<- Prev     Contents     Next ->

Adjustments to income

Click for accompanying notes, and online audio samples from our tape on income tax planning.

Other income

After adding in any taxable Social Security, you'll have to add in all other forms of taxable income that you received. Some items that you'll have to include are gambling winnings or other prizes.

Note that gambling operations are required to send out W-2G forms if the prize was fairly large. Basically, if you've received a W-2 or 1099 from someone, you'd better report the income or expect an IRS letter.

Adjustments to income

After listing all your sources of income, you get to make adjustments to your income. These items reduce your taxable income, but they aren't exemptions or itemized deductions.

IRAs

One of the more popular adjustments is your Individual Retirement Account deduction. Note that your IRA deduction may be limited. Everyone can contribute up to $2,000 or their earned income to an IRA, but not everyone can deduct it from their taxes.

Here's an example. If you're married and earned $75,000 in salary last year, you can contribute $2,000 to your IRA account. But, you won't be able to deduct this $2,000 if you or your spouse are covered by a company pension plan.

This is a little complicated, so you'll have to check the IRS instructions, but here's an overview of what's going on. If neither you nor your spouse are covered by an employer's pension plan, you can contribute to an IRA and deduct the full contribution, even if you made $50,000 or more last year.

But, if you or your spouse were covered by an employer's pension plan, and you have income above $25,000 for singles, or $40,000 for couples, you won't be able to deduct your full IRA contribution. The ability to deduct IRA contributions for these people is phased out as their income increases. See my tape on retirement planning for more information.

Moving expenses

After the IRA deduction comes moving expenses. This adjustment allows you to subtract expenses for a job-related move like a transfer. You'll normally be able to deduct a good portion of your expenses related to a long-distance transfer made by your company.

Until a few years ago this used to be an itemized deduction. By making it an adjustment to income, more people can take advantage of it because they don't have to itemize their deductions.

Self-employment tax

Next comes an adjustment for half of the self-employment tax. This is for people who file Schedule C or otherwise pay Social Security taxes for themselves.

Self-employed people currently can deduct 30 percent of their health insurance. This deduction figure will increase to 40 percent in 1997 and 45 percent after that. This deduction helps to level the playing field between small businesses and corporations which can deduct 100 percent of their health insurance costs.

Keogh or SEP contribution

Next comes the adjustment for a Keogh retirement plan or a self-employed SEP plan. These are retirement plans that self-employed people can set up.

They require more paper work than an IRA, but they allow you to set aside more money on a tax-deferred basis than an IRA. If you're self-employed and making good money, you should look into a SEP or the more complex Keogh. Again, see my tape on retirement planning for more information about these plans.

Alimony paid

Finally comes the adjustment for alimony paid. Remember, alimony is income to the recipient and a deduction for the payer.

Note that the IRS has a line for you to fill in your ex-spouse's Social Security number. Even if you and your ex aren't generally on speaking terms, make sure you both have the same alimony payment in your respective slots. If the payer has a high payment, and the recipient has a low payment, you both may be getting an IRS letter.

Body text copyright 1997 by David Luhman