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§ 2.5 DEDUCTIONS• Health savings accounts• Higher education expenses• Interest on education loans• Moving expensesMaking adjustments to gross income by deducting certain amounts to arrive atadjusted gross income is the third step in computing and determining tax onincome.The reason for the concept of adjusted gross income is to provide a fair basisfor the allowance of noneconomic personal expense deductions. Thus, adjustedgross income is gross income after adjusting for the taxpayer’s economic costs ofgenerating revenue.§ 2.5 DEDUCTIONSDeductions are expense items incurred in the production of gross income that areallowed to be subtracted (deducted) from gross income to arrive at adjustedgross income.(a) Business Expense DeductionsDeductions are a reflection of the fact that there are inherent costs associatedwith the production of income, and that these costs are neither uniform norequally borne by all taxpayers. Equal amounts of gross income (revenue) mayhave different costs of production (expense). Therefore, to arrive at a fair base onwhich to impose an income tax, deductions are allowed to cover the costs associatedwith the production of a given amount of income. As a result of the businessdeductions allowed by the federal tax law, income tax is imposed on the neteconomic gain, not the total gross gain.For example, assume two taxpayers have received equal amounts of grossincome and have equal adjustments. Each taxpayer is an air courier company.They each have a gross income of $1 million, representing its revenue for the year.Taxpayer A has a fleet of modern, fuel-efficient planes. During the year, TaxpayerA burned $10,000 of fuel. The fuel expense is a cost of doing business and is adeduction from gross income. The adjusted gross income of Taxpayer A for theyear (aside from other deductions) thus is $990,000. Taxpayer B, however, has afleet of old, inefficient, fuel-hungry planes. During the same year, Taxpayer Bburned $40,000 of fuel. The comparable adjusted gross income of Taxpayer B forthe year is $960,000. Although each taxpayer has generated the same amount ofgross revenue for the year, each had different costs of doing business in earning therevenue. Therefore, to arrive at a fair base on which to tax the income of each taxpayer,deductions are allowed to cover the differing costs of generating revenue.Deductions against income are allowed for costs associated with profit-seeking(business or investment) activities that generate income. Personal, living, orfamily expenses are not profit-seeking expenses and are not allowed as businessexpense deductions. 7 Furthermore, business expense deductions are generally7 IRC § 262. 31