Adjustments to Income
17-1
Adjustments to Income
Introduction
This lesson covers the Adjustments to Income section of Form 1040, Schedule 1. Taxpayers can subtract
certain expenses, payments, contributions, fees, etc. from their total income. The adjustments, subtracted
from total income on Form 1040, establish the adjusted gross income (AGI).
Some items in the Adjustments to Income section are out of scope. This lesson will cover all in-scope
topics. Refer to the Volunteer Resource Guide, Tab B, Starting a Return and Filing Status, or go to irs.gov to
view Form 1040.
Objectives
At the end of this lesson, using your resource materials, you will be able to:
• Identify which adjustments are within the scope of the VITA/TCE
programs
• Calculate and accurately report the adjustments to income that are
within the scope of the VITA/TCE programs
What do I need?
□ Form 13614-C
□ Form 8889
□ Form 8889 Instructions
□ Publication 4012
□ Publication 17
□ Publication 969
Optional:
□ Publication 504
□ Publication 590-A
□ Publication 970
□ Form 1040 Instructions
□ Form 1040 (Sch SE)
□ Form 1098-E
□ Form 1099-INT
□ Form 1099-OID
□ Form 8606
□ IRA Deduction Worksheet
□ Student Loan Interest
Deduction Worksheet
How do I determine if the taxpayer has adjustments to
income?
To identify the adjustments to income that taxpayers can claim, you will
need to ask the taxpayers if they had the types of expenses listed on the
Adjustments to Income section of Schedule 1. Review the taxpayers’
answers on their intake and interview sheet.
During the tax year did the taxpayer or spouse:
• Pay qualied educator expenses?
• Receive income from self-employment?
• Have self-employed health insurance?
• Pay a penalty for early withdrawal of savings?
• Pay alimony?
• Make contributions to a traditional IRA?
• Make a contribution to a health savings account?
• Pay student loan interest?
• Receive income from jury duty that was turned over to an employer?
• Have a Form W-2 Box 12 code H contribution to Sec 501(c)(18)(D) pension plan?
There are other adjustments to income, such as self-employed SEP, SIMPLE, and other qualied plans.
These are beyond the scope of the VITA/TCE programs. If you believe a taxpayer could benet from one of
these other adjustments, encourage the taxpayer to consult a professional tax preparer.
Adjustments to Income
17-2
Tax Software Hint: To review the tax software entry screen for Adjustments, go to the Volunteer
Resource Guide, Tab E, Adjustments.
How do I handle educator expenses?
Who is eligible?
Eligible educators can deduct up to $250 of qualied expenses paid during the tax year. If the taxpayer and
spouse are both eligible educators, they can deduct up to $500, but neither can deduct more than their own
expenses up to $250. The deduction amount is indexed for ination, so future maximum deduction amounts
may be higher.
If the taxpayer or spouse is an educator, probe a little deeper to see if they qualify for this adjustment. Ask
questions such as:
• Are you or your spouse a teacher, instructor, counselor, principal, or aide in a school? (Cannot be a
home school)
• What grade or grades do you teach? (Must be K-12)
• Were you employed for at least 900 hours during the school year? (Required minimum)
What expenses qualify?
If the taxpayer or spouse is an eligible educator, ask about their qualied expenses. Advise taxpayers that
they must have receipts for verication if they get audited.
Expenses that qualify include books, supplies, equipment (including computer equipment, software, and
services), and other materials used in the classroom. The educator’s own professional development
expenses related to the curriculum in which the educator provides instruction are also included. Qualied
expenses also include amounts paid or incurred for personal protective equipment, disinfectant, and other
supplies used for the prevention of the spread of coronavirus. Qualied expenses don’t include expenses
for home schooling or for nonathletic supplies for courses in health or physical education.
What other rules apply?
Probe to learn if the taxpayer or spouse received reimbursement that would reduce the amount of their
educator expenses. For example, ask:
• Did you receive reimbursement that is not listed as income on Form W-2?
• Did you redeem U.S. Series EE or I Savings Bonds where the interest would be tax-free, such as
redeeming savings bonds to pay educational expenses?
• Did you receive a nontaxable distribution from a qualied tuition program (QTP) or a distribution of
nontaxable earnings from a Coverdell education savings account (ESA)?
Educator expenses are reduced by any of these applicable reimbursements.
example
Gloria is a 5th and 6th grade teacher who works full-time in a year-round school. She had 1800 hours
of employment during the tax year. She spent $262 on supplies for her students. Of that amount, $212
was for educational software. The other $50 was for supplies for a unit she teaches sixth graders on
health. Only the $212 is a qualied expense. She can deduct $212.
example
Debbie is a part-time art teacher at an elementary school. She spent $185 on qualied expenses for
her students. Because she has only 440 hours of documented employment as an educator during the
tax year, she cannot deduct her educator expenses.
Adjustments to Income
17-3
How do I report this?
Educator expenses are reported in the adjustments section of Form 1040, Schedule 1. Don’t forget to
reduce the total educator expenses by any reimbursements, nontaxable savings bond interest, nontaxable
distribution from a QTP, or nontaxable distribution of earnings from an ESA.
Taxpayer Example
Bob teaches elementary school. His wife Janet teaches high school chemistry. Here is how a volunteer
helped them determine if they can take the deduction for educator expenses.
SAMPLE INTERVIEW
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
.
VOLUNTEER SAYS… JANET & BOB RESPOND…
You’ve already mentioned that you both work full-time
as teachers, so you may be able to deduct some of
the money you spent on qualied educator expenses.
Can you tell me how much you spent, or did you bring
your receipts?
