Preliminary Work and Taxpayer Data · Preliminary work to prepare tax returns

Sources of applicable exclusions and adjustments to gross income

Verification 2026 Verified
tax year · reviewed 2026-08-19 · Draft for I. Ohu review

Two different machines operate between what a taxpayer receives and what appears on the tax return, and the interview has to keep them apart. An exclusion keeps an amount out of gross income altogether, so it never appears. An adjustment is a deduction that IRC § 62(a) names, taken from gross income in arriving at adjusted gross income. Both reduce tax. Only one of them reduces adjusted gross income, and because adjusted gross income drives phase-outs, floors and credit eligibility all over the return, the difference is worth more than its size suggests.

The rule

Adjusted gross income is defined by a closed list. Adjusted gross income means gross income minus the deductions § 62(a) enumerates (IRC § 62(a)). That is the operative test for whether a deduction is “above the line”: it is above the line if and only if § 62(a) names it. The definition then feeds § 63(d), which defines itemized deductions residually as everything allowable other than the deductions taken in arriving at adjusted gross income and the items § 63(b) lists.

The list, grouped by what it actually reaches. Trade or business deductions, where the business does not consist of the taxpayer’s services as an employee (IRC § 62(a)(1)) — this is the paragraph through which a sole proprietor’s expenses arrive. Then four narrow employee categories that survived the general disallowance of employee expenses: reimbursed expenses under a reimbursement or expense allowance arrangement, qualified performing artists, fee-basis State and local officials, eligible educators, and reserve component members more than 100 miles from home (IRC § 62(a)(2)(A)–(E)). Then losses from sale or exchange of property; deductions attributable to rents and royalties; depreciation and depletion of life tenants and income beneficiaries; the § 404 deduction for a self-employed individual’s plan; § 219 retirement savings; forfeited early-withdrawal penalties; § 194 reforestation; repaid supplemental unemployment benefits; jury pay remitted to an employer; § 217 moving expenses; the § 220 Archer MSA deduction; § 221 education loan interest; the § 223 health savings account deduction; and attorney fees in discrimination and whistleblower matters (IRC § 62(a)(3)–(21)).

The gaps in the numbering are the history. Paragraphs (8), (10), (14) and (18) are repealed, and one of them matters: (10) was the deduction for alimony paid, repealed by Pub. L. 115-97 § 11051(b)(2)(A). For an instrument executed after 2018 there is neither an inclusion by the recipient nor a deduction by the payer.

Two important adjustments are not named in § 62(a) at all, and reach the same place by a different route. One-half of the taxes imposed by § 1401, other than the § 1401(b)(2) additional Medicare tax, is allowed as a deduction, and § 164(f)(2) directs that it be treated as attributable to a trade or business — so it arrives through § 62(a)(1). Self-employed health insurance is likewise a § 162 deduction (IRC § 162(l)(1)) and arrives the same way.

Self-employed health insurance has two gates worth knowing exactly. The deduction covers insurance constituting medical care for the taxpayer, spouse, dependents, and any child of the taxpayer who has not attained age 27 by the end of the year (IRC § 162(l)(1)(A)–(D)). It cannot exceed the taxpayer’s earned income from the trade or business with respect to which the plan is established (IRC § 162(l)(2)(A)). And it is unavailable for any calendar month in which the taxpayer is eligible to participate in a subsidized health plan maintained by an employer of the taxpayer, the spouse, a dependent, or that under-27 child (IRC § 162(l)(2)(B)). Eligibility defeats it; actual participation is not required.

Moving expenses are suspended, and now permanently. Section 217 does not apply to any taxable year beginning after 31 December 2017 except for an individual to whom § 217(g) applies — a member of the Armed Forces on active duty moving pursuant to a military order and incident to a permanent change of station (IRC § 217(k)(1)). A new paragraph treats an employee or new appointee of the intelligence community who moves pursuant to a change in assignment requiring relocation in the same way (IRC § 217(k)(2)).

On the exclusion side, the interview must reach the foreign earned income and housing cost exclusions for a qualifying individual abroad (IRC § 911(a), (c)), employer health coverage, cafeteria plan salary reductions, educational assistance, dependent care assistance and qualified fringe benefits. The two mechanisms can collide: the educator deduction is allowed only to the extent expenses exceed the amounts excludable for the same items (IRC § 62(d)(2)).

