Gross Income broadly encompasses nearly all income from whatever source derived. However, it’s crucial to understand that Gross Income is merely the initial calculation. It doesn’t represent the final figure upon which your tax liability is determined.  Adjustments and deductions act as refinements, reducing Gross Income to reflect varying financial circumstances, business realities, and certain expenditures that Congress has deemed appropriate to incentivize or recognize. Ultimately, the goal of these reductions is to calculate Taxable Income.

The importance of deductions and adjustments stems from principles of both equity and economic policy. From an equity perspective, these provisions acknowledge that taxpayers have diverse financial situations. It would be unfair to tax the gross receipts of a business without allowing for the deduction of the costs of running that business. Similarly, certain personal expenditures, like significant medical expenses, can demonstrably reduce a taxpayer’s capacity to pay taxes. From an economic and social policy viewpoint, Congress strategically uses deductions and adjustments to encourage specific behaviors and support societal goals. Deductions for retirement savings incentivize individuals to plan for their future, while deductions for charitable contributions encourage philanthropic giving.

We will first explore Adjustments to Gross Income, often referred to as “above-the-line” deductions, which lead us to Adjusted Gross Income (AGI). We will then delve into Deductions from Adjusted Gross Income, or “below-the-line” deductions, examining the choice between the Standard Deduction and Itemized Deductions. Finally, we will briefly revisit the Qualified Business Income (QBI) deduction, which further refines taxable income.

Adjustments to Gross Income (§62)

To begin refining Gross Income, we first encounter Adjustments to Gross Income. These are specific deductions allowed by Congress that are subtracted directly from your Gross Income to arrive at Adjusted Gross Income (AGI). Often termed “above-the-line” deductions, this terminology stems from their placement on older versions of tax forms, appearing before the “line” where AGI was calculated.

Adjustments to Gross Income are generally considered more advantageous than other types of deductions because they reduce AGI. Why is reducing AGI significant? Because AGI serves as a crucial benchmark throughout the tax system. Many other deductions, credits, and limitations are often based on or limited by your AGI. Therefore, lowering your AGI can have a cascading positive effect, potentially increasing your eligibility for various tax benefits and further reducing your overall tax liability.

The definitive list of Adjustments to Gross Income is explicitly defined in Internal Revenue Code Section 62, titled “Adjusted Gross Income Defined.” Section 62(a) provides a comprehensive catalog of these deductions. Let’s examine some of the most common and relevant adjustments for individual taxpayers, each grounded in the IRC:

Trade or Business Deductions (§62(a)(1)):

This adjustment allows self-employed individuals and business owners to deduct ordinary and necessary expenses directly connected with carrying on a trade or business. These are the day-to-day costs of operating a business. It’s important to distinguish between business expenses and personal expenses; only business-related costs are deductible as adjustments.

Deduction for Contributions to Traditional IRAs (§62(a)(7)):

To encourage retirement savings, the tax law allows eligible taxpayers to deduct contributions made to a Traditional Individual Retirement Account (IRA). This deduction helps individuals save for retirement on a tax-deferred basis. There are limitations on the amount that can be contributed and deducted, and these limitations can vary based on factors like filing status, age, and whether the taxpayer (or their spouse, if married) is covered by a retirement plan at work.

Student Loan Interest Deduction (§62(a)(1)):

Recognizing the burden of student loan debt, the tax code permits a deduction for interest paid on qualified student loans. This deduction is subject to limitations, including a maximum annual deduction amount and income-based phase-outs. The loan must be for qualified higher education expenses, and the student must be the taxpayer, their spouse, or a dependent when the debt was incurred.

Health Savings Account (HSA) Deduction (§62(a)(16)):

Health Savings Accounts (HSAs) are tax-advantaged savings accounts that can be used to pay for qualified medical expenses. Individuals who are covered under a high-deductible health plan (HDHP) may be eligible to contribute to an HSA. Contributions to an HSA are deductible, earnings grow tax-free, and withdrawals for qualified medical expenses are also tax-free, offering a triple tax benefit.

Moving Expenses (For Members of the Armed Forces) (§62(a)(8)):

It is important to note that for most taxpayers, the deduction for moving expenses was suspended by the Tax Cuts and Jobs Act (TCJA) of 2017. However, an exception remains for members of the Armed Forces on active duty who move pursuant to a military order related to a permanent change of station. In these specific circumstances, moving expenses are still deductible as an adjustment.