[Janet] Yes, all teachers keep careful records
of their expenses. Here are my receipts and
here are Bob’s.
Can you tell me what you purchased? Janet, maybe
you could go rst.
[Janet] Sure. Three receipts are for quick
reference cards for my chemistry students.
And two are for special reagents the
department doesn’t stock.
Your receipts add up to $382. Now, we can count only
the rst $250 of educator expenses, but because you
are married and ling jointly, we can count up to $250
for Bob. Bob, tell me about your expenses.
[Bob] These four receipts are for art supplies
– paint and brushes, as you can see –
and these two are for special papers and
sculpting clay.
Yours total $263. Now, did either of you receive any
reimbursement that is not shown on Form W-2?
[Janet] No, we paid these expenses out of
our own pockets.
[Bob] Wait, now that I think about it, I got
reimbursed $50 for the clay.
That would bring your total down to $213. [Janet] Can’t we apply some of my excess
expense to Bob and bring his total up to
$250?
No, I’m sorry, each person’s expenses have to stand
alone.
[Janet] Okay.
Did you redeem U.S. series EE or I Savings Bonds
during the tax year?
[Janet] No, we didn’t. What if we had?
We would complete a form to see what percentage
of the tax-free interest should be applied as a
reimbursement. One more thing: did you receive
distributions from a qualied tuition program or a
Coverdell education savings account?
[Bob] No, neither of those.
Okay, we can claim $213 for Bob and the maximum
$250 for Janet. That gives you a total of $463 on your
joint return as a deduction for educator expenses. Any
questions before we go on?
[Janet] No, I think we understand.
[On the intake and interview sheet, indicate that
the taxpayers are entitled to the educator expense
adjustment.
Adjustments to Income
17-4
example
Carson is single and has his own business. During the year, he paid qualied health insurance
premiums of $3,000. His Schedule C shows a prot of $5,500 and his self-employment tax deduction is
$389 for a net of $5,111 ($5,500 – $389). The full $3,000 premium paid is deductible as self-employment
health insurance because it is less than the net prot.
How do I handle self-employment tax?
Self-employed taxpayers can deduct a portion of their self-employment tax from their income. Self-
Employment Tax is covered in the Other Taxes Lesson.
Tax Software Hint: The deductible portion of the self-employment tax is automatically calculated
on Schedule SE by the software and the deductible portion is carried to the adjustments section on Form
1040, Schedule 1. To review information related to the software, go to the Volunteer Resource Guide, Tab
E, Adjustments.
How do I handle self-employed health insurance deduction?
Self-employed taxpayers who reported a net prot on Schedule C for the year may be able to deduct the
cost of their health insurance paid as a deduction from their gross income. The insurance plan must be
established under the trade or business and the deduction cannot be more than the earned income from
that trade or business. When ling Schedule C, the health insurance policy can be either in the taxpayer’s
name, the spouse’s name (if Married Filing Jointly), or in the name of the business.
Medicare premiums voluntarily paid to obtain insurance in the taxpayer’s name that is similar to qualifying
private health insurance can be used to gure the deduction. The spouse’s Medicare premiums qualify
for the deduction when Married Filing Jointly even though paid from the spouse’s benets. Include health,
dental, vision, supplemental, limited coverage, and long-term care (LTC) premiums. LTC is limited to the
deduction cap for Schedule A, based on age.
Self-employed taxpayers cannot deduct payments for medical insurance for any month in which they were
eligible to participate in a health plan subsidized by their employer, a spouse’s employer, or an employer
of the taxpayer’s dependent or child under age 27 at the end of the tax year. Taxpayers cannot deduct
payments for a qualied long-term care insurance contract for any month in which they were eligible to
participate in an employer-subsidized long-term care insurance plan.
Whose health coverage qualies?
For this purpose, health coverage can be for the taxpayer, spouse, dependents, or the taxpayer’s child
under the age of 27 even though the child is not the taxpayer’s dependent. A child includes a son, daughter,
stepchild, adopted child, or foster child.
What is the limit on the self-employed health insurance deduction?
The self-employed health insurance deduction is limited to the net self-employment prot shown on the
return reduced by the deduction for one-half of the self-employment tax.
When the total health insurance costs exceed the self-employed health insurance deduction limit, a taxpayer
can generally include any remaining premiums as an itemized medical expense deduction Form 1040, Schedule A.
Adjustments to Income
17-5
example
Gloria withdrew $5,000 early from a one-year, deferred-interest certicate of deposit. She had to pay a
penalty of three months’ interest. She can claim this penalty amount as an adjustment to income.
What if the insurance was purchased through the Marketplace?
Self-employed taxpayers who purchased their coverage from the Marketplace and are eligible for the
Premium Tax Credit are out of scope for the VITA/TCE programs and should be referred to a professional
preparer.
How do I handle penalties on early withdrawal of savings?
Taxpayers can adjust their gross income to deduct penalties they paid for withdrawing funds from a deferred
interest account before maturity. Ask if the taxpayer and/or spouse made any early withdrawals during the
tax year. If so, ask to see Form 1099-INT, Interest Income, or Form 1099-OID, Original Issue Discount,
documenting the penalty. The early withdrawal penalty deduction is reported on Form 1040, Schedule 1.
Tax Software Hint: The early withdrawal penalty amount should be entered in the interest income
section if it is listed on Form 1099-INT. Otherwise, go to the Deductions section, then Adjustments, and click
begin on the Penalty on Early Withdrawal of Savings or CD line.
How do I handle alimony paid?
