Published on February 8, 2022 in the Rochester Business Journal

Many people may be finding it easier to prepare their year-end tax returns since the Tax Cuts and Jobs Act was passed in December of 2017. At that time, the below-the-line standard deduction nearly doubled from $6,500 to $12,000 for individuals, and from $13,000 to $24,000 for those who were married filing jointly. This led to far more people taking advantage of the standard deduction at year-end, as opposed to itemizing deductions for things like medical expenses, home mortgage interest, state and local income tax, sales tax, and property tax, since the new standard deduction became larger than all of one’s itemized deductions combined for most taxpayers.

Taking advantage of the new standard deduction lowered many people’s taxable income and, ultimately, their tax bill. While below-the-line deductions like this, or those items that impact adjusted gross income (AGI) in the calculation of taxable income, are certainly important, they only impact a portion of an individual’s tax return. Equally important are what are referred to as above-the-line adjustments, which can significantly reduce total income in the calculation of AGI.

Above-the-line adjustments are reflected on Schedule 1 of your Federal tax return. Here, total income may be adjusted upward, based on the receipt of state and local income tax refunds, alimony, unemployment compensation and income from other sources including business interests, rental real estate, farms, and trusts, but there may also be important adjustments available that reduce total income. Some of the more popular offsets include expenses for self-employment health insurance, a portion of self-employment tax, alimony payments, and student loan interest.

Aside from the offsets mentioned above, perhaps the most valuable and often overlooked adjustments available to reduce total income are the ones we have the most control over. These would include deductible contributions to retirement accounts like traditional IRAs, SEPs, SIMPLEs, and other qualified plans for the self-employed, and contributions to health and well-being platforms like Health Savings Accounts and Archer Medical Savings Accounts.

In the case of a traditional Individual Retirement Account (IRA), deductible contributions really depend on your employment status. If you and your spouse aren’t covered by a qualified retirement plan at work, each can make a fully deductible contribution to his or her traditional IRA account in the amount of $6,000 for the years 2021 and 2022 - $7,000 in each of those years, for those that were age 50 or older. If one or both of you are covered by a qualified retirement plan offered by your employer, you can still contribute to a traditional IRA, but the deductibility of your contributions will depend on your modified AGI. In both cases, the deductibility of your contributions is subject to reduction and eventual elimination, as your modified AGI exceeds certain income thresholds.

For the self-employed and in addition to contributing to a Traditional IRA, funding a Simplified Employee Pension plan (SEP), a Savings Incentive Match Plan for Employees (SIMPLE IRA), or some other type of qualified retirement plan can also reduce total income. SEP plans only allow for employer contributions, and these contributions are limited to no more than 20% of net earnings from self-employment (less self-employment tax deduction), up to $58,000 in 2021 and up to $61,000 in 2022.

For SIMPLE plans, both employers and employees can contribute. Employers can choose to match employee salary deferrals on a dollar-for-dollar basis up to 3% of compensation, or they can make a non-elective contribution of 2% for all employees, up to certain limits. Employee contributions for SIMPLE plans are limited to $13,500 in 2021 and $14,000 in 2022, with an additional catch-up contribution of $3,000 allowed for each of those years in cases where the participant is age 50 or older. For individuals that participate in more than one qualified plan, employee contributions to all plans combined are limited to $19,500 in 2021 and $20,500 in 2022, with an additional $6,500 catch-up contribution allowed in years when the participant is age 50 or older.

Aside from the advantages that contributions to retirement accounts can provide toward reducing one’s total income, contributing to a Health Savings Account (HSA) or an existing Archer Medical Savings Account (MSAs) can also be beneficial. Essentially, an HSA account is designed for individuals and families where one spouse is enrolled in a high-deductible health plan, while an MSA is available to self-employed individuals or for people that are employed by a company with 50 or fewer employees, where the participant is enrolled in a high-deductible health plan, is not currently covered by Medicare and cannot be claimed as a dependent on someone else’s tax return. In these instances, individuals may generally make deductible contributions to their HSA/MSA accounts and withdraw funds tax-free, as needed, so long as funds are used for legitimate qualifying medical expenses. Note that MSAs were essentially discontinued after 2007, but there are still some of these types of accounts in existence.

For 2021, contributions to HSAs were capped at $3,600 for self-only ($7,200 for families), and for 2022, contributions are capped at $3,650 for self-only ($7,300 for families); contributions made by one’s employer count toward these limits. For MSAs, contributions for both years are capped at 65% of your overall deductible for individual-only plans, and 75% of your overall deductible for family plans. Contributions can be made by the employer or the employee in any given year, but not both.

Working with a qualified financial advisor or a seasoned tax preparer can help you identify several ways to lower your overall tax bill. In addition to standard and itemized below-the-line adjustments that can lower one’s taxable income, above-the-line adjustments that reduce adjusted gross income can provide additional benefits. Look over and pay particular attention to opportunities for retirement account and health/medical savings account contributions in this regard. There’s still time to make such contributions to favorably impact your 2021 tax return and the significant benefits of doing so are often overlooked.

To see this column in the RBJ, click here.