Adjusted Gross Income ( AGI ) is a calculation made from your gross income and is used to determine how much of your income is taxable. It is the starting point for calculating a taxpayer’s tax burden in the United States. Among other things, it is also the basis for many deductions and credits. When filing your taxes online, as about 90% of taxpayers do, the software you use will calculate your AGI. Read on to learn more about what AGI is.
What is AGI
- Adjusted gross income ( AGI ) is calculated from the taxpayer’s gross income.
- The AGI, which is reported on IRS Form 1040, is used to calculate an individual’s tax liability.
- AGI directly influences a taxpayer‘s eligibility to claim many of the deductions and credits available on the tax return.
How Adjusted Gross Income (AGI) Works
The A GI is a modified gross income in the United States tax code. Gross income is simply the sum of all the money you earn in a year, this can include your wages, dividends, alimony, capital gains, interest income, royalties, rental income, and retirement distributions.
AGI takes into account several allowable deductions from your gross income to reach the figure on which your income tax share will be calculated.
AGI is generally more useful than gross income for individual tax activities. Deductions that change gross income to adjusted gross income are all above the line, meaning they are taken into account before tax exemptions for military service, dependent status, etc. Those above the line are also counted before itemized deductions a taxpayer takes on Schedule A and standard deductions.
Deductions taken to figure AGI are called adjustments to income. Some of the more prominent deductions made to reach an individual’s adjusted gross income include:
- Certain retirement plan contributions, such as individual retirement accounts ( IRAs ), SIMPLE IRAs, SEP-IRAs, and qualified plans.
- Half of the self-employment tax.
- Health savings account ( HSA ) deductions.
- Alimony paid (included in the beneficiary’s gross income).
- Moving expenses (but as of 2018, only if you are an active-duty military moving on military orders).
- Losses from the sale or exchange of property.
- Penalties for early withdrawal are imposed by financial institutions.
- School tuition, fees, and student loan interest (exceptions and limits usually apply).
- Jury duty pay is paid to the declarant’s employer.
- Some business-related expenses are incurred by artists, teachers, government officials, and reservists.
Adjusted Gross Income (AGI) Calculation
When calculating AGI, start by counting your reported income for the year in question, and add other sources of taxable income as well: profits from the sale of a property, unemployment compensation, pensions, Social Security payments, and any other income not included. on your tax returns. From this earnings total, subtract any applicable deductions and payments. After subtracting these payments from your gross income, the resulting figure is your adjusted gross income, which serves as a starting point for calculating your taxable income.
After calculating AGI, you can apply standard federal tax deductions to reach your taxable income. Or, if you’re eligible, you can itemize your expenses and take itemized deductions instead, which may be better for you in some situations.
Note: As a result of the increase in the standard deduction and the $10,000 limit on deductions for SALT (state and local taxes) resulting from the passage of the Tax Cuts and Jobs Act of 2017 (TCJA), it was expected that fewer taxpayers made the breakdown of expenses when filing their returns. The projections were that 30% of all filers would go to 10%. Itemizing expenses should continue to be a useful tax reduction strategy for wealthier taxpayers.
Requirements for gross income deductions
The full list of requirements for potential gross income deductions can be found in the Internal Revenue Code (IRC) or on the Internal Revenue Service (IRS) website. Many of the requirements are very specific, so you should look very carefully at the federal tax code to make sure you’re eligible before taking any deductions.
AGI directly influences your eligibility to claim many of the deductions and credits available on your tax return. The lower the AGI, the more deductions and credits you can receive.
Example of adjusted gross income that affects deductions
Detailed Explanation of Deductions and Reporting of Dental Expenses Not Reimbursed by Insurance: You can only take a deduction for the portion of dental expenses that exceed 10% of your AGI for the tax year 2019. This means that if you report $12,000 in unreimbursed dental expenses and have an AGI of $100,000, you must reduce your deduction by $10,000, ending up with a $2,000 deduction. However, if your AGI is $50,000, the reduction is only $5,000 and you are left with a $7,000 deduction.
Adjusted Gross Income Vs. Modified Adjusted Gross Income (MAGI)
When working with individual taxes, AGI is an important step in determining how much of your gross income is taxable. Be careful not to confuse AGI with modified adjusted gross income (MAGI). MAGI further modifies the adjusted gross income figure by adding certain items, such as foreign-earned income, tax-exempt student loan interest, and costs of higher education.
The MAGI is used in the calculation of certain tax benefits, credits, and exclusions. For example, MAGI is used to determine how much of your annual IRA contributions are deductible and whether you’re eligible for premium tax credits.
Adjusted Gross Income (AGI) and IRS Form 1040
Adjusted gross income is reported on IRS Form 1040 (more formally known as the United States Individual Income Tax Return ). The form is two pages long and is used primarily to recapitulate income, deductions, and credits. More detailed information is reported in schedules 1 through 6. In many cases, additional forms and schedules are required for taxpayers who engage in certain trades and business activities or who have certain types of income or deductions.
List A is used to report itemized deductions. List B is used for interest and dividends. Schedule C is used for small business owners, such as those with business income from a sole proprietorship or those who are sole proprietors of a limited liability company (LLC). Schedule D reports capital gains and losses. For rental income, there is Schedule E, and for farms, Schedule F.
To consider
According to the IRS, “Adjusted Gross Income (AGI) is defined as gross income minus adjustments to income.” You can get a quick estimate of your AGI by looking at line 7 of the 1040 form. If you’re married filing jointly, the $69,000 AGI limitation for using the IRS free return applies to both you and your spouse together. To electronically file a federal tax return, you must verify your identity to the IRS, either with your AGI from last year’s return or with a personal identification number (PIN) you select yourself. The IRS has stopped issuing new PINs due to cyberattacks, but you can still use yours if you selected it in a previous year.
Many states in the United States base a taxpayer’s total tax bill on a calculation that begins with adjusted gross income. From there, state-specific deductions and credits are taken into account in determining an individual’s state taxable income.