Pre-2019 Divorces
Alimony is a payment to a spouse or former spouse under a divorce or legal separation instrument. The
payments do not have to be made directly to the ex-spouse. For example, payments made on behalf of
the ex-spouse for expenses specied in the instrument, such as medical bills, housing costs, and other
expenses can qualify as alimony. Alimony does not include child support or voluntary payments outside the
instrument. The person paying alimony can subtract alimony payments as an adjustment to income; the
person receiving alimony must treat it as income. A summary of the alimony requirements can be found in
Tab E, Adjustments, in the Volunteer Resource Guide.
When you conduct the interview, ask if the taxpayer paid alimony under a divorce or separation instrument.
If so, explain that you need the exact amount, as well as the Social Security number of the recipient,
because the recipient must report the payment to the IRS as income and the two amounts must agree. The
date of the divorce, or a reasonable estimate, is also needed to complete Schedule 1.
For additional information on alimony, refer to Publication 504, Divorced or Separated Individuals.
Post-2018 Divorces
Alimony or separate maintenance payments made under a divorce or separation agreement (1) executed
after 2018, or (2) executed before 2019, but later modied if the modication expressly states the repeal
of the deduction for alimony payments applies to the modication, are no longer deductible. Alimony and
separate maintenance payments received under such an agreement are not included in the gross income of
the recipient.
Adjustments to Income
17-6
How do I handle IRA contributions?
Individual Retirement Arrangements (IRAs) are personal savings plans that oer tax advantages to set
aside money for retirement. This section discusses “traditional” IRAs. A traditional IRA is any IRA that is not
a Roth or SIMPLE IRA. See Publication 590-A, Individual Retirement Arrangements, for more information
on all types of IRAs.
Some of the features of a traditional IRA are:
• Taxpayers may be able to deduct some or all of their contributions to the IRA (depending on
circumstances).
• Generally, amounts in an IRA, including earnings and gains, are not taxed until distributed.
• Contributions may be eligible for the retirement savings contributions credit.
Although contributions to a Roth IRA cannot be deducted, the taxpayer may be eligible for the retirement savings
contributions credit, discussed in the lesson on Miscellaneous Credits.
Based on the intake and interview form, ask the taxpayer about any IRA contributions during the year or that
they intend to make by the due date of the return.
Repayment of a coronavirus-related distribution is not an IRA contribution. Refer to the Income - Retirement
Income lesson and Form 8915-F, Qualied Disaster Retirement Plan Distributions and Repayments, and instructions.
EXERCISES
Answers are at the end of the lesson summary.
Question 1: Victoria divorced in 2007. Her divorce settlement states that she must pay her ex-husband
$12,000 a year. She is also required to pay his ongoing medical expenses for a condition he acquired
during their marriage. During the tax year, the medical expenses were $11,400. How much can she
deduct as an adjustment to income?
A. $12,000
B. $11,400
C. $23,400
D. $600
example
Anthony was divorced in 2017. Under his divorce instrument, he paid his ex-wife $8,000 during the tax
year. As a favor, he also made $4,000 in payments to cover part of her vehicle lease so she could keep
steady employment. He can take the $8,000 as an adjustment to income. He cannot count the lease
payments because those were payments not required by the divorce instrument.
example
Fred has a traditional IRA account and a Roth IRA account. During the tax year, Fred contributed $2,200
to his traditional IRA and $1,000 to his Roth IRA. The most Fred will be able to deduct is the $2,200
contribution to his traditional IRA.
Adjustments to Income
17-7
What are the eligibility requirements for an IRA contribution?
The taxpayer, and the taxpayer’s spouse if applicable, must meet these eligibility requirements in order to
make an IRA contribution:
• Types of IRAs: Verify the types of IRAs to which the taxpayer and spouse contributed. Only
contributions to traditional IRAs are deductible.
• Age limit: Under the SECURE Act of 2019, there is no age limit for either traditional or Roth IRA
contributions eective for tax years beginning after December 31, 2019.
• Compensation: Individuals must have taxable compensation (i.e., wages, self-employment income,
commissions, taxable alimony, or taxable scholarships or fellowships, as shown in Box 1 of Form W-2).
• Time limits: Contributions must be made by the due date for ling the return, not including extensions.
Verify with the taxpayer and spouse that they made the contribution(s) (or will make them) by the due
date of the return.
Be sure the taxpayer knows that if a contribution is reported on the tax return but is not made by the deadline,
the taxpayer must le an amended return.
How much can a taxpayer deduct for an IRA contribution?
Generally, you can deduct the lesser of:
• The contributions to your traditional IRA for the year, or
• The general limit reduced for Roth IRA contributions made for the same tax year
What is the compensation requirement?
Compensation is generally the income a taxpayer has earned from working; wages, salaries, tips,
professional fees, bonuses, and other amounts you receive for providing personal services are
compensation. See Publication 590-A, for other types of compensation.Taxpayers cannot make IRA
contributions that are greater than their compensation for the year.
An IRS certied volunteer preparer must exercise due diligence when preparing or assisting in the preparation
of, approving, and ling tax returns. Based on this, volunteers may rely in good faith without requiring certain docu-
ments from the taxpayer. However, the volunteer preparer may not ignore the implications of information furnished to,
or actually known by, the preparer. The preparer must ask questions if the information furnished appears to be incor-
rect, inconsistent, or incomplete.
If taxpayers le a joint return, and one spouse’s compensation is less than the other spouse’s
compensation, the most that can be contributed for that spouse is the lesser of:
• The general limits, or
• The total compensation includible in the gross income of both spouses for the year, reduced by:
○ Traditional IRA contributions for the spouse with the greater compensation
○ Any contribution for the year to a Roth IRA for the spouse with the greater compensation
In other words, as long as they le a joint return, married taxpayers’ combined IRA contributions cannot
exceed their combined compensation, and neither spouse can contribute more than the general IRA limit to
their own IRA.
