The power of deductive logic

By Bob and Brad
 

Dear Bob and Brad:

My spouse and I received our teaching credentials several years ago and took teaching positions. This year, I went back to school to work on my master's degree. I was going to deduct the tuition and related expenses as an unreimbursed employee expense on Schedule A. But recently I was told that higher education tuition expenses in 2002 can be deducted from adjusted gross income on the front side of Form 1040. Does it make any difference where I deduct it?

--George C., Seattle
 

Brad: Before we analyze your situation with a little "deductive" logic, George, let us congratulate you on being one smart tax frog! So our readers know, by taking that first job, and then going back to school, you turned all these educational expenses into unreimbursed employee expenses that are fully tax deductible. And now you can teach at the college level as well as K-12. That's pretty clever!

Bob: We'll assume that you have already performed the calculations and have figured out that in your tax bracket a deduction will save you more than you would get if you applied for the Lifetime Learning tax credit. This is a credit against taxes owed of 20 percent for each dollar of tuition expenses up to a maximum of $5,000 ($1,000 in tax credits).

Brad: So, here is the new wrinkle: For tax years 2002 through 2005, there is an "above the line" deduction for qualified tuition and related higher education expenses. "Qualified" here means the same as in the Hope and Lifetime Learning tax credit definition. For 2002 and 2003, up to $3,000 of tuition can be deducted from adjusted gross income (AGI) on Form 1040, line 26. However, this is not an option if (1) your AGI exceeds $65,000 ($130,000, married filing jointly) and/or (2) you are using tuition tax credits or IRA distributions for the same expenses.

Bob: So your choice boils down to taking the deduction before calculating your AGI on the front side of Form 1040, or taking the deduction on the back side of 1040 to reduce taxable income. At first blush, one might say, "Hey, a deduction is a deduction is a deduction." Either method lowers your taxable income, so other than making taxes more complicated, what's the big difference here?

Brad: This is where the tax-smart frog uses a little bit of "deductive" logic Bob! In this example, if one takes the $3,000 tuition deduction on the front side of Form 1040, then one will end up with $3,000 less on Form 1040, line 38, AGI. Now it just so happens that the number on line 38 determines the threshold for deducting unreimbursed employee expenses on Schedule A.

Bob: Aha! So using the deduction to lower AGI means more of one's unreimbursed expenses become deductible. Brilliant, my dear Sherlock, er, Brad. So a deduction on the front side of Form 1040 is worth more than one on the back side.

Brad: No kidding, Watson! Sleuthing like this can pay off quite handsomely for the smart frog. In our next column, we'll explore the case of Sherlock Holmes and The Sign of 1040!