Chapter 6,
Individual
Deductions
FALL 2025
PROFESSOR TODD SIMMENS
Adapted from McGraw Hill’s
Taxation of Individuals 2026 Edition
(Spilker, Ayers, Barrick, Lewis,
Robinson, Weaver, Worsham)
Issues to cover in Chapter 6
1. Identify the common deductions necessary for calculating
adjusted gross income (AGI). (Adjustments for AGI or
adjustments to arrive at AGI.)
2. Describe the different types of itemized deductions available to
individuals. (Generally, schedule A.)
3. Determine the standard deduction available to individuals.
(Amount varies based on filing status, age, and whether
taxpayer is blind.)
4. Calculate the deduction for qualified business income, tip
income, overtime income, car interest, and senior deduction.
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Deductions for AGI
(aka
Deductions to arrive at AGI)
Deductions for AGI
• Three categories of deductions for AGI.
• Directly related to business activities.
• Indirectly related to business activities.
• Subsidizing specific activities.
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Deductions for AGI (cont’d)
Directly Related to Business Activities.
• Taxpayers are allowed to deduct expenses incurred to generate
business income.
• For tax purposes, activities are either profit-motivated or motivated
by personal objectives.
• Profit-motivated activities are classified as:
1. Business activities (called “trade or business”).
2. Investment activities.
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Deductions for AGI (cont’d)
Although both are motivated primarily by profit, business activities
are distinguished from investment activities.
• Trade or business activities require a relatively high involvement or
effort from the taxpayer, whereas investment activities do not.
• Investment activities involve investing in property for appreciation or
for income payments.
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Deductions for AGI (cont’d)
• Exhibit 6-1 Individual Business and Investment-Related Expense
Deductions for AGI, from AGI, and Not Deductible.
Activity Type
Deduction Type:
Deduction for AGI
Deduction Type:
Deduction from
AGI (itemized
deduction)
Not Deductible
Business activities
Self-employed
business expenses
Qualified business
income deduction;
deduction for
qualified tip income;
deduction for
qualified overtime
compensation
Unreimbursed
employee business
expenses
Investment
activities
Rental and royalty
expenses
Investment interest
expense
Other investment
expenses
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Deductions for AGI (cont’d)
Trade or business expenses must be:
• Directly connected to the business activity.
• Ordinary and necessary for the activity (example, appropriate and
helpful for generating a profit).
• Reasonable in amount (not extravagant).
Expenses are claimed on Schedule C.
• Revenues from the same activity are also reported on the same
Schedule C.
• The net income or loss from Schedule C is transferred to Schedule 1,
line 3, and then combined with other items and included on Form 1040
(page 1), line 8.
8
Deductions for AGI (cont’d)
Rental and Royalty Expenses.
• Claimed above the line (for AGI).
• Could either be an investment activity or a trade activity depending on facts.
• Taxpayers report expenses and revenue on Schedule E and transfer the net
income or loss from Schedule E to Schedule 1, line 5, and then combine
with other items and include on Form 1040 (page 1), line 8.
Flow-Through Entities.
• Expenses and losses incurred by a flow-through entity pass through to the
entity owners, who typically report these amounts on Schedule E, then
Schedule 1, line 5, and then combine with other items and include on Form
1040 (page 1), line 8.
9
Deductions for AGI (cont’d)
Losses.
Taxpayers disposing of trade or business assets at a loss are allowed
to deduct the loss for AGI.
Losses from investment assets (called capital assets) are offset against
capital gains.
If capital losses exceed capital gains, this is called a net capital loss.
A net capital loss is deducted for AGI but limited to $3,000.
• Losses in excess of the $3,000 limit are carried forward
indefinitely to subsequent years.
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Deductions for AGI (cont’d)
Excess Business Loss Limitation.
• Excess business loss is excess of aggregate business deductions
over the sum of aggregate business gross income or gain plus
$315,000 ($626,000 for taxpayers married filing jointly).