Beginning in 2019, taxpayers can elect to increase their compensation for diculty of care payments that
are excluded from gross income for the purpose of nondeductible IRA contributions.
Adjustments to Income
17-8
example
Gene and Sue are married and are both over 50 years old. Gene earned $70,000 and Sue earned
$1,500. During the tax year, Gene contributed $3,500 to his traditional IRA and $2,000 to a Roth IRA,
making his total contributions $5,500. To gure the maximum contribution to Sue’s IRA, use a total
compensation of $66,000 (i.e., $71,500 – $5,500). If Gene and Sue le jointly, they can contribute up to
the IRA limit to Sue’s IRA even though her own compensation was just $1,500.
EXERCISES (continued)
Question 2: Stan, an unmarried college student working part time, earned $4,500 during the tax year.
What is the maximum he can contribute to an IRA?
A. $1,000
B. $3,500
C. $4,500
D. $5,500
Question 3: Bob and Carol are married and both are 55 years old. They both work and each has a
traditional IRA. During the tax year, Bob earned $2,000, and Carol earned $50,000. If they le separate
returns, what is the maximum that Bob can contribute to his IRA? $ .
example
Bill is 29. He has a traditional IRA account at City Home Savings Bank and another traditional IRA
account through his stockbroker. He also opened a Roth IRA through his stockbroker. Bill can contribute
to any or all of his accounts this year, but the combined contributions for the tax year cannot exceed the
lesser of the general IRA limit or his compensation for the tax year.
Although a person may have IRA accounts with several dierent nancial institutions, the tax law treats
all of their traditional IRA accounts as one single IRA. Inherited IRAs, however, are treated separately. If
a taxpayer inherits a traditional IRA from a deceased spouse, they can treat the account as their own and
make contributions and rollovers into the inherited account. A taxpayer cannot make a contribution to an
IRA they inherited from someone other than a spouse. A surviving spouse who elects to transfer an IRA
inherited from their spouse to their own IRA can make contributions to the transferred IRA.
Are there special rules for certain military personnel?
Current or former members of the Armed Forces may qualify for additional retirement benets. Under
the Heroes Earned Retirement Opportunities (HERO) Act, taxpayers can count tax-free combat pay as
compensation when determining whether they qualify to contribute to either a Roth or traditional IRA. Before
this change, members of the Armed Forces whose earnings came entirely from tax-free combat pay were
generally barred from using IRAs to save for retirement.
When can IRA contributions be deducted?
Deductions can be taken for contributions to traditional IRAs for returns that are in scope. The taxpayer’s
deduction for IRA contributions may be “phased out” (i.e., reduced or eliminated) depending on their
income, ling status, and whether the taxpayer is covered by a retirement plan at work. The dierence
between the permitted contributions and the IRA deduction, if any, is the taxpayer’s nondeductible
contribution. Form 8606, Nondeductible IRAs, must be completed for any nondeductible traditional IRA
contributions.
Adjustments to Income
17-9
If taxpayers do not report nondeductible contributions, all of the contributions to a traditional IRA will be
treated as having been deducted. This means all distributions will be taxed when withdrawn unless the
taxpayer can show, with satisfactory evidence, that nondeductible contributions were made.
Form 8606 requires basis information in IRAs from prior years and can be complex. If Form 8606 is
required, refer the taxpayer to a professional tax preparer.
How do I determine the deduction amount?
The factors that aect whether traditional IRA contributions are deductible include:
• Whether the taxpayer (or spouse, if ling a joint return) is covered by a retirement plan at work.
• The taxpayer’s Modied Adjusted Gross Income (MAGI) before taking the deduction. If the taxpayer or
spouse is covered by a retirement plan, the deduction amount will be reduced or eliminated if the MAGI
on the tax return is above a certain limit.
Retirement coverage at work
Ask if the taxpayer and/or spouse were covered by a retirement plan at work at any time during the tax year. If
so, their deduction may be limited. Employees covered by a retirement plan will have Box 13 on Form W-2 checked.
Filing status and income
If the taxpayer or spouse was covered by an employer retirement plan, they may not be able to deduct the
full amount. Notice that the income limitation amount may be dierent for each spouse on a joint return, but
that the MAGI computation is the same. This is because if one spouse is covered by a retirement plan but
the other is not, the noncovered spouse will have a higher income limit before their IRA deduction is phased
out.
If the MAGI is greater than the income limits, the deduction cannot be taken. If this is the case, explain to
the taxpayers and answer any questions they may have about why the deduction cannot be taken. The
contribution may still be made, it is just not deductible.
Enter the total contributions to traditional IRAs that were made (or will be made) for each spouse (on a joint
return) by the due date of the return.
How do I report the IRA deduction?
Report the deduction in the adjustments section of Form 1040, Schedule 1.
Tax Software Hint: To review information related to the software, go to the Volunteer Resource
Guide, Tab E, Adjustments.
What if the taxpayer has an excess IRA contribution?
An excess IRA contribution is an amount contributed to a traditional or Roth IRA that is more than the
lesser of:
• The taxable compensation for the year, or
• General limit amount
The taxpayer may not know that a contribution qualies as “excess” until the tax return is completed. When
this situation is identied, the excess amount, with any earnings on that amount, must be withdrawn by
the due date of the return (including extensions). If the excess amount is not withdrawn by the due date
of the return, including extensions, the taxpayer will be subject to an additional 6% tax on this amount.
