Tax Deductions

What are Above the line Tax Deductions?

What are Above the line Tax Deductions?

According to Internal Revenue Code Section 62, an above-the-line tax deduction is a term used to describe the deductions which are allowed by the Internal Revenue Service for a taxpayer to subtract from the gross income. 
The reason they are referred to as “above-the-line” is because these tax deductions are subtracted from a taxpayer’s gross income in order to calculate the adjusted gross income. Any further deductions applied to the newly calculated adjusted gross income are commonly referred to as “below-the-line” deductions.
Above-the-Line vs. Below-the-Line:
Above-the-line deductions are considered to be more advantageous than below-the-line deductions because they do not have income-sensitive phase outs and other types of limitations, excluding certain taxpayers from eligibility. 
In typical cases, when below-the-line tax deductions are calculated and subtracted from an adjusted gross income, many wealthier taxpayers are phased out under the guidelines of Revenue Code Section 68. Above-the-line tax deductions are also relevant to all tax payers with a tax deduction checklist, even if the tax payer chooses to take a standard tax deduction approach as apposed to a .
Additionally, certain below-the-line deductions may be dropped from a taxpayer’s tax deduction list if the deduction exceeds a certain percentage of the taxpayer’s adjusted gross income. 
In this case, if a below-the-line tax deduction for medical expenses is considered for tax deduction, it is only deductible to the extent in which it exceeds 7.5 percent of the taxpayer’s total income. Above-the-line tax deductions will lower the total amount of a taxpayer’s adjusted gross income, giving them a greater eligibility for further below-the-line deductions, which may be subject to certain percentage of adjusted gross income limitations.
Examples of Above-the-Line Deductions:
Above-the-line business deductions are generally allowed for most necessary business expenses having to do with normal business trade or functions, which are considered to be normal and reasonable, without crossing the line of extravagant. The deductions contained in the tax deduction checklist cannot be services performed by the taxpayer as an employee. 
The tax deduction list includes any reasonable allowance for an employee’s salary, with compensation for personal services; any expenses that are required during an employee’s travels for the purpose of business operations, including reasonable meals and necessary lodging; and rental payments which are required for the continued use and possession of an article. The above-the-line tax deduction checklist extends to:
         Employee expenses which have been reimbursed by the employer;
         The expenses incurred by a performing artists, members of the Army Reserve, and state officials;
         The expenses incurred by teachers, including for books and other school supplies;
         Payments of alimony;
         Vehicles that meat a certain standard of emission quality;
         Net losses incurred from the sale of property;
         Expenses as a result of creating rental or royalty income;
         Expenses incurred as a result of moving to another residence;
         Expenses incurred from receiving a higher education;
         Repayments required for supplemental unemployment compensation; 
         Fees incurred due to a premature withdrawal of funds.

Applying of Tax Deductions Instead of Tax Credits

Applying of Tax Deductions Instead of Tax Credits

Tax deductions are a method of reducing the amount of Federal tax dollars owed by an individual by noting various items that have incurred expenses, though were required in order to earn the individual’s income. The various types of tax deduction methods are only available through certain limitations and conditions. 
Items in which a business has invested in, such as factory equipment, can earn the business a certain tax deduction allowance over the course of several years as the equipment declines in value and depreciates. Tax deductions are generally divided into business expenses and non-business expenses.
Tax Deduction for the Individual Taxpayer:

Depending on the eligibility of an individual taxpayer, the standard tax deduction or the itemized tax deduction may be chosen. The method chosen generally depends on which method produces the greater amount of tax deductions to benefit the individual. 
The standard method is based on a certain dollar amount, which is specific to the filing status of the taxpayer. The itemized deduction requires that certain individual expenses of an individual are noted and deducted off of the taxpayer’s adjusted gross income (AGI). All U.S. citizens and resident aliens are eligible for the standard tax deduction. 
Also, if a spouse chooses to itemize, then the other spouse cannot choose the standard method. Although the itemized method may provide further benefits, especially for those individuals in higher tax brackets, some individuals may choose the standard method to prevent any adjustments from the Internal Revenue Service from being made not in the taxpayer’s favor.

