Retirement accounts, deductions and credits

The previous lessons covered wages, business income, investment income and capital gains. This lesson gathers the remaining pieces of an individual's return: other kinds of income such as Social Security benefits and retirement distributions, the tax-advantaged accounts that shelter saving, itemized deductions and the choice between itemizing and taking the standard deduction, the major credits, and the alternative minimum tax. Along the way it settles the Brandts' choices for 2026 and introduces the new deduction for taxpayers aged 65 and over through Leah's father.

Other income

Other items of gross income include unemployment compensation, alimony received under divorce or separation agreements executed before 2019 (later agreements are neither deductible nor taxable), distributions from traditional IRAs and pre-tax 401(k) accounts, pensions and annuities (with a tax-free return of after-tax contributions), gambling winnings, prizes, jury duty pay and canceled debts. Gambling losses are deductible only as an itemized deduction and only up to winnings, and from 2026 the 2025 act limits the deduction to 90 percent of losses. Social Security benefits are partly taxable for higher-income recipients: if provisional income (AGI excluding Social Security, plus tax-exempt interest, plus half of benefits) exceeds $25,000 for single filers or $32,000 for joint filers, up to 50 percent of benefits are taxable, and above $34,000 or $44,000, up to 85 percent. These thresholds have never been indexed. Child support, gifts, inheritances, qualified scholarships for tuition and Roth IRA qualified distributions are not taxable.

Tax-advantaged accounts

Tax-advantaged accounts are the most widely used tax planning tool in the United States. Each combines a deduction or a tax-free withdrawal with tax-free growth inside the account.

Traditional IRA contributions are deductible in full if neither spouse is covered by a workplace retirement plan; otherwise the deduction phases out over modified AGI ranges that depend on filing status and on which spouse is covered. Leah is covered by Red River's 401(k), and the Brandts' income is above the phase-out range for a covered participant, so a traditional IRA contribution would not be deductible for her. Roth IRA contributions are limited above higher income ranges, though high earners can use a nondeductible traditional IRA contribution followed by a conversion. The HSA is the only account that is deductible on the way in and tax-free on the way out when used for medical costs, which is why it is often called triple tax-advantaged. Whether a traditional or Roth account is better depends mostly on the taxpayer's marginal rate now compared with their expected rate on withdrawal.

Itemized deductions

A taxpayer who itemizes deducts the total of the following on Schedule A instead of the standard deduction. State and local income or sales taxes and property taxes are deductible up to a cap, which the 2025 act raised from $10,000 to $40,000 for 2025 and $40,400 for 2026, rising 1 percent a year through 2029 and reverting to $10,000 in 2030; the cap is reduced by 30 percent of modified AGI above $505,000 for 2026, but not below $10,000. Home mortgage interest is deductible on up to $750,000 of acquisition debt (made permanent), and from 2026 mortgage insurance premiums are again deductible. Charitable contributions are deductible up to percentage limits of AGI (60 percent for cash to public charities), and from 2026 only to the extent they exceed 0.5 percent of AGI. Medical and dental expenses are deductible above 7.5 percent of AGI. Casualty losses are deductible only in federally declared disasters. For taxpayers in the 37 percent bracket, the 2025 act limits the value of itemized deductions to 35 cents per dollar.

Credits

Credits reduce tax dollar for dollar. Non-refundable credits can reduce income tax to zero; refundable credits are paid even if they exceed the tax.

The child tax credit is the credit most families claim. For 2026 it is $2,200 for each qualifying child under 17 who has a Social Security number, indexed to inflation, with up to $1,700 refundable for families with earnings above $2,500. It is reduced by $50 for each $1,000 of modified AGI above $200,000, or $400,000 for joint filers, so middle-income families like the Brandts receive the full amount. The earned income tax credit is the largest refundable credit for low-income working families. Many energy credits, including those for new and used clean vehicles and for energy-efficient home improvements, ended for vehicles acquired after September 2025 or property placed in service after 2025 under the 2025 act.

