRS will keep the balance.
You can claim any nonrefundable credits you're entitled to on Schedule 3. These include:
- The Foreign Tax Credit
- The Child and Dependent Care Credit
- The Retirement Savings Contribution Credit
- Education credits
- Residential energy credits
Schedule 4: Other Taxes
Schedule 4 was eliminated in 2019. It reported other taxes you owed in 2018, including self-employment tax, some Social Security and Medicare taxes, household employment taxes, and retirement plan taxes. This information is included on Schedule 2 instead beginning with tax year 2019.
Schedule 5: Other Payments and Refundable Credits
Schedule 5 has also been eliminated. It used to detail any estimated tax payments you made, as well as any payment you might have sent in when and if you asked the IRS for an extension to file to file your tax return. They're entered on Schedule 3 beginning with tax year 2019.
Schedule 6: Foreign Address and Third-Party Designee
Schedule 6 has been eliminated as well. Beginning in tax year 2019, Schedule 6 will be included on Form 1040 or Form 1040-SR, whichever form you qualify to use. The foreign address will be included on page 1 of the 1040 or 1040-SR Form after the United States address. The Third-Party Designee will be on page 2 following line 24 on the 1040 Form or the 1040-SR Form.
Added all together, filing a tax return and getting it right can seem very intimidating. But most tax preparation software is well-equipped to handle all these different scenarios, and you can always seek the help of a tax professional if you really don't feel that you can handle it all yourself.
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