Personal Income Taxation: Gross Income, Adjustments, and Deductions
The architecture of the individual return
Every individual return follows the same staircase: total income, minus adjustments (the "above-the-line" deductions), equals adjusted gross income (AGI); AGI minus the standard or itemized deduction and the qualified business income deduction equals taxable income; tax is then computed and credits applied. Questions love to test which step an item belongs to, because placement changes whether a taxpayer benefits.
Inclusion and exclusion
Gross income is all income from whatever source derived unless a statute excludes it. Know the classic exclusions: gifts and inheritances, life insurance proceeds paid by reason of death, municipal bond interest, qualified scholarships for tuition and required fees, and employer-provided health coverage. Traps: unemployment compensation is included; punitive damages are included; interest on a state refund is generally included; a scholarship covering room and board is taxable.
Above-the-line vs. below-the-line
Adjustments reduce AGI and therefore help even non-itemizers. Core adjustments include the self-employed health insurance deduction, the employer-equivalent portion of self-employment tax, contributions to traditional IRAs and HSAs, alimony paid under pre-2019 instruments, and student loan interest (subject to phase-out). Itemized deductions include medical expenses above a percentage-of-AGI floor, state and local taxes (capped), home mortgage interest, charitable contributions, and the standard deduction as the alternative.
Rates and character
Long-term capital gains and qualified dividends get preferential rates; short-term gains are ordinary. Net investment income tax and additional Medicare tax apply above threshold MAGI amounts. Know the basis rules: inherited property is generally stepped to fair market value at death, while gifted property carries over the donor's basis.
Worked rule of thumb
A taxpayer with $60,000 wages and a $5,000 HSA contribution: AGI is $55,000. If they take the standard deduction, the HSA contribution still helped because it was above the line. An itemized charitable gift of the same size would have helped only if total itemized deductions exceeded the standard deduction.