What it means
The "line" in question is adjusted gross income, or AGI, a subtotal that appears part way down a personal tax return. Anything subtracted before that subtotal is above the line, and anything subtracted after it, such as the standard deduction or itemised deductions, sits below.
The distinction matters because AGI is not just one number on one form. Eligibility for many credits, allowances and phase-outs is tested against AGI, so pulling it down can quietly earn you benefits that a below the line deduction would never touch.
The second advantage is availability. Below the line deductions only help people who itemise, and most taxpayers take the standard deduction instead, so an above the line deduction is worth something to almost everyone rather than to a minority.
Typical items include contributions to a traditional retirement account, health savings account payments, the deductible half of self employment tax, student loan interest and certain educator expenses. The precise list is set by legislation and shifts from year to year, so anyone planning around it should check the current rules rather than last year's return.
For business owners the idea overlaps with ordinary trading expenses. A sole trader's legitimate costs reduce business profit before that profit ever reaches the personal return, which produces the same effect as an above the line deduction without appearing on the published list.
In practice
Real-world examples.
Example
A self employed photographer contributes $12,000 to a retirement plan set up for sole traders. The contribution reduces adjusted gross income directly, cutting the tax bill without requiring her to itemise anything, which she could not do because her mortgage interest and charitable giving together fall short of the standard deduction.
Example
A secondary school teacher spends $280 of his own money on classroom materials and claims the educator expenses deduction. It is a small sum, but it comes off gross income rather than needing to compete with the standard deduction, so every dollar counts.
Example
A software engineer earning $146,000 pays $16,000 into a health savings account and a retirement plan combined, dropping her adjusted gross income to $130,000. That move brings her under the income threshold for an education credit she would otherwise have lost entirely, so the deduction is worth more than its face value suggests.
Formula
Calculation
Adjusted gross income = gross income - total above the line deductions
Tax saved = total above the line deductions x marginal tax rate
A freelance designer earns $118,000 of gross income for the year. She contributes $7,000 to a traditional retirement account, pays $4,300 into a health savings account and pays $2,500 of student loan interest, giving above the line deductions of $7,000 + $4,300 + $2,500 = $13,800.
Her adjusted gross income is therefore $118,000 - $13,800 = $104,200. She then takes a standard deduction of $15,000, leaving taxable income of $104,200 - $15,000 = $89,200. At a marginal rate of 24%, the above the line deductions are worth $13,800 x 0.24 = $3,312 in tax saved, and she keeps the full standard deduction on top.Case study
Seen in the real world.
The following is an illustrative and entirely fictional example. Marchfield Design Studio is an invented two person consultancy whose founders drew $124,000 each in their third year of trading. Their accountant pointed out that they had been treating tax planning as an itemising exercise, comparing mortgage interest and charitable donations against the standard deduction and concluding, correctly, that itemising was not worth it.
What they had missed was the set of deductions sitting above the line. Each founder opened a retirement plan for the self employed and contributed $18,000, and each also began paying $4,000 a year into a health savings account. Their combined above the line deductions of $22,000 each reduced adjusted gross income to $102,000 without disturbing the standard deduction at all.
In this fictional scenario the tax saving came to roughly $5,300 per founder at a 24% marginal rate, and lower adjusted gross income also restored a credit that had been phasing out. The money had not disappeared; most of it now sat in their own retirement and medical accounts rather than in a tax payment.
Watch out
Common mistakes.
- Assuming you must itemise to benefit, when the whole point of an above the line deduction is that it applies regardless of which route you take below the line.
- Treating the deduction as a credit and expecting a dollar of deduction to save a dollar of tax, when it actually saves your marginal rate times the deduction.
- Forgetting that lowering adjusted gross income can restore eligibility for credits and allowances, and so undervaluing a deduction by looking only at the direct rate saving.
Questions
People also ask.
Are above the line deductions the same as business expenses?
No, but they behave similarly, because both reduce income before the standard or itemised deduction is applied.
Which is better, an above the line deduction or a below the line one of the same size?
The above the line version, because it reduces adjusted gross income and therefore also affects any test or phase-out that uses that figure.
Does the list of above the line deductions ever change?
Yes, it is set by tax law and items are added, capped or removed from year to year, so it is worth confirming the current position each filing season.
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