A deduction is a dollar-for-dollar reduction of taxable income. If your gross income is $100,000 and your deductions total $50,000 your net taxable income is $50,000.
The value of a deduction depends on your tax bracket. A $1,000 deduction is worth $250 to a taxpayer in the 25% bracket but only $150 to someone in the 15% bracket. A deduction of $1,000 could push you into the next lower tax bracket, so part of the deduction will be worth 25%, and part worth 15%.
There are two types of deductions — those allowed “above the line” and those claimed “below the line.” The “line” is your Adjusted Gross Income (AGI).
Above-the-line deductions include business deductions claimed on Schedules C, E and F, and “adjustments to income.” These deductions are ultimately claimed on the first page of Form 1040.
Deductions claimed above the line reduce your AGI and could reduce the amount of tax benefits that are phased out based on AGI or “modified” AGI. An above-the-line deduction could increase your allowable itemized deductions and allowable tax credits. So an “above-the-line” deduction is generally “more better” than a deduction claimed below the line.
Below-the-line deductions include the standard deduction, any additional standard deduction amounts, personal exemptions and itemized deductions reported on Schedule A.
Itemized deductions only provide a tax benefit if the total amount exceeds the standard deduction, including any “additional” amounts, allowed for your filing status. A tax deduction, whether claimed above or below the line, is also of no benefit if your net taxable income is 0.