When preparing your federal tax return, you’re bound to come across the term “adjusted gross income.” The official IRS “ Tax Guide for Individuals 2016 ” uses the term 69 times.

So what is adjusted gross income? The official IRS definition isn’t much help: “Adjusted Gross Income is defined as gross income minus adjustments to income.” Okay, great, but what does that mean?

Have no fear. In today’s post, we’ll break down each part of the IRS’ definition. By the end, you’ll have a comprehensive understanding of what adjusted gross income is and how it can help you save money on your taxes.

What Is Gross Income?

Before we can understand adjusted gross income, we need to understand gross income. The IRS defines gross income as “all income from whatever source derived.” That is, any kind of income that fits into the following categories (not just cash received):

Wages (this includes tips and fees for services performed)

Interest received. This even applies to interest earned on your checking or savings account (assuming it exceeds $10 in a year). If this is the case, your financial institution will notify you and send you a Form 1099-INT .

(assuming it exceeds $10 in a year). If this is the case, your financial institution will notify you and send you a . Dividends

Gross profit from selling inventory

Gains on the sale of property

“Rents and royalties from use of tangible or intangible property”

Alimony

“Pensions, annuities, and income from life insurance or endowment contracts”

“Distributive share of partnership income or pro rata share of income of an S corporation.”

State and local income tax refunds

Any other income. Yes, this includes income from illegal activities (the most famous case of this led to Al Capone’s arrest and conviction for tax evasion )

Of course, there are exceptions. Some common forms of income excluded from gross income include the following:

Gifts and inheritances

Interest earned on state and municipal bonds

Life insurance proceeds

401(k) contributions

Scholarships

There are many others, as well as exceptions to those we listed above. For more information, consult “ Exclusions from gross income: U.S. Federal income tax law ” (this gives a clear summary) or 26 U.S. Code Part III – ITEMS SPECIFICALLY EXCLUDED FROM GROSS INCOME (for the full, detailed version). Tax preparation software will walk you through determining what portions of your income are exempt.

Now that we have an understanding of gross income, let’s cover the next part of the IRS definition: adjustments to income.

What Are Adjustments to Income?

Once you’ve figured out your gross income (your income excluding any allowable exemptions), you’re ready to calculate your adjusted gross income. The IRS determines your adjusted gross income by subtracting the “adjustments” it allows.

One advantage of adjustments is that, unlike other types of tax deductions , you’re not required to itemize them. This allows you to claim them in addition to the standard deduction, reducing the complexity of your tax preparation while also saving you additional money.

You’ll also sometimes see these referred to as “above-the-line deductions,” since you calculate them before “below-the-line deductions.” Your adjusted gross income is “the line.” We’ve illustrated this in the following image of a 2016 Form 1040 :

Here are the available adjustments as of this writing:

1. Educator expenses

The IRS allows you to deduct up to $250 of “unreimbursed trade or business expense” if you’re an “eligible educator.” Qualifying expenses include the following:

Professional development courses

Books

Supplies

Computer equipment (including related software and services)

Other equipment

Supplementary materials that you use in the classroom

2. Certain business expenses of reservists, performing artists, and fee-basis government officials

You report these on Form 2106 . For more information, see Publication 529 (2016), Miscellaneous Deductions .

3. Health savings account deduction

Money that you contribute to a health savings account qualifies as a tax deduction. Report your contributions to this account on Form 8889 . For more information, consult Publication 969 (2016), Health Savings Accounts and Other Tax-Favored Health Plans .

4. Moving expenses

If you move because you changed your job or business location or because you started a new business, your expenses may be tax-deductible. That is, provided they pass the following three criteria:

Your move closely relates to the start of work. To meet this criterion, you must have incurred the moving expenses within “one year from the date you first reported to work at the new location.” Also, “the distance from your new home to the new job location” must not be “more than the distance from your former home to the new job location.” This is to make sure that you are in fact moving to a new home as part of your new job.

To meet this criterion, you must have incurred the moving expenses within “one year from the date you first reported to work at the new location.” Also, “the distance from your new home to the new job location” must not be “more than the distance from your former home to the new job location.” This is to make sure that you are in fact moving to a new home as part of your new job. You meet the distance test. The IRS explains that “Your new workplace must be at least 50 miles farther from your old home than your old job location was from your old home. If you had no previous workplace, your new job location must be at least 50 miles from your old home.”

The IRS explains that “Your new workplace must be at least 50 miles farther from your old home than your old job location was from your old home. If you had no previous workplace, your new job location must be at least 50 miles from your old home.” You meet the time test. “If you’re an employee, you must work full-time for at least 39 weeks during the first 12 months immediately following your arrival in the general area of your new job location. If you’re self-employed, you must work full time for at least 39 weeks during the first 12 months and for a total of at least 78 weeks during the first 24 months immediately following your arrival in the general area of your new work location.”

“If you’re an employee, you must work full-time for at least 39 weeks during the first 12 months immediately following your arrival in the general area of your new job location. If you’re self-employed, you must work full time for at least 39 weeks during the first 12 months and for a total of at least 78 weeks during the first 24 months immediately following your arrival in the general area of your new work location.” For more information on the moving expenses deduction (including exceptions), see Publication 521 .

