Welcome to the Roadmap of Individual Taxation!
Hello, future CPA! Today, we are diving into one of the most important parts of the REG exam: moving from your total income down to the number you actually pay taxes on. Think of this process like a filter. You start with a big bucket of "Gross Income," and as you move down the "Tax Form Waterfall," we filter out certain expenses to reach Adjusted Gross Income (AGI) and finally Taxable Income.
Why does this matter? Because AGI is the magic number! It determines your eligibility for many credits and further deductions. If you understand how to get to AGI, you’ve mastered half the battle of individual taxation.
Part 1: Adjustments (The "Above-the-Line" Deductions)
Adjustments are special expenses that you subtract from your Gross Income to arrive at your AGI. These are often called "Above-the-Line" deductions because, on the old tax forms, they literally sat above the line where AGI was calculated. These are great for taxpayers because you can take them even if you don't itemize!
Key Adjustments to Remember:
For 2026, an eligible educator may deduct up to $350 of qualifying unreimbursed expenses in arriving at AGI; joint filers may deduct up to $700 only if both qualify, limited to each spouse’s own $350 and actual eligible costs. Eligibility includes the applicable K–12 role and 900-hour requirement. Separately assess any additional eligible itemized educator-expense deduction under 2026 law; do not double deduct costs. Adjustments have separate eligibility and limits. HSA contributions require an eligible individual (qualifying coverage, no disqualifying coverage/Medicare, and not another taxpayer’s dependent). The deductible employer-equivalent SE tax excludes Additional Medicare Tax. Self-employed health-insurance deductions are limited by eligible earned income and unavailable for months eligible for subsidized employer coverage. Qualified student-loan interest is capped at $2,500 with filing-status/MAGI restrictions. From 2026, moving-expense exceptions cover qualifying military and intelligence-community moves; ordinary personal moves remain nondeductible. For divorce or separation instruments executed on or before December 31, 2018, qualifying alimony is generally deductible by the payer and included by the recipient, unless a later modification expressly adopts the new treatment. For instruments executed after that date, alimony is generally neither deductible by the payer nor taxable to the recipient. Child support is neither deductible nor included as income.
Memory Aid: The "Self-Employed Trio"
The ordinary deductible employer-equivalent portion is generally 50% of regular SE tax. Self-employed taxpayers may qualify for the employer-equivalent portion of SE tax, eligible health-insurance premiums and retirement-plan contributions as adjustments, each under its own limit. Additional Medicare Tax is not included in the deductible half of SE tax. Health-insurance eligibility and earned-income limits prevent an automatic deduction of all premiums.
Quick Review: Adjustments reduce your Gross Income to get to AGI. You don't need to choose between these and the standard deduction—you get these automatically if you qualify!
Part 2: The Fork in the Road—Standard vs. Itemized
Eligible taxpayers generally compare the standard deduction with allowable itemized deductions. Eligibility exceptions matter: for example, a married-filing-separately taxpayer generally cannot use the standard deduction if the spouse itemizes; nonresident aliens generally cannot claim it either. Use the applicable year and filing status rather than assuming an unrestricted choice.
The Standard Deduction
Eligible taxpayers generally compare the standard deduction with allowable itemized deductions. Eligibility exceptions matter: for example, a married-filing-separately taxpayer generally cannot use the standard deduction if the spouse itemizes; nonresident aliens generally cannot claim it either. Use the applicable year and filing status rather than assuming an unrestricted choice.
Itemized Deductions (Schedule A)
If your personal expenses are higher than the standard amount, you’ll "itemize" them on Schedule A. Here are the big ones for the exam:
1. Medical Expenses: You can only deduct the part of your medical bills that exceeds 7.5% of your AGI.
Analogy: Imagine a hurdle. If your AGI is \( \$100,000 \), your hurdle is \( \$7,500 \). If you spent \( \$8,000 \) on doctors, you only get to deduct the \( \$500 \) that went over the hurdle.
For 2026, itemized deductions include eligible charitable gifts (subject to a 0.5%-of-AGI floor and applicable percentage limits), medical costs above 7.5% of AGI, qualified mortgage interest, and eligible taxes and casualty losses. The SALT cap is $40,400 ($20,200 married filing separately), reduced by 30% of MAGI above $505,000 ($252,500 separately), but not below $10,000 ($5,000 separately). Personal casualty losses generally require a federally or state-declared disaster, subject to applicable exceptions and limitations. Do not use an unconditional $10,000 SALT cap or a federal-disaster-only rule for 2026.