This additional tax is covered in the Other Taxes lesson, but is out of scope for the VITA/TCE programs.
Taxpayers subject to the additional 6% tax should be referred to a professional tax preparer.
Adjustments to Income
17-10
When the taxpayer has modest wages or other compensation and traditional or Roth IRA contributions, conrm
that the limit has not been exceeded.
The withdrawn excess contribution is not included in the taxpayer’s gross income before the tax return is
due if both of the following conditions are met:
• No deduction was allowed for the excess contribution
• All interest or other income earned on the excess contribution is withdrawn
If taxpayers timely led the tax return without withdrawing a contribution that they made during the tax
year, they can still have the contribution returned to them within 6 months of the due date of the tax return,
excluding extensions.
Taxpayers must include in gross income the interest or other income that was earned on the excess
contribution. Taxpayers must report it on their return for the year in which the excess contribution was made.
The withdrawal of interest or other income may be subject to an additional 10% tax on early distributions.
Form 1099-R
Taxpayers will receive Form 1099-R indicating the amount of the withdrawal. If the excess contribution was
made in a previous tax year, the form will indicate the year in which the earnings are taxable.
How do I handle Health Savings Accounts?
What is an HSA?
An HSA is a tax-exempt trust or custodial account that a taxpayer sets up with a qualied HSA trustee.
Distributions from an HSA are nontaxable if the funds are used for qualied medical expenses. A taxpayer
must be an eligible individual to qualify to contribute to an HSA.
Individuals Who Qualify for an HSA
To be an eligible individual and qualify for an HSA, the taxpayer must meet the following requirements:
• Be covered by a high-deductible health plan (HDHP) on the rst day of the month
• Not be covered by other health insurance (see Publication 969 for exceptions)
• Not be enrolled in Medicare (the individual can be HSA-eligible for the months before being covered by
Medicare)
• Not be eligible to be claimed as a dependent on someone else’s tax return (see Caution)
If another taxpayer is entitled to claim the individual as a dependent, the individual cannot claim a deduction for
an HSA contribution. This is true even if the other person does not actually claim the dependent.
example
Maria, age 35, made an excess contribution of $1,000, which she withdrew by the due date of her
return. At the same time, she also withdrew the $50 income that was earned on the $1,000. She must
include the $50 in her gross income (for the year in which the excess contribution was made). She must
also pay an additional tax of $5 (the 10% additional tax on early distributions because she is not yet 59½
years old), but she does not have to report the excess contribution as income or pay the 6% excise tax.
Maria receives a Form 1099-R showing that the earnings are taxable for the current year.
Adjustments to Income
17-11
Rules for Married Individuals
In the case of married individuals, each spouse who is an eligible individual who wants to have an HSA
must open a separate HSA. Married couples cannot have a joint HSA, even if they are covered by the same
HDHP; however, distributions can be used to cover the qualied expenses of the other spouse. In the event
of the death of one of the married individuals, the HSA will be treated as the surviving spouse’s HSA if the
spouse is the designated beneciary of the HSA.
An employee covered by an HDHP and a health Flexible Spending Account (FSA) or an Health
Reimbursement Arrangement (HRA) that pays or reimburses qualied medical expenses generally cannot make
contributions to an HSA.
Contributions to HSA
Any eligible individual can contribute to an HSA. For an employee’s HSA, the employee, employer, or
both may contribute to the employee’s HSA in the same year. For an HSA established by a self-employed
(or unemployed) individual, the individual can contribute. Family members or any other person may also
contribute on behalf of an eligible individual. Contributions to an HSA must be made in cash. Contributions
of stock or property are not allowed. Amounts contributed to an HSA, except for employer contributions
and qualied HSA funding distributions from IRAs, can be used as an adjustment to income for the account
owner.
Employer Contributions
Employer contributions (including an employee’s contribution through a cafeteria plan) are allowed to be
made to an employee’s HSA. Generally, employer contributions are excluded from an employee’s income.
Employer contributions are reported on Form W-2, Box 12 using code W. Taxpayers must reduce the
amount they, or any other person, can contribute to their HSA by the amount of any contributions made
by the taxpayer’s employer that are excludable from income. This includes amounts contributed to the
taxpayer’s account by the employer through a cafeteria plan. For example, if the employer contributed
$1,000 to a taxpayer’s HSA who had a self-only HDHP, the remaining contribution limit would be reduced by
that $1,000. Refer to the Volunteer Resource Guide,Tab E, Adjustments, for current year contribution limits.
HSA Limits on Contributions
The amount the taxpayer or another other person can contribute to the taxpayer’s HSA depends on the type
of HDHP coverage (individual or family) the taxpayer has, the taxpayer’s age, the date the taxpayer became
an eligible individual, and the date the taxpayer ceases to be an eligible individual.
Eligible individuals who are 55 or older by the end of the tax year can increase their contribution limit up to
$1,000 a year. This extra amount is the catch-up contribution allowed for an HSA. Refer to HSA contribution
limits in the Volunteer Resource Guide, Tab E, Adjustments.
Taxpayers with excess contributions (contributions over the limits) must withdraw the excess to avoid an addi-
tional 6% tax. If the excess is not timely withdrawn, refer the taxpayer to a professional tax preparer. Review Form
5329, Additional Taxes on Qualied Plans (Including IRAs) and Other Tax-Favored Accounts, Form 8889, Health
Savings Accounts (HSAs) Instructions, and Publication 969, Health Savings Accounts and Other Tax-Favored Health
Plans, for details.
example
Arnold has a high-deductible health plan with an HSA with his company. His mother contributed to his
HSA as a gift on his 40th birthday, which is an allowable contribution.
