As an accounting major in college, I quickly learned all of the complicated parts of the accounting cycle. I discovered how to input the details of business transactions into a computerized accounting system. At the end of an accounting cycle, such as a month, I became experienced with calculating the revenue for the period. If you’re starting a new business, determining an accurate amount of revenue for each accounting cycle is crucial. You must know how much profit you’re making each accounting period in order to be successful in the long-term. On this blog, you will discover how an experienced accountant can help you keep track of your revenue.
Deductions are a critical part of minimizing your income tax obligation. But not all deductions are built the same. Tax deductions, in fact, come in two varieties: above-the-line and below-the-line. What does this designation mean? And how does it affect your taxes? Here's what you need to know.
What Is "the Line?"
When referring to items above or below the line, the line refers to your adjusted gross income on Form 1040. Adjusted gross income is the sum total of all your reportable income sources — including wages or salary, interest, taxable Social Security benefits, capital gains, and business profit — reduced by certain allowed tax deductions. These are the above-the-line deductions.
Below-the-line deductions are items that can directly reduce your taxes after they've been calculated based on your AGI. Generally, this means your standard deduction or itemized deductions.
What Makes AGI So Vital?
Why is this distinction important? Because AGI is essentially a base number on which other tax decisions are made. Many deductions are 'phased out', or reduced incrementally, based on your adjusted gross income. It may be used by state tax agencies as a base to determine your tax obligations to them. Even stimulus checks during recessions (or the COVID-19 pandemic) are usually based on your AGI.
Which Deductions Are Better?
Because it has a profound effect on your whole tax rate, reducing AGI as much as possible is a valuable move. You may lower other taxes at the same time. Do this by deducting such things as educator expenses, health savings account contributions, half of the self-employment tax, IRA contributions, tuition, and fees, or self-employed health insurance.
Below-the-line deductions still affect your taxable income, so don't rule them out. While many people just take the standard deduction ($24,800 for a married couple in 2020), finding more expenses to itemize can lower your income before the tax due is calculated. You might do this by deducting things like medical expenses, state and local income taxes, mortgage interest, casualty losses, or charitable contributions. So, while all deductions help reduce your taxes, those which also affect AGI can have a wider impact on your bill — both state and federal.
Where Should You Start?
Tax deductions can be very complicated. Anyone who wants to learn more about either above-the-line deduction options or itemizing their expenses should begin by meeting with a tax preparation service in their state. Make an appointment today to begin taking control of your tax bill.
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