Tax Deduction for Business Expenses:
When businesses are taxed, there are a variety of tax deductions which may be used to reduce the overall amount of taxable income. Tax deductions can be made for any expenses incurred having a direct result of trading goods and services or operation of the business. 
Common business expenses which are tax deductible are cost of goods sold (total costs of manufacturing an end product) and trading and necessary business expenses. Although most business expenses are tax deductible, there are limitations on which expenses may be deducted, even if such expenses are related to business operation. These include:
         Deductions for the use of automobiles for daily operations;
         Limits on tax deductions for compensations given to certain employees;
         Limits on tax deductions for entertainment provided by a business;
         Payments of criminal fines for violations of public policy.
Tax Deduction for Capitalized Items:

Items that are purchased with the purpose of providing a future benefit to an individual or a business are considered to be capitalized items, and are tax deductible. A capitalized item can be equipment used to manufacture items in a plant and even expenses used to create a patentable invention. Tax deduction is applied to such capitalized items in a process known as depreciation for physical items, and amortization for intangible assets. Depreciation and amortization can be done in a straight line approach at a fixed yearly rate, or by a declining balance.
Tax Deduction for Non-Business Expenses:

Certain systems of tax deduction hold a distinction between assets of a business and assets used to produce an income. Non-business expenses which are tax deductible can include losses on sales or exchanges, though in the United States, losses of non-business assets is considered a capital loss and the deduction is based on the limits of capital gains. 
Losses on personal assets in the U.S. are not tax deductible unless it was caused by theft. Taxable income may be reduced for certain types of assets unrelated to business, referred to as itemized deductions. Personal payments in certain jurisdictions can also be deducted, such as alimony, as the payment becomes taxable to the receiver of the payment.

Difference Between Tax Deduction and Tax Credit:
There are two methods in which the amount of money an individual owes to the Federal government can be reduced. It can be done either with a tax deduction or a tax credit. A tax deduction is a way of lowering an individual’s taxable income, usually with the purpose of placing the person into a lower tax bracket, requiring less tax money to be owed from the individual. 
A tax deduction can be done by figuring out one’s adjusted gross income by filling out tax Form 1040. This form is used to discover an individual’s adjusted gross income before being placed into a specific tax bracket. Once a gross income is determined on Form 1040, further deductions can be taken from it, either through itemized deductions or standard deduction. The method used for deduction usually depends on the filing status of the applicant, such as married, single, etc.
A tax credit, on the other hand, is a type of credit earned after the tax bracket of an individual is determined, in which case a tax credit is determined and deducted from the actual amount of tax dollars owed. For example, if a person owes $300 and has a tax credit of $50, then the individual will only owe $250 in tax dollars. A tax credit, unlike a tax deduction, is not dependent on a person’s annual income, and a tax credit of $100 would be $100 to anyone, no matter how much money is earned in a year by a given person.


Qualifications for Tax Deductions:

Certain tax deductions are not available to everyone. The factors that determine whether or not an individual qualifies for a certain tax deduction usually depends on a person’s annual income. If a person makes more than a certain amount of money every year, saving account deductions and others may not be available to that person. Also, expenses that a person would like to deduct from their taxes must be proven to be important to a person’s current benefits.

An Overview on Tax Deductions

An Overview on Tax Deductions

Income tax deductions are a way of lowering the amount of a taxpayer’s taxable income so that the total amount of taxes paid for that individual will ultimately be lowered, and is allowed for various items in which taxpayers incur expenses for. Tax deductions are often confused with tax credits, but they are two different concepts in American tax law. 
A tax credit is a direct credit that reduces the total amount of taxes due from a taxpayer. This means that a person who owes $10,000 in taxes to the Internal Revenue Service, but receives a $1,000 credit, the taxpayer will have the total tax obligation reduced to just $9,000. A tax deduction, on the other hand, reduces the amount of taxable income to a certain extent and are usually limited to how much an expense exceeds a certain percentage of a taxpayer’s income.
Purpose:
Tax deductions, along with tax credits is a system that was created by the United States government in order to reward and promote certain behavior or to encourage investment in specific types of property by taxpayers. For example, the government encourages taxpayers to donate to eligible charitable organizations and provides tax deductions for the amount that has been donated from a taxpayer. 
Also, taxpayers that spend money on investments for a company, such as new factory equipment or brand new software may be eligible for itemized tax deductions for their monetary contributions to the economy. There are two means for calculating tax deductions in the United States. 
The “regular tax” method determines a taxpayer’s gross income, makes the necessary tax deductions and finally, a marginal tax percentage is applied based on the tax bracket of the individual. The “Alternative Minimum Tax” (AMT) is the second method of calculation, which uses a taxpayer’s gross income, ignores certain tax preference items and applies a reduced amount of tax deductions.
Criticisms:

Tax deductions have been criticized over the years because many taxpayers believe that it is an anti-progressive system that favors taxpayers with higher incomes. This is because individuals with lower wages may not qualify for the benefits of the itemized tax deduction method, instead settling for the standard deduction method. 
A person with a high salary, especially those with a six figure salary, will most likely be eligible for itemized tax deductions, given these individuals, what critics of the system call an unfair tax break unattainable by those in lower tax brackets. This has put doubt into the American system of progressive tax, which many believe negates the basic idea that the tax rate should increase when the amount of taxable income increases.

A Helpful Overview on Tax Deductions

A Helpful Overview on Tax Deductions

Application of Tax Deductions and Differences from Tax Credit: 

Individual Taxpayers:

For individual tax payers, tax deductions are different expenses which are eligible to be reported on a tax return in order to reduce the amount of the individual’s taxable income. Individuals are generally given the choice between an itemized tax deduction and a standard tax deduction to determine the total taxable income. The choice is generally dictated by which method produces the greater amount of tax deductions for the taxpayer. The standard deduction procedure, which is generally a more attractive choice for individuals who wish to avoid disputes and adjustments by the Internal Revenue Service (IRS), is only available for U.S. citizens and resident aliens. Also, itemized tax deductions require a taxpayer to keep detailed records of their expenses and other transactions, as such deductions require proof before being applied to tax returns.

Business Expenses:

Business expenses, which are the costs that are incurred by a company to carry out its daily business operations, are generally tax deductible. This can include the renting of office space and storefronts, business trips provided to employees, and operations associated with employee payroll. One of the largest items that can be written off by a company are its cost of goods sold (COGS), the amount of money it costs for a company to purchase raw goods, develop it into a final product, and sell it to the public.

Capitalized Expenses:

Capitalized items in a company are generally considered to be items purchased by a company as an investment which are used to create a profit in the future. For example, a capitalized business item can be factory equipment for manufacturing a product, which is depreciated over time. In most cases, capitalized items that have depreciated value are deducted over time.

Difference Between Tax Deduction and Tax Credit:

Though both terms are easily mistaken, tax deductions and tax credits are two completely different terms in United States tax law. Though both terms reduce the amount of money and individual or business owes in taxes to the government, they are both given for different reasons and use different methods for doing so. A tax deduction is a method used to write off certain expenses incurred by an individual or business in order to lower the taxable income. In some instances, this may place a taxpayer into a lower tax bracket, requiring a smaller percentage of taxes to be paid. A tax credit, is a payment to an individual or company after their tax bracket has been determined, and it directly reduces the amount of taxes a taxpayer is obligated to pay to the federal government. The tax credit would then be subtracted from the total tax amount.

Itemized Tax Deductions:Eligible Itemized Tax Deductions:

         Medical Expenses: Though there are certain limits, medical expenses may be written off. The amount of allowed deductible medical expenses is determined by calculating 7.5 percent of a taxpayer’s gross adjusted income and subtracting it from the total medical expenses. These will usually include payments to doctors, physical therapists, psychologists and other health care professionals.

         Mortgage Interest: Can include debt which has been accumulated from up to two different houses.

         Charitable Contributions: These include donations that are made to eligible charities, such money, goods and expenses incurred for providing services.

Small Business Tax Deductions:

Small businesses write off deductible expenses to help lower the taxable profit. By doing this, it will have more money to reinvest and spend for future operations and expansion. Businesses should keep organized records of all deductible expenses to ensure the maximum amount of deductible expenses. These expenses are decided into business expenses and capital expenses.

Expenses on Entering a Business: This type of expense is considered to be a capital expense because it is part of an investment that a company puts into something for future income and profit.

Books and Legal Fees: It is not uncommon for a business to seek professional legal counsel when performing operations and acquiring additional knowledge. Yearly fees for professional help and amounts paid for books and other educational sources can be tax deductible.

Interest: For an owner to purchase a business, in many cases credit would be used to finance it. The interest and carrying charges for such a procedure are tax deductible.

If you need legal advice and assistance, contact tax lawyers.

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