. Report moving expenses on Form 3903 .

5. Deductible part of self-employment tax

If you’re self-employed (meaning that your net earnings from self-employment income were $400 or more), the IRS allows you to deduct the “employer-equivalent portion of your self-employment tax in figuring your adjusted gross income.”

For a refresher, the self-employment tax consists of the 12.4% social security tax and 2.9% Medicare tax that your employer would be responsible for paying if you weren’t self-employed.

You’re allowed to deduct 50% of your total self-employment tax from your gross income. You calculate this amount (along with your self-employment tax) using the Schedule SE .

This number can be tricky to calculate on its own (since there are so many business-specific tax deductions available). We recommend using tax preparation software to ensure this number is correct.

6. Self-employed SEP, SIMPLE, and qualified plans

Provided that you are a sole proprietor or a working partner in a partnership or limited liability company , you may deduct the amount of money you contributed toward a self-employed SEP (Simplified Employee Pension) or a SIMPLE IRA (Savings Incentive Match PLan for Employees).

So how much can you deduct ? US tax law places a total limit on the amount of annual compensation that you can use to calculate retirement account contributions. For 2018, this amount is $275,000 ($270,000 for 2017). This number changes each year .

In addition to this total limit, your specific plan also has limits on annual contributions. For a SEP, the limit is either 25% of the employee’s compensation or $55,000 for 2018 ($54,000 for 2017), whichever number is less.

For a SIMPLE IRA, the contribution limit is $12,500 (for 2015-2018).

7. Self-employed health insurance deduction

If you’re self-employed and receive no other health insurance, you are allowed to deduct 100% of the amount paid for medical and dental insurance and qualified long-term care insurance for yourself, your spouse, and your dependents.

Note that your business must have earned a net profit in the year for which you are filing taxes in order for you to qualify for this deduction.

8. Penalty on early withdrawal of savings

If you withdraw the money from a Certificate of Deposit (CD) before it reaches maturity, the financial institution in charge of the CD may charge you a penalty.

If so, this penalty will appear on the Form 1099-INT that the financial institution will send to you come tax time. You are allowed to deduct 100% of this penalty from your gross income.

Note that this deduction does not apply to the 10% penalty incurred when you make a withdrawal from your IRA.

9. Alimony paid

If you’re divorced or separated and required to pay alimony to or for your spouse or former spouse, the IRS allows you to deduct the amount paid from your gross income.

Note that you must include the alimony recipient’s Social Security Number in the appropriate line of Form 1040.

10. IRA deduction

In certain cases, you can deduct contributions that you make to an IRA.

To start, contributions to a Roth IRA are not tax deductible. From there, your possible deductions depend on if you (or your spouse) are covered by a retirement plan at work, as well as your modified adjusted gross income .

Assuming you’re filing Form 1040, your modified adjusted gross income (MAGI) is your adjusted gross income without taking into account the following deductions:

IRA deduction

Student loan interest deduction

Tuition and fees deduction

Domestic production activities deduction

Foreign earned income exclusion

Foreign housing exclusion or deduction

Exclusion of qualified savings bond interest shown on Form 8815

Exclusion of employer-provided adoption benefits shown on Form 8839

If you’re covered by a retirement plan at work, then consult this table to determine how much you can deduct. If you are NOT covered by a retirement plan at work, consult this table .

11. Student loan interest deduction

If you paid interest on student loans during the past year, you can deduct the amount you paid up to $2,500. This includes loans to pay for your own higher education, as well as higher education for your spouse and your dependents.

For further information on whether or not your expenses qualify, consult Publication 970 (2016), Tax Benefits for Education .

12. Tuition and fees

In addition to interest on student loans, you can also deduct up to $4,000 of tuition and fees paid toward higher education for you, your spouse, or your dependents in the previous tax year.

There are several exceptions, however, which include the following:

Your filing status is married filing separately

Another person can claim an exemption for you as a dependent on his or her tax return

Your modified adjusted gross income (MAGI) is more than $80,000 ($160,000 if filing a joint return)

You were a nonresident alien for any part of the year and did not elect to be treated as a resident alien for tax purposes

An education credit is claimed for expenses of the student for whom the qualified education expenses were paid.

To calculate your deduction for tuition and fees, use Form 8917 (which you should also include alongside your Form 1040 when you file).

13. Domestic production activities deduction

This deduction is less likely to apply to you than the others we’ve listed. The purpose of this deduction is to encourage production of goods (or certain services) in the United States as opposed to overseas.

If you qualify, then the IRS lets you deduct 9% of the income you receive from such domestic production activities. These include domestic construction projects, domestic film and software production, and the manufacture of goods. For a full list of qualified activities, see the instructions for Form 8903 .

Adjust to Adjustments

Understanding adjusted gross income can allow you to save lots on your taxes. Some of the calculations required take some extra work, but it’s worth it for the potential savings. To make your life easier and ensure that you receive every deduction for which you’re eligible, we recommend using tax preparation software.

To save you the work of comparing each and every program on the market, we’ve put together reviews of the best tax software on the market. Currently, our list includes reviews of FreeTaxUSA , H&R Block , TurboTax , and TaxAct .