Difference Between Above the Line & Below the Line Deductions

by Michael Marz, Demand Media

Not all tax deductions are created equal as some can have a more favorable impact on your tax bill than others. And this is the case with above-the-line and below-the-line deductions. Although both types of deductions ultimately reduce your taxable income, the amount of above-the-line deductions you take can directly affects the amount and types of below-the-line deductions you're eligible for.

The AGI “Line”

You may be wondering what this so-called “line” is and why it's so important. This important line refers to your adjusted gross income, or AGI. Adjusted gross income is a preliminary figure calculated on tax returns after reporting all income that's subject to tax -- including the taxable profits on your Schedule C or C-EZ -- and reducing it with a number of specific types of deductions, which are commonly referred to as being above-the-line. The amount of AGI you report is important because the Internal Revenue Service uses it as a threshold amount for assessing your eligibility to take other tax credits and below-the-line deductions. Generally, the lower your AGI is, the less restrictions you'll face on other tax benefits.

Above-the-Line Deductions

Some above-the-line deductions, which are also known as “adjustments to income,” will also have limitations, but they're usually less restrictive than below-the-line deductions and directly offset the income you report. Each above-the-line deduction that's offered in a particular tax year is listed on separate lines on the first page of the 1040 form. Typically, above-the-line deductions include the contributions you make to health savings and individual retirement accounts. For self-employed taxpayers who report business earnings on a personal return, deductions for one-half of self-employment taxes owed, health insurance premiums paid, contributions to certain retirement plans, like a savings incentive match program for employees, or SIMPLE, simplified employee pension plans, or SEPs, and domestic production activities are available. Other write-offs that are used to calculate AGI also include the moving expenses you incur when relocating for business purposes, alimony payments, student loan interest and a number of others.

Below-the-Line Deductions

Any deduction that's reported on a line that comes after the AGI calculation on a return is a below-the-line deduction. This does include personal and dependent exemptions you take, but these aren't affected by your AGI like itemized deductions are. For example, if you incur deductible medical and dental expenses during the year, the total deduction amount you can report on Schedule A is limited to the amount that exceeds 7.5 percent of your AGI. And if you have job-related and other miscellaneous expenses to report on Schedule A, know that your total deduction is reduced by 2 percent of your AGI. Therefore, the lower your AGI is, the larger your deduction will be for these and other itemized deductions.

AGI Thresholds

In addition to limiting deductions, your AGI can also impact your ability to take tax credits. The IRS frequently uses modified adjusted gross income, or MAGI, as an income threshold for tax credit eligibility. Your MAGI is essentially your AGI with certain items added to it. Take, for example, the lifetime learning credit. This credit is only available if your MAGI is equal to or more than the maximum allowed. For this particular credit, your MAGI is calculated as your AGI plus foreign income that's excluded on your return and the amount of any foreign housing deduction or exclusion taken.

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