15.2 Adjustments to Arrive at AGI
Key Takeaways
- Adjusted gross income is gross income minus IRC §62 adjustments; those adjustments are allowed whether the taxpayer itemizes or takes the standard deduction.
- Self-employment adjustments include one-half of self-employment tax, deductible HSA contributions, self-employed health insurance, and contributions to a self-employed SEP, SIMPLE, or qualified plan.
- For tax years 2025–2028, OBBBA allows above-the-line deductions for qualified tips (up to $25,000) and for the qualified overtime premium (up to $12,500, or $25,000 MFJ), each with MAGI phaseouts; they are deductions, not gross-income exclusions.
- Student loan interest is an above-the-line deduction with a MAGI phaseout that is inflation-indexed; REG tests that the deduction exists, not a memorized phaseout dollar.
- Beginning in 2026, nonitemizers may deduct cash gifts to public charities under §170(p) up to $1,000 ($2,000 MFJ); that deduction is taken in addition to the standard deduction and reduces taxable income, not AGI — a Roth IRA contribution is not an adjustment.
15.2 Adjustments to Arrive at AGI
REG Blueprint Area IV, Group C asks you to identify adjustments allowed in calculating adjusted gross income given a scenario, including a contribution to a qualified retirement plan, a contribution to a health savings arrangement, and self-employment expenses. Adjusted gross income (AGI) is the 1040 checkpoint used for phaseouts, the medical-expense floor, charitable percentage limits, and many credits. The arithmetic is:
Gross income − §62 adjustments = AGI.
Adjustments are above the line. They are allowed whether or not the taxpayer itemizes. Itemized deductions in 15.3 come after AGI. Do not put an above-the-line item on Schedule A, and do not refuse an adjustment because the taxpayer takes the standard deduction.
Gross-income inclusions and exclusions are the prior chapter (14.1 and 14.2). This section starts after those amounts are already in, or kept out of, gross income.
Self-employment expenses that adjust AGI
A sole proprietor reports profit on Schedule C. That profit is gross income. Three related items then adjust AGI; they are not additional Schedule C expenses once the net-profit figure is fixed:
| Adjustment | Statute | Teaching point |
|---|---|---|
| One-half of self-employment tax | IRC §164(f) | The employer-equivalent half of the 15.3% SE tax on net earnings from self-employment. SE tax itself is computed on 92.35% of net earnings; employment-tax structure is 8.1. |
| Self-employed health insurance | IRC §162(l) | Premiums for the self-employed individual and family, limited to net SE earnings from the business; not allowed for any month the taxpayer is eligible for subsidized employer coverage. |
| Self-employed SEP, SIMPLE, or qualified-plan contribution | IRC §62(a)(6) | An above-the-line deduction for the owner's contribution to the owner's plan. The deductible amount is a function of net SE earnings after the §164(f) deduction; REG tests the placement, not a contribution-limit table. |
Health savings account (HSA) contributions (IRC §223) are also §62 adjustments when the taxpayer has a qualifying high-deductible health plan and is otherwise eligible. The annual contribution limit is inflation-indexed and is not a REG-tested dollar. Catch-up contributions for age 55 and older exist as a statutory add-on. An employee whose employer already excluded HSA amounts from wages under a cafeteria plan does not deduct those same amounts again as an adjustment.
Employee elective deferrals to a §401(k) reduce W-2 wages. They never appear as a §62 adjustment. A traditional IRA deduction is an adjustment, subject to active-participant MAGI phaseouts that are indexed. A Roth IRA contribution is not deductible. REG's fork is: qualified-plan or IRA deduction versus Roth nondeductible contribution versus wage-reducing 401(k) deferral.
Student loan interest and educator expense
Student loan interest (IRC §221) is an above-the-line deduction for interest paid on qualified education loans. It is subject to a MAGI phaseout. The phaseout thresholds are inflation-indexed; the AICPA's REG assumption is that you will not be tested on those dollars. Know that the deduction exists, that it is above the line, that MAGI can reduce or eliminate it, and that married filing separately is generally ineligible.
Educator expenses remain an above-the-line adjustment under §62(a)(2)(D) for eligible K–12 educators' unreimbursed classroom costs. OBBBA did not repeal that adjustment; it also created a separate path for additional educator costs as an itemized deduction beginning after 2025. For AGI, the tested fact is that a qualifying educator expense is still an adjustment, not that you have memorized this year's dollar cap (the cap is indexed).