Qualified acquisition mortgage debt generally has a $750,000 limit ($375,000 MFS) for post-December 15, 2017 debt, with grandfathered-debt and other special rules; the loan must meet security and residence/use requirements. Investment interest is generally limited to net investment income. Ordinary personal interest is generally nondeductible, but qualifying vehicle-loan interest has a separate limited 2025–2028 deduction with eligibility and MAGI conditions.
For 2026 itemizers, apply the new 0.5%-of-AGI charitable floor and the applicable percentage ceilings. Cash to qualifying public charities generally has a 60% ceiling, while long-term capital-gain property to such charities commonly has a 30% ceiling; property type, recipient and elections can change the limit and valuation. Nonitemizers may separately deduct eligible cash gifts up to $1,000 ($2,000 joint). Carryovers have specific conditions.
For 2026, itemized deductions include eligible charitable gifts (subject to a 0.5%-of-AGI floor and applicable percentage limits), medical costs above 7.5% of AGI, qualified mortgage interest, and eligible taxes and casualty losses. The SALT cap is $40,400 ($20,200 married filing separately), reduced by 30% of MAGI above $505,000 ($252,500 separately), but not below $10,000 ($5,000 separately). Personal casualty losses generally require a federally or state-declared disaster, subject to applicable exceptions and limitations. Do not use an unconditional $10,000 SALT cap or a federal-disaster-only rule for 2026.
Key Takeaway:
Eligible taxpayers generally compare the standard deduction with allowable itemized deductions. Eligibility exceptions matter: for example, a married-filing-separately taxpayer generally cannot use the standard deduction if the spouse itemizes; nonresident aliens generally cannot claim it either. Use the applicable year and filing status rather than assuming an unrestricted choice.
Part 3: Qualified Business Income (QBI) Deduction
Section 199A generally permits an eligible noncorporate taxpayer a deduction based on 20% of QBI, with a taxable-income-minus-net-capital-gain ceiling and, where applicable, wage/property and specified-service-business restrictions. It is below AGI and may be available with either standard or itemized deductions. Apply the year-specific thresholds and any special minimum-deduction rule; 20% of business receipts is not the formula.
Don't worry if this seems tricky! For the REG exam, focus on the fact that this deduction exists to help non-corporate business owners get a tax break similar to the lower corporate tax rate.
Summary: The Step-by-Step Process
For 2026, start with AGI and subtract the allowable standard or itemized deduction, the allowable QBI deduction and other applicable deductions below AGI. Schedule 1-A provides deductions for qualified tips, qualified overtime, qualifying car-loan interest and eligible seniors, each with its own limits and conditions; these do not reduce AGI. Eligible nonitemizers may also deduct up to $1,000 of qualifying cash charitable gifts ($2,000 jointly). Do not assume the standard/itemized deduction and QBI are the only deductions.
Common Traps to Avoid
The ordinary deductible employer-equivalent portion is generally 50% of regular SE tax. Self-employed taxpayers may qualify for the employer-equivalent portion of SE tax, eligible health-insurance premiums and retirement-plan contributions as adjustments, each under its own limit. Additional Medicare Tax is not included in the deductible half of SE tax. Health-insurance eligibility and earned-income limits prevent an automatic deduction of all premiums. For 2026, start with AGI and subtract the allowable standard or itemized deduction, the allowable QBI deduction and other applicable deductions below AGI. Schedule 1-A provides deductions for qualified tips, qualified overtime, qualifying car-loan interest and eligible seniors, each with its own limits and conditions; these do not reduce AGI. Eligible nonitemizers may also deduct up to $1,000 of qualifying cash charitable gifts ($2,000 jointly). Do not assume the standard/itemized deduction and QBI are the only deductions.
Did you know? The 7.5% floor for medical expenses is one of the hardest hurdles to clear. Most taxpayers don't get to deduct medical expenses because their insurance covers too much or their income is too high!
Final Encouragement: You are doing great! Tax becomes much easier when you visualize the 1040 form. Just keep asking yourself: "Is this above the line (Adjustment) or below the line (Itemized)?" You've got this!