• Effectively, a taxpayer may take up to $315,000 ($626,000 MFJ)
to offset other income in a given tax year
• Excess business loss is not deductible but is carried forward.
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Deductions for AGI (cont’d)
Health Insurance Deduction by Self-Employed Taxpayers.
• Deduction provides equity with employees who receive health
insurance as a qualified fringe benefit.
• Self-employed taxpayers can claim personal health
insurance premiums for the taxpayer, the taxpayer’s spouse, the
taxpayer’s dependents, and the taxpayer’s children under age 27 as
deductions for AGI, but only to the extent of the self-employment
income derived from the specific trade or business.
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Deductions for AGI (cont’d)
Self-Employment Tax Deduction.
• Employers deduct the Social Security and Medicare taxes they pay on
employee salaries.
• Self-employed individuals are required to pay self-employment tax in
lieu of Social Security tax. This tax represents both the employee’s and
the employer’s share of the Social Security and Medicare taxes.
• Self-employed taxpayers are allowed to deduct the employer portion
of the self-employment tax they pay to compensate for employers
deducting their portion of Social Security.
13
Deductions for AGI (cont’d)
Deductions for Individual Retirement Accounts.
• Deductible contributions to traditional IRAs are for AGI deductions.
Deduction amount depends on a number of factors.
• Distributions from traditional IRAs are taxed as ordinary income and
early distributions (before age 59½) are generally subject to a 10
percent penalty.
• Nondeductible contributions can be made. On distribution, the
taxpayer is taxed on the earnings generated by nondeductible
contributions but not on the actual nondeductible contributions.
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Deductions for AGI (cont’d)
Deductions for Health Savings Accounts.
• Individuals covered by a high deductible health plan with no other health coverage
can set aside amounts for payment of qualified medical and dental expenses for the
taxpayer, spouse, and dependents.
• For 2025, high deductible health plans have a minimum annual deductible of $1,650
for self-only coverage ($3,300 for family coverage) and their maximum annual
deductible and other out-of-pocket expenses cannot exceed $8,300 for self-only
coverage ($16,600 for family coverage).
• For 2025, individuals can contribute up to $4,300 for self-only coverage ($8,550 for
family coverage) to a HSA and deduct these contributions for AGI. Individuals age
55 or older at the end of the tax year may contribute and deduct an additional $1,000
annually.
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Deductions for AGI (cont’d)
Deductions for Health Savings Accounts (cont’d)
• Distributions from a HSA are tax free if they pay for qualified medical
expenses of the taxpayer, spouse, and dependents. Otherwise,
distributions are taxed as ordinary income (and subject to an additional
20% tax unless the taxpayer is disabled, age 65 or older, or deceased).
Penalty for early withdrawal of savings.
• Reduces the taxpayer’s net interest income to the amount actually
received.
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Deductions for AGI (cont’d)
• Alimony payments are deductible for AGI to maintain equity if paid
pursuant to a divorce or separation agreement executed before
2019. (The recipient picks up the income.)
• If paid pursuant to an agreement executed in or after 2019, there
is no deduction (and no income pickup to the recipient).
• Contributions to a qualified retirement account are deductible for AGI to
encourage savings.
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Deductions for AGI (cont’d)
Deduction for interest on qualified education loans.
• Up to $2,500 of interest on education loans is deductible for
AGI.
• The interest deduction is phased out for taxpayers with AGI
exceeding $85,000 ($170,000 filing jointly).
• The deduction is eliminated for taxpayers with AGI exceeding
$100,000 ($200,000 filing jointly).
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Deductions for AGI (cont’d)
• Exhibit 6-4 Summary of Limitations on Deduction of Interest on
Education Loans.
• Panel A: AGI Limitations.
Modified AGI Level
Deduction
Not over $85,000 ($170,000 for married
filing jointly)
Amount paid up to $2,500
Above $85,000 ($170,000 for married filing
jointly) but below $100,000 ($200,000 for
married filing jointly)
Amount paid up to $2,500 reduced by the
phase-out amount. The phase-out amount is
the amount paid up to $2,500 times the phaseout percentage (see Panel B for the phase-out
percentage computation).