OBBBA 2026: nonitemizer cash charitable deduction (§170(p)) — the deliberate near-miss
This paragraph sits on the AGI page on purpose: §170(p) is not an adjustment to AGI, and treating it as one is the designed exam miss. Beginning with tax years after December 31, 2025, a taxpayer who does not itemize may deduct cash contributions to public charities (organizations described in §170(b)(1)(A), generally not donor-advised funds, supporting organizations, or private nonoperating foundations) under §170(p). The statutory cap is $1,000 ($2,000 MFJ); amounts above the cap do not carry forward. Mechanically, §170(p) is a from-AGI deduction taken in addition to the standard deduction — §63 computes taxable income as AGI minus the standard deduction (or itemized deductions) minus this §170(p) amount. Because it never touches AGI, it does not move the medical 7.5% floor, the charitable percentage of AGI limits, or any AGI-based phaseout, and it does not appear as a §62 adjustment. It is not available to a taxpayer who itemizes, and it requires no Schedule A. The provision is a 2026-effective IRC change, so it is testable on REG beginning July 1, 2026. Do not confuse it with the 0.5 percent AGI floor that applies only to itemized charitable deductions, and do not describe it as above the line — despite the nickname many summaries use, the deduction reduces taxable income, not AGI. The itemized charitable rules themselves live in 15.3.
OBBBA 2025–2028: qualified tips and qualified overtime premium
The One Big Beautiful Bill Act (signed July 4, 2025) added two temporary above-the-line deductions for tax years 2025 through 2028. AICPA treats provisions with 2025 effective dates as testable on REG beginning July 1, 2026. They are deductions. They are not exclusions from gross income. Tips and overtime still go into wages (or into nonemployee compensation). The taxpayer then subtracts a qualified amount in arriving at AGI.
| Deduction | Statute | What is deductible | Statutory cap | MAGI |
|---|---|---|---|---|
| Qualified tips | IRC §224 | Cash tips in an occupation that customarily and regularly received tips, included on a required information return (W-2 or 1099) | $25,000 per year | Phases out above MAGI $150,000 ( $300,000 MFJ) |
| Qualified overtime compensation | IRC §225 | Only the premium portion of FLSA-required overtime — the extra half of time-and-a-half, not the underlying straight-time pay | $12,500 ($25,000 MFJ) | Same MAGI thresholds |
Both deductions require a valid taxpayer identification number on the return. Mandatory service charges and automatic gratuities that the customer cannot refuse generally are not qualified tips. For overtime, if the regular rate is $20 and the FLSA overtime rate is $30, ten overtime hours produce $300 of overtime pay but only $100 of qualified overtime premium. REG will punish a candidate who deducts the full $300 or who excludes the $300 from gross income.
These amounts are statutory OBBBA figures, not inflation-indexed standard-deduction amounts, so the caps and the MAGI starting points are in-scope. The deductions sunset after 2028 unless Congress extends them.
Worked scenario: sole proprietor, SE tax, and HSA
Facts. Priya is a calendar-year sole proprietor filing single. Schedule C net profit is $80,000. She has no employees and no other gross income. She is covered by a qualifying high-deductible health plan and contributes $4,000 to her HSA, an amount within the indexed self-only limit. She pays her own health-insurance premiums of $6,000 and is not eligible for subsidized employer coverage. She makes no retirement-plan contribution and has no student-loan interest, tips, or overtime.
Analysis.
- Gross income includes the $80,000 of Schedule C profit. The HSA contribution is not a Schedule C expense. Neither is the deductible half of SE tax.
- SE tax. Net earnings from self-employment = $80,000 × 92.35% = $73,880. SE tax = $73,880 × 15.3% = $11,304 (rounded). The §164(f) adjustment is one-half, $5,652.
- HSA. The $4,000 contribution is an above-the-line deduction on Form 8889 / Schedule 1. It does not reduce Schedule C net profit.
- Self-employed health insurance. The $6,000 of premiums is an additional §162(l) adjustment, limited to net SE earnings after the SE-tax deduction (here, well above $6,000). It is not an itemized medical expense and is not run through the 7.5% AGI floor in 15.3.
- AGI from these facts: $80,000 − $5,652 − $4,000 − $6,000 = $64,348.
If Priya had instead been a W-2 employee who deferred $5,000 into a 401(k), that $5,000 would already be missing from wages; it would not appear a second time as an adjustment. If she contributed $5,000 to a Roth IRA, AGI would not change.
For 2026, a W-2 server reports $22,000 of qualified tips in Box 1 wages and on the required tip statement. MAGI is well below the statutory phaseout. Which statement correctly describes the OBBBA tip provision?
Priya's Schedule C net profit is $80,000. SE tax on that profit is $11,304. She contributes $4,000 to an HSA while covered by a qualifying high-deductible health plan. She takes the standard deduction. Which statement is correct?
Which statement correctly identifies an adjustment allowed in calculating AGI?