What tax deductions can be included in a plan?

When producing tax estimates, the Income Lab app includes the following types of deductions, which reduce the amount of income subject to Federal ordinary and/or long-term capital gains tax.

1. Standard deductions, including age 65+ additional standard deductions
2. Itemized deductions, including 5-year carry-forward deductions
3. Deductions from earned income due to pre-tax items like health insurance premiums
4. Deduction of 1/2 of FICA paid on self-employment income
5. Qualified Distributions from accounts like HSAs, 529s, and IRAs (QCDs)

All deducted income, and any non-taxable income such as return of cost basis in withdrawals, is included in the '0% Bracket' in the Tax Lab > Explore > Income 'Tax Brackets' graph.

Standard Deductions

Income Lab will apply the greater of the standard deduction or applicable itemized deductions in each year of a plan when producing future tax estimates. These standard deductions include additional deductions for being age 65+ for one or both spouses in the relevant years.

Standard deductions are modeled as growing with the plan's inflation assumption.

Itemized Deductions

In any given year of a plan, tax estimates could reflect itemized, instead of standard deductions, if this would create a larger deduction. Income Lab tax calculations include the following as potential itemized deductions.

1. Charitable donations (capped at 60% of AGI)
2. Medical expenses (in the amount that they exceed 7.5% of AGI)
3. State & Local Taxes (capped at $10,000 per year during TCJA; TCJA sunsets by default in plans but this can be turned off in a plan's advanced settings)

When itemized deductions cannot be taken in full in a given year, the application will apply unused deductions during a 5-year carryforward period, whenever possible and advantageous.

Deductions from Earned Income

Often, a certain amount of earned income is not subject to tax because it goes toward pre-tax expenses like health insurance premiums and retirement account contributions. You can enter these amounts in the "Deductible Amount" field for any 'Other Income' item in the plan whose tax treatment is 'Wages' or 'Self-Employment'.

Deduction of 1/2 of FICA Paid on Self-Employment Income

Those who earn self-employment income must pay all of their FICA tax. Those who earn wages (not through self-employment) pay only 1/2 of FICA, while the employer pays the other half. Because of this difference, 1/2 of FICA taxes paid for self-employment income are deducted against ordinary income tax. This is not an itemized deduction, but is deducted in all cases, even when the standard deduction is applied.

Qualified Distributions from accounts like HSAs, 529s, and IRAs (QCDs)

Certain expenses in a plan will result in non-taxable distributions from tax-deferred accounts that, in other situations, would have been taxable. For example, a plan with medical expenses and HSA funds will automatically use those HSA funds in the years when medical expenses are present in order to qualify for tax-free distributions. The same is true for 529 accounts and education expenses, and for IRAs and charitable expenses.

• Qualified HSA Distributions: Taken in any year that contains medical expenses. Otherwise, HSA distributions when the owner is age 65+ are treated as IRA distributions. Non-qualified distributions before age 65 are subject to a penalty.
• Qualified 529 Distributions: Taken in any year that contains education expenses. Otherwise, distributions are taxed and subject to penalties.
• Qualified Charitable Distributions (QCDs): Take from IRAs (including inherited IRAs) after the account owner turns 70.5, when there are charitable expenses. QCDs are taken instead of itemized deductions when possible.

To ensure that these tax-free planning options are included in a plan, simply include charitable, education, or medical expenses (baseline or other/variable) in the plan.