The Income Funnel
Think of federal income tax as a funnel:
- Gross Income — everything unless excluded by law
- Minus: Above-the-line deductions = Adjusted Gross Income (AGI)
- Minus: Standard or Itemized deduction
- Minus: QBI deduction (if applicable) = Taxable Income
Exam Tip: AGI is the gatekeeper. Many other deductions, credits, and phase-outs are based on AGI. Reducing AGI often unlocks more tax benefits than a dollar-for-dollar deduction below the line.
Above-the-Line Deductions (For AGI)
These deductions are taken before arriving at AGI. You get them even if you take the standard deduction.
- Self-employment tax deduction — 50% of SE tax paid
- Self-employed health insurance premiums (not to exceed net SE income)
- SE retirement plan contributions (SEP, SIMPLE, solo 401k)
- Traditional IRA contributions (subject to phase-out if active participant in employer plan)
- Alimony paid — only if divorce finalized before January 1, 2019
- Student loan interest (up to $2,500; phases out at higher MAGI)
- HSA contributions
- Early withdrawal penalty (forfeited interest on CDs, savings accounts)
- Educator expenses ($300 per educator)
Below-the-Line Deductions (From AGI)
Taxpayer chooses the greater of: Standard Deduction OR Itemized Deductions.
| Filing Status | 2024 Standard Deduction |
|---|---|
| Single | $14,600 |
| Married Filing Jointly | $29,200 |
| Head of Household | $21,900 |
Common Itemized Deductions
- SALT (State and Local Taxes): Capped at $10,000 per return ($5,000 if MFS) — includes state income tax OR sales tax plus property taxes.
- Mortgage interest: Deductible on first $750,000 of acquisition indebtedness (post-2017 loans).
- Charitable contributions: Up to 60% of AGI for cash gifts to public charities.
- Medical expenses: Only the amount exceeding 7.5% of AGI.
- Casualty losses: Only in federally declared disaster areas; subject to $100 floor + 10% of AGI.
IRA Deductibility Phase-Out (Active Participant)
If the taxpayer (or spouse) is an active participant in an employer-sponsored retirement plan, the Traditional IRA deduction phases out:
| Filing Status | 2024 Phase-Out Range |
|---|---|
| Single / HOH | $77,000 – $87,000 |
| MFJ (active participant) | $123,000 – $143,000 |
| MFJ (spouse is active, filer is not) | $230,000 – $240,000 |
Exam Tip: Even if the IRA contribution is not deductible, you can still make a nondeductible traditional IRA contribution — or consider a Roth IRA if income qualifies. Track nondeductible basis on Form 8606.
Alimony Rules: Pre-2019 vs. Post-2019
| Pre-2019 Divorce | Post-2018 Divorce | |
|---|---|---|
| Payer | Deductible (above-the-line) | NOT deductible |
| Recipient | Included in gross income | NOT included in gross income |
Child support: Never deductible to the payer. Never income to the recipient. Period.
What Is Excluded from Gross Income?
- Municipal bond interest — excluded from federal gross income (may be subject to AMT)
- Life insurance death benefit — excluded (IRC §101)
- Gifts and inheritances — excluded from recipient's income (giver may owe gift tax)
- Workers' compensation — excluded
- Physical injury/sickness compensatory damages — excluded
- Employer-paid health insurance premiums — excluded from employee income
What IS Taxable (Common Traps)
- Punitive damages — always taxable, regardless of the underlying claim
- Unemployment compensation — fully taxable
- Social Security benefits — up to 85% taxable based on provisional income
- Cancellation of debt income — generally taxable (exceptions: insolvency, bankruptcy, qualified principal residence)
- Gambling winnings — fully taxable; losses deductible only as itemized deduction up to winnings
Memory Trick: "GIFTS are Graciously Excluded (Gifts, Inheritance, physical injury, workers' comp, Tax-free muni interest, Social Security partial exclusion). But Punitive damages and Gambling winnings are always IN."