One-Half of Self-Employment Tax (§62(a)(14)):

Employees and employers share the burden of Social Security and Medicare taxes. However, self-employed individuals are responsible for paying both the employer and employee portions of these taxes, collectively known as self-employment tax. To partially offset this, self-employed individuals are permitted to deduct one-half of their self-employment tax as an adjustment to gross income. This helps to equalize the tax burden between employees and the self-employed.

Adjustments to Gross Income are critical in moving from the broad concept of Gross Income to the more refined measure of Adjusted Gross Income (AGI). They are often advantageous due to their “above-the-line” nature, directly reducing AGI, which in turn can positively influence various other aspects of your tax calculation. Remember, AGI is not your final taxable income, but it is a vital intermediate step in the process.

Deductions From Adjusted Gross Income (§63)

Deductions from Adjusted Gross Income are often called “below-the-line” deductions, are subtracted after AGI is calculated. Taxpayers generally have a choice in this stage: they can choose to take the Standard Deduction or, if eligible, they can choose to Itemize Deductions. These are mutually exclusive options – you must choose one or the other, not both. The general rule is to choose the option that results in the larger deduction, thereby further reducing your Taxable Income.

The framework for deductions from AGI is established in Internal Revenue Code Section 63, “Taxable Income Defined.” Specifically, §63(b) defines the Standard Deduction, and §63(d) defines Itemized Deductions.

The Standard Deduction vs. Itemized Deduction

Standard Deduction

The Standard Deduction is a fixed dollar amount that Congress sets annually based on your filing status (Single, Married Filing Jointly, Head of Household, etc.). It is a simplified deduction designed to ease tax preparation for many taxpayers, particularly those with relatively straightforward financial situations. For taxpayers whose qualifying itemized deductions are less than the standard deduction amount, it is generally more beneficial to claim the standard deduction.

Standard Deduction Amounts:

The specific dollar amounts for the standard deduction are updated each year to account for inflation. Filing status, taxpayer’s age and blindness will determine the amount of standard deduction.

Increased Standard Deduction for Age 65 or Older and/or Blindness (§63(f)):

Taxpayers who are age 65 or older and/or blind are eligible for an additional standard deduction amount. This additional amount is also set annually and varies depending on filing status (e.g., a higher additional amount for single filers than for married filers). For example, a single individual who is both age 65 or older and blind would receive two additional standard deduction amounts on top of the base standard deduction for single filers. Refer to §63(f) for the specific rules and amounts.

Limitations on the Standard Deduction (§63(c)(5) & (6)):

There are some limitations on who can claim the full standard deduction. For example, the standard deduction is limited for individuals who can be claimed as a dependent on another person’s tax return and for certain other special situations.

Itemized Deductions

Itemized Deductions are specific expenses that Congress has explicitly allowed taxpayers to deduct from their AGI. These are listed in Part VI of Subchapter B of Chapter 1 of the IRC, titled “Itemized Deductions for Individuals and Corporations.” Taxpayers may choose to itemize if their total qualifying itemized deductions exceed their applicable standard deduction amount. Itemizing can be more beneficial for taxpayers with significant expenses in categories like medical care, state and local taxes, home mortgage interest, charitable contributions, and casualty losses (within limitations).

Let’s explore some common itemized deductions:

Medical Expenses (§213):

Taxpayers can deduct qualified medical expenses that exceed 7.5% of their Adjusted Gross Income (AGI) for tax year 2023. It is important to note that this percentage threshold can change in future years, so always verify the current percentage limitation. “Medical care” is broadly defined to include amounts paid for the diagnosis, cure, mitigation, treatment, or prevention of disease, and for treatments affecting any part or function of the body. This can include payments to doctors, dentists, hospitals, for prescription medications, health insurance premiums, and certain long-term care expenses, among many others.

Taxes – State and Local Taxes (SALT) (§164):

Taxpayers can deduct certain state and local taxes, including:

• State and local real estate taxes.
• State and local personal property taxes.
• State and local income taxes or general sales taxes (taxpayers can elect to deduct either state and local income taxes or state and local general sales taxes, but not both).