Adjustments to Income
17-12
Rules for Married People
The rules for married people apply only if both spouses are eligible individuals. If either spouse has family
HDHP coverage, the family contribution limit applies and both spouses are treated as having family HDHP
coverage.
If both spouses are 55 or older and not enrolled in Medicare:
• Each spouse is entitled to increase his or her contribution limit with an additional contribution.
• Their maximum total contributions under family HDHP coverage would include a catch-up contribution
for each spouse.
• The contribution limit is divided between the spouses by agreement. If there is no agreement, the
contribution limit is split equally between the spouses.
• Any additional contribution for age 55 or over must be made by each spouse to his or her own HSA.
Distributions from an HSA
Distributions for Qualied Medical Expenses
Generally, taxpayers will pay medical expenses during the year without being reimbursed by the HDHP
until the plan’s annual deductible is reached. When the taxpayer pays these medical expenses that are not
reimbursed by the HDHP, the taxpayer can request a distribution from the HSA trustee. The taxpayer can
receive tax-free distributions from an HSA to pay or be reimbursed for qualied medical expenses incurred
in the current or prior year, but after the taxpayer establishes the HSA.
Qualied medical expenses include the medical expenses of the taxpayer, their spouse, or a dependent at
the time the expense was incurred. It does not matter whether the taxpayer has self-only or family HDHP
coverage.
Qualied medical expenses are expenses that generally would qualify for the medical and dental expenses
deduction. Examples include unreimbursed expenses for doctors, dentists, and hospitals. The Coronavirus
Aid, Relief, and Economic Security (CARES) Act modies the rules that apply to various tax-advantaged
accounts (HSAs, Archer MSAs, Health FSAs, and HRAs) so that additional items are “qualied medical
expenses” that may be reimbursed from those accounts. Specically, the cost of menstrual care products
is now reimbursable. These products are dened as tampons, pads, liners, cups, sponges or other
similar products. In addition, over-the-counter products and medications are now reimbursable without a
prescription. The new rules apply to amounts paid after Dec. 31, 2019. Health insurance premiums are not
included as qualied medical expenses except for Medicare premiums.
See Publication 502, Medical and Dental Expenses, for more information.
For recordkeeping requirements on HSA distributions see Publication 969, Distributions from an HSA.
Taxpayers are not required to take annual distributions from their HSA. However, taxpayers who have
taken HSA distributions will receive Form 1099-SA, Distributions from an HSA, Archer MSA, or Medicare
Advantage MSA, from their HSA trustee and must provide it before the return can be completed.
example
This year, Mr. Auburn and his wife are both eligible individuals. They each have family coverage under
separate HDHPs. Mr. Auburn is 58 years old and Mrs. Auburn is 53. Mr. and Mrs. Auburn can split the
family contribution limit equally, or they can agree on a dierent division. If they split it equally, each
can contribute one-half the maximum contribution for family coverage. Mr. Auburn can contribute
an additional $1,000 because he is age 55 or over. Refer to HSA contribution limits in the Volunteer
Resource Guide, and Publication 969.
Adjustments to Income
17-13
Form 8889, Health Savings Accounts (HSA)
A taxpayer must complete Form 8889 with Form 1040 if the taxpayer (or spouse if ling a joint return) had
any activity in an HSA. This is true even if only the taxpayer’s employer or the spouse’s employer made
contributions to the HSA.
Taxpayers who are ling jointly and who each have separate HSAs will each complete a separate Form
8889. Married taxpayers cannot have a joint HSA.
Ask taxpayers during the interview process if their HDHP coverage is “self-only” or “family,” and check the
corresponding box on Form 8889, click to view Form 8889.
Form 8889, Part I
Form 8889, Part 1, is used to report all HSA contributions and to compute the allowable HSA deduction.
This includes contributions made by the ling deadline that are designated for the tax year. Contributions
made by an employer are also shown in Part I, but are not included in the deductible amount.
An HSA may receive contributions from an eligible individual or any other person, including an employer or
a family member, on behalf of an eligible individual.
Form 8889, Part II
Form 8889, Part II, is used by taxpayers to report distributions from an HSA. Taxpayers receive tax-free
distributions from an HSA to pay or be reimbursed for qualied medical expenses. The taxpayer will have to
tell you what types of expenses were paid or reimbursed with the distribution.
Form 1099-SA reports distributions to a taxpayer. Box 5 will indicate whether the distribution is from
an HSA, Archer MSA, or a Medicare Advantage MSA. The code in Form 1099-SA, Box 3, identies
the distribution the taxpayer received. Code 1 is a normal distribution. Refer to Form 1099-SA for an
explanation of the other codes.
If distributions are not oset with qualied medical expenses, the amount withdrawn will be included in
income and reported on Form 1040. HSA distributions included in income are subject to an additional 20%
tax unless the account beneciary:
• Dies
• Becomes disabled (see Form 8889 instructions)
• Turns age 65
Form 8889, Part III
Form 8889, Part III, is out of scope for the VITA and TCE programs.
Tax Software Hint: Refer to Tab E, Adjustments, in the Volunteer Resource Guide for software entries.
example
Vikki’s doctor suggested she take some exercise classes. Vikki signed up for yoga, swimming classes,
and a health club. Since these are for general health improvement, they cannot be considered as
qualied medical expenses.
Adjustments to Income
17-14
How do I handle student loan interest?