The Brandts' choices

The program checks whether the Brandts should itemize and computes their child tax credit, then shows how the SALT cap shrinks for a high-income couple.

# Standard or itemized deduction, and the child tax credit, 2026 (illustrative)
agi = 159_459                                   # the Brandts' approximate AGI
salt_paid = 7_900                               # state income tax and property tax
salt_cap = 40_400
if agi > 505_000:                               # cap phases down above $505,000 of MAGI
    salt_cap = max(10_000, salt_cap - 0.30 * (agi - 505_000))
itemized = {"State and local taxes (capped)": min(salt_paid, salt_cap),
            "Mortgage interest (home)": 9_800,
            "Charitable gifts": 1_200,
            "Medical above 7.5% of AGI": max(0, 3_400 - 0.075 * agi)}
standard = 32_200
total = sum(itemized.values())
for k, v in itemized.items():
    print(f"  {k:<34}{v:>9,.0f}")
print(f"Itemized total {total:,.0f} versus standard {standard:,}: "
      f"take the {'itemized' if total > standard else 'standard'} deduction")

# Child tax credit for Nora
children, ctc = 1, 2_200
reduction = 50 * max(0, -(-(agi - 400_000) // 1_000))   # $50 per $1,000 over $400,000
credit = max(0, children * ctc - reduction)
print(f"Child tax credit: {credit:,} (refundable portion up to $1,700 per child)")

# High-income couple for contrast: MAGI $640,000, SALT paid $52,000
agi2 = 640_000
cap2 = max(10_000, 40_400 - 0.30 * (agi2 - 505_000))
print(f"At MAGI {agi2:,}: SALT cap falls to {cap2:,.0f}")

  State and local taxes (capped)        7,900
  Mortgage interest (home)              9,800
  Charitable gifts                      1,200
  Medical above 7.5% of AGI                 0
Itemized total 18,900 versus standard 32,200: take the standard deduction
Child tax credit: 2,200 (refundable portion up to $1,700 per child)
At MAGI 640,000: SALT cap falls to 10,000

Their potential itemized deductions total $18,900: $7,900 of state income and property taxes (well under the SALT cap), $9,800 of mortgage interest and $1,200 of charitable gifts, with no medical expenses above the 7.5 percent floor. That is far below their $32,200 standard deduction, so they take the standard deduction, like most households. Because they do not itemize, their charitable gifts give no deduction in 2026 unless they qualify for the new non-itemizer deduction of up to $2,000 for cash gifts to public charities by joint filers, which starts in 2026; for simplicity, the capstone ignores it. Their child tax credit is the full $2,200, because their modified AGI is well below $400,000. For contrast, a couple with $640,000 of modified AGI would see the SALT cap reduced to the $10,000 floor.

Clawbacks and the alternative minimum tax

The alternative minimum tax is a parallel tax system meant to ensure that taxpayers with large deductions, exclusions and preferences pay at least a minimum amount. Alternative minimum taxable income starts from taxable income, adds back items such as the standard deduction, state and local taxes, the spread on exercised incentive stock options and interest on private activity bonds, and subtracts an exemption of $90,100 for single filers and $140,200 for joint filers in 2026. The exemption phases out by 50 cents per dollar of AMTI above $500,000 ($1,000,000 joint), a faster phase-out than before 2026 under the 2025 act. Tax at 26 percent and 28 percent, with capital gains and qualified dividends still at their preferential rates, gives the tentative minimum tax; the taxpayer pays the excess over regular tax as AMT. Since the 2017 changes, few middle-income families pay AMT; the main triggers are large ISO exercises and very large state tax payments.

Two other surtaxes apply to high earners: the 3.8 percent net investment income tax (lesson 8) and the 0.9 percent additional Medicare tax on wages and self-employment income above $200,000 for single filers or $250,000 for joint filers (lesson 5). Phase-outs of credits and deductions, such as the child tax credit and the new deductions for tips, overtime and seniors, create higher effective marginal rates in particular income ranges, a point worth remembering when advising clients near those ranges.