Equal to or above $100,000 ($200,000 for
married filing jointly)
Zero
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Deductions for AGI (cont’d)
• Panel B: Phase-Out Percentage*
Filing Status
Phase-Out Percentage
Single or head of household
(Modified AGI − $85,000) ∕ $15,000
Married filing jointly
(Modified AGI − $170,000) ∕ $30,000
*Married taxpayers filing separately are ineligible for the
deduction.
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Deductions from AGI: Itemized Deductions
Deductions from AGI: Itemized Deductions
Medical Expenses.
• Taxpayers may deduct medical expenses incurred to treat
themselves, their spouse, and their dependents.
• Qualifying medical expenses include unreimbursed payments for
care, prevention, diagnosis, or cure of injury, disease, or bodily
function.
• Taxpayers using personal automobiles for medical transportation
purposes may deduct a standard mileage allowance (21 cents per
mile in 2025) in lieu of actual costs.
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Deductions from AGI: Itemized Deductions (cont’d)
Hospitals and Long-Term Care Facilities.
• Taxpayers may deduct the costs of actual medical care whether the care is
provided at hospitals or other long-term care facilities.
Medical Expense Deduction Limitation.
• It is limited to the amount of unreimbursed qualified medical expenses
paid during the year (no matter when the services were provided) reduced
by 7.5 percent of the taxpayer’s AGI.
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Deductions from AGI: Itemized Deductions (cont’d)
Taxes.
Individuals may deduct itemized deductions payments for the following taxes:
• State, local, and foreign income taxes.
• State and local real estate taxes on property held for personal or investment purposes.
• State and local personal property taxes that are assessed on the value of the specific
property.
Sales tax deduction.
• State and local sales taxes can be deducted in lieu of state and local income taxes.
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Deductions from AGI: Itemized Deductions (cont’d)
Taxes (continued).
The One Big Beautiful Bill Act of 2025 (OBBB) limits the total itemized deduction for
state and local taxes to $40,000 ($20,000 for a taxpayer filing married separate).
• The itemized deduction for foreign income taxes is not subject to this limit.
• The $40,000 state and local tax deduction cap ($20,000 for a taxpayer filing married
separate) is reduced by 30 percent of the excess of the taxpayer's modified AGI over the
phase-out threshold ($500,000 in 2025; $250,000 for a taxpayer filing married separate in
2025).
• However, the cap is not reduced below $10,000 ($5,000 for a taxpayer filing married
separate), so everyone gets at least a $10,000 deduction.
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Deductions from AGI: Itemized Deductions (cont’d)
Interest.
Two itemized deductions for interest expense.
• Deduction of investment interest is limited to a taxpayer’s net investment
income.
• Any investment interest in excess of the net investment income limitation
carries forward to the subsequent year.
Home mortgage interest.
• Interest on acquisition indebtedness of $1 million if incurred before
December 16, 2017.
• Interest on acquisition indebtedness of $750,000 if incurred after December
15, 2017.
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Deductions from AGI: Itemized Deductions (cont’d)
Charitable Contributions.
Contribution of money or property must be made to a qualified domestic
charity.
Special rules apply to charitable contributions of certain types of property:
• Capital gain property.
• Ordinary income property.
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Deductions from AGI: Itemized Deductions (cont’d)
Exhibit 6-9 Summary of Charitable Contribution Limitation Rules.
Public Charity and Private
Operating Foundation
Private Nonoperating
Foundation
Amount
Cash amount
Cash amount
AGI limit
60%
30%
Amount
FMV
Basis*
AGI limit
30%
20%
Amount
Lesser of basis or F MV
Lesser of basis or F MV
AGI limit
50%
30%
Contribution Type
Cash:
Capital gain property:
Ordinary income property:
• *FMV if the stock is publicly traded [IRC §170(e)(5)].
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Deductions from AGI: Itemized Deductions (cont’d)
• Charitable Contribution Deduction Limitations.