Current figures

Item	2026
Foreign earned income exclusion	$132,900 of foreign earned income^TY2026
Foreign housing cost amount	housing expenses above 16 percent of the exclusion amount, capped at 30 percent of it, both computed on a daily basis over the qualifying period^TY2026
IRA deduction limit	$7,500, plus a further $1,100 for an individual who has attained age 50 before the close of the taxable year^TY2026
IRA active-participant phase-out	$81,000 to $91,000 for a single active participant; $129,000 to $149,000 on a joint return where the contributing spouse is an active participant; $242,000 to $252,000 where only the other spouse is; and an unindexed $0 to $10,000 for a married active participant filing separately^TY2026
Health savings account contribution limit	$4,400 for self-only coverage and $8,750 for family coverage, plus an unindexed $1,000 for an individual who has attained age 55 before the close of the taxable year^TY2026
High deductible health plan definition	an annual deductible of at least $1,700 for self-only or $3,400 for family coverage, with annual out-of-pocket expenses not exceeding $8,500 or $17,000 respectively^TY2026
Education loan interest deduction	$2,500, phasing out between $85,000 and $100,000 of modified adjusted gross income, or between $175,000 and $205,000 on a joint return^TY2026
Eligible educator deduction	$350 of the expenses of an eligible educator — a kindergarten through grade 12 teacher, instructor, counselor, principal or aide for at least 900 hours in a school year^TY2026
Dependent care assistance exclusion	$7,500, or $3,750 on a separate return by a married individual, raised from $5,000 and $2,500 for taxable years beginning after 31 December 2025^TY2026
Educational assistance exclusion	$5,250, unchanged for 2026 and first indexed for taxable years beginning after 2026^TY2026

How it works in practice

Ask about the mechanisms in the order the return computes them. Exclusions mostly arrive already applied — the wage figure is net of cafeteria plan reductions, employer health premiums and dependent care assistance — so the intake question is whether anything excludable was missed. Adjustments are the opposite: nobody applies them for the taxpayer, and each carries an eligibility question the client cannot be expected to raise.

For a self-employed client, the order matters arithmetically as well as logically. Net profit determines self-employment tax; half of that tax is an adjustment; net profit less that half is the earned income figure that caps both the § 162(l) health insurance deduction and the § 404 or § 219 retirement deduction. Compute them out of order and the caps come out wrong.

The two questions most often skipped are eligibility questions rather than amount questions. For health insurance it is “were you or your spouse eligible for a subsidized employer plan in any month” — eligibility, not enrolment, and month by month. For the IRA deduction it is “were you or your spouse covered by a retirement plan at work”, because the answer selects which phase-out range applies, and the range where only the other spouse is covered is far higher than the one where the contributor is.

For a client abroad the § 911 exclusion is elective and interacts with the foreign tax credit, so it is a decision rather than a default — and the housing cost amount is not the rent paid but housing expenses above a floor, subject to a ceiling, both computed daily across the qualifying period.

The eligibility that cost the deduction

Marta is a sole proprietor and pays $9,800 for a marketplace health policy covering herself and her husband. Her husband works part time and was offered coverage by his employer, with the employer paying most of the premium. He declined it because Marta’s policy was better.

Marta gets no § 162(l) deduction for the months he was offered that coverage. IRC § 162(l)(2)(B) denies the deduction for any calendar month in which the taxpayer is eligible to participate in a subsidized health plan maintained by an employer of the taxpayer or of the spouse, and eligibility is the test — declining the offer does not restore the deduction.

Two follow-ups. The denial is monthly, so if the offer only ran from September the earlier months still qualify. And premiums that fail § 162(l) are not lost: they become medical expenses for the itemized deduction, subject to the adjusted gross income floor.

One spouse covered at work, the other not

Ben and Alice file jointly with modified adjusted gross income of $196,000. Alice is covered by a retirement plan at work. Ben is not, and wants to make a deductible traditional IRA contribution.

Ben’s contribution is fully deductible. Where the contributing spouse is not an active participant but the other spouse is, IRC § 219(g)(7) applies its own, much higher phase-out range, and $196,000 is below it. Had Ben been the covered spouse, the far lower joint range for an active participant would have applied and his deduction would have been eliminated entirely.

Alice’s own contribution is a separate computation on the same return, and hers is governed by the active-participant range. The same joint income produces a full deduction for one spouse and none for the other. The intake question that finds this is not about income; it is “which of you is covered at work”.

The teacher who spent more than the cap

Priya teaches grade 4, worked the whole school year, and spent $1,150 of her own money on classroom supplies. Her school reimbursed $200 of it under a plan that excluded that amount from her income.

Three layers apply. IRC § 62(d)(2) removes the reimbursed portion first: the § 62(a)(2)(D) deduction is allowed only to the extent expenses exceed amounts excludable from gross income, so her deductible base is $950. The § 62(a)(2)(D) deduction is then capped at the indexed amount, which she exceeds.

What happens to the rest changed for 2026. Educator expenses are now excluded from the definition of miscellaneous itemized deductions (IRC § 67(b)(13)), so the excess above the cap is an itemized deduction rather than a disallowed one — available to her only if she itemizes, but no longer dead.

