Above-the-line tax deduction – how many people understand that term? All tax deductions are expenses that reduce your taxable income, but there are two distinct categories; above-the-line and below-the-line. What is “the line?” The line item in question is on Form 1040, labeled Adjusted Gross Income, or AGI. Until Tax Years beginning in 2018, AGI was the last line on Page 1 of Form 1040. Beginning in 2018, it will be in an as-yet-to-be-determined location, once IRS finishes the redesign of all 2018 tax forms. Portions of your annual tax calculation depend on AGI for computations and limitations, so AGI is important to you as a taxpayer.
Reducing your AGI directly reduces your tax bill (less income = less tax). For tax purposes, a lower AGI is equivalent to not making as much money, except that you actually did. Above-the-line deductions reduce your AGI, and so are the most valuable subtractions. Everyone should understand how these subtractions apply, and how they affect your ultimate tax bill.
Only a few types of expenses reduce AGI. Contributions to Individual Retirement Accounts, or IRAs, are among the most flexible tax planning tools available. Contributions to (non-Roth) IRAs can be deducted on 2018 tax returns, but don’t have to be deposited until April 15th of 2019. That creates a long planning period for determining the tax-reducing value of actual contributions. It also provides extra time to generate the cash needed for those contributions.
IRS can divert some or all of your 2018 refund into an IRA of your choice. Doing so preserves your 2018 IRA deductibility, potentially even enlarging your contribution. For small business owners, other types of IRAs are even more flexible. Small businesses can still open a 2018 SEP IRA or a Personal(k) Plan in 2019, as well, and both have larger contribution limits than Traditional IRAs.
Tax deductibility is only the beginning of IRA benefits. Saving tax-deferred funds for retirement is an absolute necessity for people desiring eventual Financial Independence. Congress has long encouraged taxpayers to save for retirement through tax deductions and investment income tax deferrals. Don’t rely on Social Security as a complete retirement income plan.
While there are not many ways to reduce 2018 taxes after December 31, 2018, if you can save a few hundred dollars in 2018, why not do so?
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