Deductions and Credits
Above-the-line, below-the-line, and credits
Deductions reduce income; credits reduce tax dollar-for-dollar, and refundable credits can generate a refund. Above-the-line adjustments include deductible traditional IRA contributions, HSA contributions, one-half of self-employment tax, self-employed health insurance, student loan interest (up to $2,500 with phaseout), and alimony paid under pre-2019 divorce instruments. Itemized deductions include medical expenses exceeding 7.5% of AGI, state and local income, sales, and property taxes capped at $10,000 ($5,000 MFS), home mortgage interest on up to $750,000 of acquisition debt, charitable contributions, and casualty losses in federally declared disaster areas. Most taxpayers take the standard deduction.
Traps. MFS couples must be consistent: both itemize or both claim the standard deduction. The SALT cap is not indexed and applies to the combined total. Medical expenses are deductible only above the 7.5% floor and only for unreimbursed amounts. Charitable gifts require written substantiation. Nonrefundable credits cannot reduce tax below zero.
Credits to know include the child tax credit (up to $2,000 per qualifying child, with a refundable portion), the child and dependent care credit, the earned income tax credit (refundable, with an investment income limit), the American Opportunity Tax Credit (up to $2,500, partly refundable), the Lifetime Learning Credit (up to $2,000, nonrefundable), and the saver's credit.
Worked example. AGI is $50,000 and medical bills are $6,000. The 7.5% floor is $3,750, so the deductible amount is $2,250.