Traps

“Above the line” has a statutory test. A deduction is an adjustment only if § 62(a) names it, or if a provision directs it to be treated as a trade or business deduction the way § 164(f)(2) does.
Alimony paid is no longer an adjustment. Former § 62(a)(10) is repealed for post-2018 instruments; a pre-2019 instrument not modified to adopt the new rule keeps the old treatment.
Self-employed health insurance turns on eligibility, month by month (IRC § 162(l)(2)(B)), not on whether the employer coverage was taken.
The § 162(l) cap is earned income from the business that established the plan (IRC § 162(l)(2)(A)), not total earned income.
One-half of self-employment tax excludes the additional Medicare tax. IRC § 164(f)(1) reaches the § 1401 taxes other than those imposed by § 1401(b)(2).
Moving expenses are suspended for civilians permanently (IRC § 217(k)(1)); only § 217(g) military moves and, now, qualifying intelligence community moves survive.
The educator deduction nets against exclusions first (IRC § 62(d)(2)).
The foreign housing cost amount is not the rent but expenses above a floor, capped by a ceiling, both derived from the exclusion amount daily (IRC § 911(c)(1), (2)).

How this has changed

Three changes made by Pub. L. 119-21, title VII, land on the 2026 return.

The dependent care assistance exclusion went up by half. Section 70404(a) substituted the new figures in IRC § 129(a)(2)(A) for the amounts that had stood since 1986, and § 70404(b) applies the change to taxable years beginning after 31 December 2025. Material giving the older amount is now wrong rather than merely dated.

Employer payment of employee student loans became permanent, and will be indexed. The exclusion in IRC § 127(c)(1)(B) had been limited to payments made before 1 January 2026; § 70412(a) struck that limitation, applying to payments made after 31 December 2025. Section 70412(b) added IRC § 127(d), which indexes the exclusion — but only for taxable years beginning after 2026, so the 2026 amount is unchanged and 2027 is the first indexed year.

The moving expense suspension became permanent and gained an exception. Section 70113(a) struck the 2026 end date from IRC § 217(k); § 70113(b) added § 217(k)(2) for the intelligence community. Anything predicting that civilian moving expenses return after 2025 is wrong.

Two older changes still catch people out. The alimony repeal removed § 62(a)(10) rather than amending it, so the numbering has a hole where study material may still show a deduction. And the § 219 phase-out ranges are re-announced annually, so any single set of figures is good for one year.

Exam focus

The examinable distinction is exclusion against adjustment against itemized deduction. Expect a question that offers a receipt and asks where it goes, and answer it by asking whether a part III section keeps it out of gross income, whether § 62(a) names a deduction for it, or neither.

Know the surviving employee categories in § 62(a)(2), and know that half of self-employment tax and self-employed health insurance are adjustments even though § 62(a) does not name them — and why.

The two gates on § 162(l) — the earned income cap and the monthly subsidized-coverage disqualification — are reliably tested, as is the § 219(g) distinction between the contributing spouse being covered and only the other spouse being covered.

Check yourself

1. A sole proprietor pays health insurance premiums of $7,000 and has net earnings from the business of $4,200 after the deduction for half of self-employment tax. How much may she deduct under IRC § 162(l)?

Answer: $4,200. IRC § 162(l)(2)(A) caps the deduction at the taxpayer’s earned income within § 401(c) derived from the trade or business with respect to which the plan is established. The remaining $2,800 is not deductible under § 162(l), though it may be a medical expense for itemized purposes.

2. Spouses file jointly. The husband is covered by a retirement plan at work; the wife is not. Are their two IRA deductions governed by the same phase-out range?

Answer: no. The husband, as an active participant, is governed by the IRC § 219(g)(3)(B)(i) joint range. The wife, who is not an active participant but is married to one, is governed by the separate and considerably higher range in IRC § 219(g)(7). The same joint income can therefore fully allow one spouse’s deduction and eliminate the other’s.

3. A civilian employee moves across the country in 2026 for a new job and pays $6,500 in moving costs, unreimbursed. What is deductible?

Answer: nothing. IRC § 217(k)(1) provides that § 217 does not apply to any taxable year beginning after 31 December 2017 except for an individual to whom § 217(g) applies, and Pub. L. 119-21 § 70113(a) struck the 2026 end date, making the suspension permanent. Only a § 217(g) military move and, under new § 217(k)(2), a qualifying intelligence community relocation are excepted.

4. Why does it matter whether an amount is excluded from gross income rather than deducted in arriving at adjusted gross income, if both reduce tax by the same amount?

Answer: because only the exclusion keeps the amount out of gross income, and a great many provisions key off gross income or adjusted gross income rather than taxable income. An adjustment reduces adjusted gross income too, so on that axis the two behave alike — the sharper contrast is with a deduction taken after adjusted gross income, such as an itemized deduction or a § 63(b) deduction, which reduces taxable income while leaving every adjusted-gross-income threshold untouched.

Change log

2026-08-19Initial draft. Records the IRC § 129(a)(2)(A) increase to the dependent care exclusion, the permanent IRC § 127(c)(1)(B) student loan payment exclusion with indexing from 2027, and the permanent IRC § 217(k) moving expense suspension with its new intelligence community exception.