• Apply the AGI limitations in the following sequence:
• Step 1: Determine limitation for the 60 percent contributions, if
applicable.
• Step 2: Apply limitation to 50 percent contributions, which is
AGI × 50% minus the contributions subject to the 60 percent limit.
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Deductions from AGI: Itemized Deductions (cont’d)
• Step 3: Apply limitation to 30 percent contributions, which is the lesser of
(a) AGI × 30% or (b) AGI × 50% minus the contributions subject to the
50 percent limit and the contributions subject to the 60 percent limit.
• Step 4: Apply limitation to the 20 percent contributions, which is the lesser
of (a) AGI × 20%, (b) AGI × 30% minus the contributions subject to 30
percent limit, or (c) AGI × 50% minus the contributions subject to the 50
percent limit, the contributions subject to the 60 percent limit, and the
contributions subject to the 30 percent limit.
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Deductions from AGI: Itemized Deductions (cont’d)
Other Itemized Deductions.
• Not deductible: unreimbursed employee business
expenses, tax preparation fees, investment expenses, and
hobby expenses.
• Deductible: gambling losses and expenses to the extent
of gambling income, casualty and theft losses on
investment property, and unrecovered cost of a life
annuity at death.
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The Standard Deduction
(which is a deduction from AGI)
The Standard Deduction
Exhibit 6-11 Standard Deduction Amounts*
2025 Amounts
Filing Status
Basic Standard
Deduction
Additional Standard Deduction
for Age and/or Blindness at
End of Year
Married filing jointly/
Qualifying surviving spouse
$31,500
$1,600
Head of household
23,625
2,000
Single
15,750
2,000
Married filing separately
15,750
1,600
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The Standard Deduction (cont’d)
*For individuals claimed as a dependent on another return,
the 2025 standard deduction is the greater of (1) $1,350 or
(2) $450 plus earned income not to exceed the standard
deduction amount of those who are not dependents.
34
Standard Deductions (cont’d)
Bunching Itemized Deductions.
Tax benefit can be gained by implementing simple timing tax planning
strategy.
• For taxpayers with itemized deductions that fall just short of the standard
deduction amount and thus do not produce any tax benefit.
The basic strategy consists of shifting itemized deductions into one year such
that the amount of itemized deductions exceeds the standard deduction for
the year and then deducting the standard deduction in the next year (or vice
versa).
35
Other Deductions from AGI
Deduction for Qualified Business Income
• Deduction is limited to qualified trade or business.
• Excludes specified service trade or business (except for
taxpayers with taxable income below $197,300; $394,600
joint returns; $197,300 married filing separately).
• Deduction is subject to wage limitation and taxable income
limitation.
36
Other Deductions from AGI (cont’d)
Deduction for Qualified Tip Income.
• Enacted with OBBA.
• Taxpayers can deduct up to $25,000 of qualified tips.
• Subject to phase-out for taxpayers with modified AGI above
$150,000 ($300,000 married filing joint).
37
Other Deductions from AGI (cont’d)
Deduction for Qualified Overtime Compensation.
• Enacted with OBBA.
• Taxpayers can deduct up to $12,500 ($25,000 for married
filing joint) of qualified overtime compensation.
• Subject to phase-out for taxpayers with modified AGI above
$150,000 ($300,000 married filing joint).
38
Other Deductions from AGI (cont’d)
Deduction for Qualified Car Loan Interest.
• Enacted with OBBA.
• Taxpayers can deduct up to $10,000 of qualified car loan
interest.
• Subject to phase-out for taxpayers with modified AGI above
$100,000 ($200,000 married filing joint).
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Other Deductions from AGI (cont’d)
Deduction for Seniors.
• Enacted with OBBA.
• Taxpayers age 65 or older can claim a $6,000 deduction (and
a $6,000 deduction for their spouse age 65 or older).
• Subject to phase-out for taxpayers with modified AGI above
$75,000 ($150,000 married filing joint).
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Discussion