Adjustments to Income: More Than They Appear

Tanya Baber is an Enrolled Agent and Certified Tax Resolution Specialist who has been practicing since 1994. Tanya is a frequent speaker on a variety of tax subjects, and took some time to delve into Income Adjustments and why they are not as simple and straightforward as they might seem to be.

Income Adjustments are uniquely positioned to change the outcome of a return after the end of the tax year. Expenses like educator expenses, moving expenses, student loan interest, and other write-in adjustments can reduce income without itemizing. 

Adjustments to Income are a valuable tool to tax preparers, who very rarely have any wiggle room in the tax code to benefit their clients.

Adjustments to Income are known as “above the line” and are reported on Schedule 1 Part II of the 1040/1040-SR. These include line items 10-22.

Educator Expenses 

When it comes to Educator Expenses, up to $250 of qualified expenses can be used as adjustments to income. The taxpayer and their spouse can each spend $250 that can be recorded on line 10. 

In order for expenses to be qualified as “educator expenses,” the taxpayer must be a teacher, K-12 teacher, instructor, counselor, Principal, or Aide, as well as working 900 hours in a school year.

Qualified expenses include professional development, books, supplies, and equipment. Not included are homeschooling supplies or non-athletic supplies for physical education teachers.

Educator expenses are reduced by things like interest on savings bonds, tax-free withdrawals from a Coverdell education savings account, etc. The general rule is: if you got a reimbursement or advantage and it wasn’t included in income, you can’t take it as a deduction.

Employee Business Expense 

Line 11 is reserved for several very specific people:

  • Armed Forces Reservist
    • Form 2106 for travel over 100 miles
    • Limited to per diem and mileage
  • Qualified Performing Artist
    • The artist must be employed with at least 2 employers, with wages of $200+ from each employer. Expenses must be greater than 10% of that income, with an annual gross income of $16,000 or less before expenses.
    • If the artist is married, they must file Married Filing Jointly, and must meet the qualifications separate from their spouse.
  • Fee-Based State/Local Government Official
    • Those employed by the state or a political subdivision and are compensated on a fee basis can use this line as well.

HSA - Form 889 

The Health Savings Account (HSA) is a hidden gem for tax preparers. An HSA is a tax-exempt trust/custodial account for medical expenses. It is not health insurance, but health insurance is required in order to qualify.

If a taxpayer has a high deductible health plan with no other coverage, is not enrolled in Medicare, and is not a dependent, they can establish an HSA. Anyone can contribute to an HSA and they require no permissions from the IRS.

The taxpayer must work with a trustee, such as a bank, insurance company, or other entity in order to establish an official HSA. HSAs follow the last-month rule, meaning that if a taxpayer is eligible on the first day of the last month of the tax year, they then must remain eligible the entire next year in order to qualify. If the taxpayer fails to be eligible, contributions become taxable plus an additional 10%.

Contributions to HSAs do have limits for both self and family accounts, which have continued to increase each year. In 2019, the limit was $3500 for self (+$1,000 for 55+) and $7000 for family (+$1000 for 55+).

Distributions used for medical expenses are not subjected to taxes. Distributions for any other purpose are subject to an additional 20% tax.

If the taxpayer is over 65, withdrawals from an HSA are penalty-free, similar to any retirement plan.

Moving Expenses Form 3903

Line 13 is reserved for members of the armed forces on active duty who are moving due to a permanent change of station.

Self-Employment Tax 

This is found on Schedule SE

Section A - line 6

Section B - line 13

The idea behind this line item is that there is no matching federal portion of tax payment if a person is self-employed, which creates an unfair disadvantage that can be remedied here.

SEP, SIMPLE & Qualified Plans 

A Simplified Employee Pension (SEP) and a SEP-IRA are formal agreements and must be available to all employees. Contributions by an employer are not considered to be income. An employer can contribute annually the lesser of $57,000 (in 2020) or 25% of compensation. 

A Savings Incentive Match Plan for Employers (SIMPLE) is a retirement plan for any employee or self-employed person making $5,000/year. Elected deferrals are limited to $13,500 and an additional $3,000 for anyone 50+.

A SIMPLE IRA must have a written agreement, similar to a retirement plan. There are also Keogh or H.R. 10 plans that can be used on line 15.

Self-Employed Health Insurance 

Those that are self-employed earning a profit, a partner with net earnings, and those that received wages on their W-2 from an S Corp at which they are greater than a 2% shareholder, can use line 16.

The plan must be established under the business, and the Partnership or S Corp must be in the name of the taxpayer. Earned income limits the deduction that can be used here.

Penalty on Early Savings Withdrawal 

Alimony Paid (line 18a, 18b, 18c)

Payments to a former spouse under an agreement can be recorded on line 18.

18a: amount that qualifies

18b: Recipients’ social security number

18c: Month and year of divorce settlement

IRA Deductions 

For those that are not 70 ½ yet, deduction amounts may be limited. A maximum contribution of $6,000 per spouse can be increased by $1,000 per spouse for those over the age of 50. If the taxpayer contributes too much, they are penalized a 6% excise tax in addition to their earnings each year.

Student Loan Interest

Usually found on 1098-E, there is no form required if the student loan interest paid is less than $600 for the year. 

Tuition & Fees 

A qualified student would be the taxpayer or their spouse, paying towards higher education expenses up to $2,500. In some cases, the taxpayer can take a credit instead of a deduction.

Write-In Adjustments

Line 22 is reserved for obscure oddball income adjustments.

Taxes are inevitable, but income adjustments allow a tax return preparer to change the outcome of the return without prior planning and even after the close of the tax year! Adjustments to income are a great tool for tax return preparers to help their clients.