The student loan interest deduction is generally the smaller of $2,500 or the interest payments paid that
year on a qualied student loan. This amount is gradually reduced (phased out) or eliminated based on the
taxpayer’s ling status and MAGI.
What type of interest qualies?
Generally, student loan interest is paid during the year on a loan for qualied higher education expenses.
The loan must meet all three of these conditions:
• It was for the taxpayer, the taxpayer’s spouse, or a person who was the taxpayer’s dependent when the
loan was obtained
• The qualied higher education expenses were paid within a reasonable period of time before or after
obtaining the loan
• It was for an eligible student
Interest does not qualify if the loan was from a related person, a qualied employer plan, or if the taxpayer
is not legally liable for the loan.
What are the exceptions?
For purposes of the student loan interest deduction, the following are exceptions to the general rules for
dependents:
• An individual can be your dependent even if you are the dependent of another taxpayer
• An individual can be your dependent even if the individual les a joint return with a spouse
• An individual can be your dependent even if the individual had gross income for the year that was
equal to or more than the threshold amount for the year (see the Volunteer Resource Guide, Tab E,
Adjustments, for the current year amount)
example
Robert has taken his rst job after completing law school. His ling status is Single. He paid $3,000
in interest on his student loans during the tax year. With all adjustments to income (except student
loan interest adjustment), his MAGI is below the limits. He can deduct $2,500 of his student loan
interest as an adjustment to income.
example
Veronica and her husband are ling jointly. She completed her doctoral degree last year and paid
$2,400 in student loan interest during the tax year. Their MAGI is above the fully deductible income
limits. Due to their high MAGI, the software will calculate their deduction; it will be less than the full
amount of interest that she paid.
EXERCISES (continued)
Question 4: Todd and Janet have a MAGI below the limits. They are ling jointly. Two years ago, they
took out a loan so Todd’s mother could earn her RN degree at night school. Todd could not claim her
as a dependent on his return because he did not pay for more than one half of her support. This year,
they paid $1,000 in interest on the loan. Does his mother meet the student qualications?
¨ Yes ¨ No
Adjustments to Income
17-15
Who is eligible for the deduction?
Generally, a taxpayer can claim the deduction if all the following are true:
• The taxpayer is not using the Married Filing Separately ling status
• The taxpayer will not be claimed as a dependent on someone else’s return
• The taxpayer is legally obligated to pay interest on a qualied student loan
• The taxpayer paid interest on a qualied student loan
Conduct a probing interview to verify that the taxpayer meets all these tests for the deduction.
What are qualied higher education expenses?
Qualied expenses include: tuition and fees; room and board; books, supplies and equipment; and other
necessary expenses (such as transportation).
Qualied expenses must be reduced by certain other educational benets. Ask the taxpayer if the expenses
were oset by any of the following:
• Employer provided educational assistance benets
• Tax-free distributions from a Coverdell ESA or from a qualied tuition program
• U.S. savings bond interest excluded from income because it is used to pay qualied higher education
expenses
• Certain scholarships and fellowships
• Veteran’s educational assistance benets
• Any other nontaxable payments (other than gifts, bequests, or inheritances) received for educational
expenses
No double benet allowed
Taxpayers cannot deduct as interest on a student loan any amount that is an allowable deduction under any
other provision of the tax law (e.g., as business interest).
A taxpayer cannot deduct as interest on a student loan any amount paid from a distribution of earnings
made from a qualied tuition program (QTP) after 2018 to the extent the earnings are treated as tax free
because they were used to pay student loan interest.
What is an eligible educational institution?
An eligible educational institution is generally any accredited public, nonprot, or private post-secondary
institution eligible to participate in the student aid programs administered by the Department of Education.
It includes virtually all accredited, public, nonprot, and privately owned prot-making post-secondary
institutions. If the taxpayers do not know if an educational institution is an eligible institution, they should
contact the school. A searchable database of all accredited schools is available on the U.S. Department of
Education website.
Who is an eligible student?
An eligible student is someone enrolled at least half-time in a program leading to a degree, certicate, or
other recognized educational credential. The standard for what is half the normal full-time work load is
determined by each eligible educational institution.
example
This year, Jeremy paid interest on a loan that allowed his 21-year-old daughter, Kate, to complete a
program in holistic medicine as a full-time student at the Southwestern College of Synergistic Therapy.
Although she qualies as his dependent, and the loan paid for books, supplies, and equipment, the
college is not accredited. Therefore, Jeremy cannot deduct the interest on the student loan.
Adjustments to Income
17-16
Where can I get the information?
If the taxpayer paid $600 or more in interest to a single lender, the taxpayer should receive Form 1098-E,
Student Loan Interest Statement, or another statement from the lender showing the amount of interest paid.
This information will assist you in completing the student loan interest deduction.
The taxpayer should keep documentation of all qualied student loan interest paid during the tax year.
See Publication 970, Tax Benets for Education, for more information on the Student Loan Interest Deduction.
Tax Software Hint: To review information related to the software, go to the Volunteer Resource
Guide, Tab E, Adjustments.
Taxpayer Interview and Tax Law Application
Here is how a volunteer helped Brenda determine if she can take the deduction for her student loan interest
SAMPLE INTERVIEW
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
.
VOLUNTEER SAYS… BRENDA RESPONDS…
In reviewing your intake and interview sheet, I see you did not
indicate if you had any educational expenses. Did you pay any
student loan interest this year?
Yes, I just graduated a year ago and I’ll be
paying those loans for a while.
Well, you might be able to take a deduction for that. You are ling
as Single, and your income before adjustments is not more than
the limit for your ling status. Do you know how much interest you
paid?
I have two loans; here are the
statements.