Crucially, there is a $10,000 annual limitation on the total amount of deductible state and local taxes (SALT) for tax years 2018 through 2025, as established by the TCJA (§164(b)(6)). This limitation can significantly impact taxpayers in high-tax states.

Interest Expense (§163):

The deduction for interest expense is subject to various limitations and categories. Two key types of deductible interest for individuals are:

• Home Mortgage Interest (§163(h)): Taxpayers can generally deduct interest paid on home mortgage debt used to buy, build, or substantially improve a qualified home (acquisition indebtedness). There are limitations on the amount of mortgage debt that qualifies for the interest deduction. For mortgages taken out after December 15, 2017, the deduction is limited to interest on acquisition of debt up to $750,000 ($375,000 if married filing separately). Prior  to this date, and for mortgages taken out before, the limit may have been higher. Home equity indebtedness interest may also be deductible in certain limited circumstances.  
  

• Investment Interest (§163(d)): Investment interest expense, which is interest paid on debt to purchase or carry investment property, is deductible, but the deduction is limited to your net investment income. Any investment interest expense that is not deductible in the current year can be carried forward to future years.

Charitable Contributions (§170):

Taxpayers are allowed to deduct contributions made to qualified charitable organizations. These organizations must generally be 501(c)(3) organizations (charities recognized by the IRS). The deductibility of charitable contributions is subject to percentage limitations based on the taxpayer’s AGI. For cash contributions to public charities, the limitation is generally 60% of AGI. Different limitations apply to contributions of property and contributions to certain types of charities (e.g., private foundations). Proper substantiation is crucial for claiming charitable contribution deductions.

Casualty and Theft Losses (§165(c) & (h)):

The deduction for casualty and theft losses of personal-use property has been significantly restricted by the TCJA. For tax years 2018 through 2025, casualty losses are generally only deductible if they are attributable to a federally declared disaster (§165(h)(5)). For deductible casualty losses (those arising from federally declared disasters), there are further limitations: a $100 floor applies per casualty event, and the total deductible loss is limited to the amount exceeding 10% of AGI.

Other Less Common Itemized Deductions:

While the above are some of the most common itemized deductions, other less frequent itemized deductions exist, such as gambling losses (deductible up to the amount of gambling winnings). It’s also important to note that prior to 2018, many “miscellaneous itemized deductions” were deductible subject to a 2% AGI floor (e.g., unreimbursed employee expenses). However, these miscellaneous itemized deductions subject to the 2% floor were suspended by the TCJA and are generally not deductible for most taxpayers for tax years 2018-2025.

Choosing Between Standard and Itemized Deductions:

At the stage of Deductions from AGI, taxpayers must calculate their total itemized deductions. They then compare this total to their applicable standard deduction amount for their filing status. They should choose to deduct whichever amount is greater – either the total itemized deductions or the standard deduction.

Taxpayers are more likely to itemize when they have significant expenses in categories like home ownership (mortgage interest and property taxes), high state and local taxes (although limited by the SALT cap), large medical expenses, or substantial charitable contributions.

Personal Exemptions and the Deduction for Qualified Business Income (QBI) (Further Reduction to Taxable Income)

Personal Exemptions:

Historically, the tax system included personal and dependency exemptions. These were fixed dollar amounts that taxpayers could deduct for themselves, their spouses, and qualifying dependents. However, personal and dependency exemptions were suspended by the TCJA for tax years 2018 through 2025. While no longer relevant for current tax calculations, it is important to be aware of personal exemptions, as they existed for many years and might be encountered when studying older tax law or in state taxation. The increase in the standard deduction and the child tax credit were, in part, intended to offset the elimination of personal exemptions.

Deduction for Qualified Business Income (QBI) (§199A)

The Deduction for Qualified Business Income (QBI), often referred to as the “pass-through deduction,” was also created by the TCJA. It allows eligible self-employed individuals and small business owners to deduct up to 20% of their Qualified Business Income. While technically listed as an adjustment in §62(a)(22), the QBI deduction is often calculated in a more complex manner after AGI, and its impact is to further reduce taxable income. It was designed to provide tax relief to businesses structured as pass-through entities (like sole proprietorships, partnerships, and S corporations).

IRS Resource: IRS Publication 529 Miscellaneous Deductions