The interest amounts add up to $2,600. Now, if your interest
payments qualify for the deduction, the most we can claim is
$2,500. Do you have any questions about that?
No, I understand.
I just need to ask a few questions to see if you qualify, okay?
Earlier we decided that you can’t be claimed as a dependent on
someone else’s return, so that’s no problem. Can you tell me what
you used the loan to pay for?
My tuition and fees, and my books.
Did you receive any educational assistance, like from your
employer or the Veteran’s Administration?
No.
How about tax-free withdrawals from a Coverdell educational
savings account, another qualied tuition program, or from U.S.
savings bonds?
No, none of those.
Did you get any other nontaxable payments, not counting gifts,
bequests, or inheritances, which were specically for educational
expenses?
Heavens, no, I wish I had!
It looks like you can claim the maximum deduction of $2,500.
[Indicate on the intake and interview sheet whether Brenda is
eligible for this adjustment.]
Adjustments to Income
17-17
Is pay for jury duty an adjustment to income?
As you learned earlier, jury duty pay received by taxpayers is included in Other income on Form
1040,Schedule 1. Some employees receive their regular wages from their employers while they are serving
on a jury instead of working at their jobs.
Often, employees must turn their jury duty pay over to their employers. This may be claimed as an
adjustment to income.
What is an entry on Form W-2 box 12 code H?
Code H reects a contribution to a Sec. 501(c)(18)(D) pension plan that has not reduced taxable wages. The
amount carries automatically to Schedule 1 as an adjustment.
How do I determine Adjusted Gross Income?
The taxpayer’s total Adjusted Gross Income (AGI) is the amount that is used to compute some limitations,
such as the medical and dental deduction on Schedule A and the credit for child and dependent care
expenses. To nd the taxpayer’s AGI:
1. Add the Income section. This is the taxpayer’s total income.
2. Add the Adjustments to Income section. These are the total Adjustments.
3. Subtract the Schedule 1 adjustments from the total income. This is the AGI.
Adjustments to Income
17-18
Taxpayer Interview and Tax Law Application
The volunteer assists Daniela with the adjustments to income covered in this lesson.
SAMPLE INTERVIEW
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
.
VOLUNTEER SAYS… DANIELA RESPONDS…
Daniela, we’ve discussed your income, so we can go on to
Adjustments to Income. We might nd ways to reduce the
income that you’re taxed on. Do you have any questions before
we go on?
No, it all makes sense.
Now, let’s review the expenses listed on your intake and
interview sheet and the deductions listed in the Adjustments to
Income section. Do you have a Health Savings Account?
No, I don’t.
Okay. That brings us to self-employment tax. The tax software will
calculate the deductible portion of your self-employment tax. The
same thing happens with the penalty for an early withdrawal. I will
put that in when I enter your interest income, and it will show up as
an adjustment.
Cool!
Did you pay any alimony? No, I’ve never even been married.
Did you pay any health insurance premiums during the year? No.
Now, did you contribute to an IRA? I put in $2,000 right after Christmas.
Good for you. Will you be contributing any more? You can put
money in your IRA before the deadline for ling the return.
I don’t think so, but that’s good to know.
Was it a traditional, Roth IRA, or a SIMPLE IRA? It was just a plain old IRA. Here’s the
statement.
There we go; it is what we call a traditional IRA. Were you
covered by any kind of employer retirement plan at any time
during the tax year?
No, none.
Because you weren’t covered by a retirement plan, you will be
able to deduct the full $2,000 you contributed.
[The volunteer reviews all expenses listed on the intake and
interview sheet and reviews all the adjustments on Schedule
1, asks more questions and determines that Daniela does not
qualify for the remaining adjustments.]
We’ll enter all the adjustments that apply to you. The software
will calculate your total income, total adjustments, and will
determine your Adjusted Gross Income that will be used to
determine your deductions.
[On the intake and interview sheet, note that you have
addressed this adjustment.]
That’s great! This program makes it really
easy!
Adjustments to Income
17-19
Summary
In this lesson, you learned how to identify and work with these adjustments to income:
• Educator expenses
• Deductible portion of self-employment tax
• Deduction for self-employed health insurance
• Penalty on early withdrawal of savings
• Alimony paid
• IRA deduction
• Health Savings Account deduction
• Student loan interest deduction
• Jury duty pay turned over to the taxpayer’s employer
If you believe a taxpayer could benet from an adjustment that is out of scope and was not covered in this
lesson, encourage the taxpayer to consult a professional tax preparer.
What situations are out of scope for the VITA/TCE programs?
The following are out of scope for this lesson:
• Other adjustments to income, such as:
○ Self-employed health insurance deduction with premium tax credits
○ Self-employed SEP, SIMPLE, and qualied plans
○ Certain business expenses of performing artists
○ Domestic production activities deduction
• Form 8606, Nondeductible IRAs
While this list may not be all inclusive, it is provided for your awareness only. Refer to the Volunteer
Resource Guide, Scope of Service, for additional items not covered in the lessons.
TAX LAW APPLICATION
To gain a better understanding of the tax law, complete the practice returns(s) for your course of
study using the Practice Lab on L<.
Adjustments to Income
17-20
Notes
EXERCISE ANSWERS
Answer 1: C. She can deduct the full $23,400 because it is all required by the divorce instrument.
Answer 2: C. His IRA contributions are limited to $4,500, the amount of his compensation.
Answer 3: If Married Filing Separately, Bob can contribute no more than $2,000, the amount of his
compensation.
Answer 4: No. Todd’s mother was not their dependent at the time they took out the loan and none of
the exceptions applies.
