Adjusted gross income (AGI) is a measure of your total income before taxes. It is calculated by subtracting certain “above-the-line” deductions from your gross income. These deductions include things like student loan interest, charitable contributions, and moving expenses.
AGI is important because it is used to determine your tax liability. The higher your AGI, the more taxes you will owe. AGI is also used to determine your eligibility for certain tax benefits, such as the Earned Income Tax Credit and the Child Tax Credit.
Here are some examples of how AGI is calculated:
- Gross income: This is your total income from all sources, including wages, salaries, interest, dividends, capital gains, and retirement benefits.
- Above-the-line deductions: These are certain deductions that can be taken from your gross income before taxes are calculated.
- Adjusted gross income: This is your gross income minus your above-the-line deductions.
- Taxable income: This is your adjusted gross income minus your deductions and exemptions.
Here are some examples of how AGI can affect your tax liability:
- Tax brackets: The tax brackets are based on your taxable income. The higher your taxable income, the higher your tax rate.
- Tax credits: Tax credits can reduce your tax liability dollar for dollar. The more AGI you have, the less likely you are to qualify for certain tax credits.
Here are some examples of how AGI can affect your eligibility for tax benefits:
- Earned Income Tax Credit: The Earned Income Tax Credit is a refundable tax credit for low- and moderate-income working individuals and families. The amount of the credit you can claim is based on your AGI and your filing status.
- Child Tax Credit: The Child Tax Credit is a non-refundable tax credit for qualifying children. The amount of the credit you can claim is based on the number of qualifying children you have and your filing status.
I hope this explanation is clear and concise. Please let me know if you have any other questions.
Key Takeaways
- Your adjusted gross income (AGI) is your taxable income after subtracting deductions from your gross income.
- AGI is used to determine any deductions and credits you might qualify for and, ultimately, how much in taxes you will have to pay.
- Your AGI is calculated before you take itemized or standard deductions.
How Adjusted Gross Income Works
When filing your taxes, your adjusted gross income is your gross income minus any adjustments. AGI is used in many tax calculations and thresholds—like credits and deductions— which is important because the lower your AGI, the less tax liability you’ll have.
To find AGI, after you have added up your full taxable income (gross income), you can take several “above-the-line” deductions to lower that taxable amount. These are called “above the line” because they apply whether you itemize your deductions or take the standard deduction. The standard deduction is an amount that the IRS sets each year that you can deduct from your taxable income, meaning a portion of your income isn’t taxed, lowering your tax bill.
In other words, if you had specific expenses or saved money to a qualified account, the IRS allows you to deduct the amounts from your gross income to produce your adjusted gross income (AGI). These deductions are also called “adjustments to income,” and they’re calculated on IRS Schedule 1.
Example of Adjusted Gross Income
Let’s say you are a school teacher who earned $40,000 in gross income from your salary. However, during the year, you purchased $2,000 worth of classroom supplies. You also contributed $1,500 to your individual retirement account (IRA).
Educator expenses and IRA contributions qualify as a deduction to your taxable income, meaning they can be deducted as an expense. As a result, your AGI would be calculated as follows:
- $40,000 gross income – $2,000 in educator supplies – $1,500 IRA contribution
- AGI = $36,500
Using adjustments to your gross income—commonly called deductions—allows you to lower how much of your income is taxed, potentially resulting in a tax refund.
Note
Adjustments to income are deducted from your gross income. Itemized or standard deductions are then deducted from your AGI to arrive at your final taxable income.
Types of Adjustments to Income
Your AGI is calculated on the first page of your U.S. federal tax return (Form 1040) using information from Schedule 1. Calculating AGI is an important first step because it serves as the foundation for determining the deduction and credits for which you may qualify and the income tax you owe. To determine your AGI, start with your gross income and subtract qualifying items to reduce the amount. Common items can include:
- Educator expenses, such as supplies paid for by teachers
- Moving expenses for members of the armed forces
- Health savings account deduction
- Student loan interest
- Contributions to certain retirement accounts
- SEP-IRA, SIMPLE IRA, and 401(k) deductions for the self-employed
- Penalties from financial institutions for early withdrawal of savings
- Alimony payments
If you’re doing your own taxes, tax software can automatically calculate your AGI. The use of tax software can help avoid mathematical errors since it will perform the tax calculations as it walks you through the tax interview. Otherwise, if you don’t understand the difference between AGI and gross income or how to calculate it, you may pay more than you should in income taxes.
Adjusted Gross Income vs. Gross Income
Before you calculate your adjusted gross income, you must determine your gross income—the total income on Form 1040—that you earned for the tax year in which you’re filing. Gross income includes all money you have made on your paychecks before payroll taxes. However, it isn’t limited to your paycheck—it includes money you earn from other sources, too.
Gross income can include other employment earnings in addition to salaries (bonuses, for example), as well as interest and dividends, long- and short-term capital gains and losses, interest, dividends, alimony, pensions and annuities, rental property income, royalties, and any revenue derived from operating a business.
Also, if you sold any items on eBay, Craigslist, or another online store, you have gained income from profits by selling goods. Gross income also includes net gains on the disposal of assets, such as selling a home or car, or any money obtained through self-employment, consulting, side jobs, and other sources of income. All of these income sources are accounted for on the first few lines of Form 1040 and Part I of Schedule 1.
Note
It’s important not to confuse gross income with net income. Net income refers to take-home pay or the amount of money earned after payroll withholding, such as state and federal income taxes, Social Security taxes, and pretax benefits like health insurance premiums.
The list of items that contribute to your total gross income is extensive, and you may need help determining what’s considered income for this purpose. Tax software will help you identify all earnings that need to be reported to the government by asking questions in the tax interview, or you can ask an accountant for advice.
Frequently Asked Questions (FAQs)
Here are some frequently asked questions about adjusted gross income (AGI):
What is AGI?
AGI is the total amount of income you have from all sources, minus certain deductions. It is used to determine your eligibility for certain tax credits and deductions, and it also affects the amount of taxes you owe.
What are some of the deductions that can be subtracted from AGI?
Some of the deductions that can be subtracted from AGI include:
- Medical expenses
- State and local taxes
- Mortgage interest
- Charitable contributions
- Casualty and theft losses
- Moving expenses
- Educator expenses
- Retirement savings contributions
What are some of the tax credits that can be claimed based on AGI?
Some of the tax credits that can be claimed based on AGI include:
- The Earned Income Tax Credit (EITC)
- The Child Tax Credit
- The American Opportunity Tax Credit
- The Lifetime Learning Credit
How do I find my AGI?
Your AGI will be listed on your Form 1040, line 8. If you filed your taxes electronically, you can also find your AGI on your tax transcript.
What are some of the things that can affect my AGI?
Your AGI can be affected by a number of things, including:
- Your income from all sources
- Your deductions
- Your tax credits
- The filing status you choose
What are some of the things I can do to reduce my AGI?
There are a number of things you can do to reduce your AGI, including:
- Make sure you are taking all of the deductions and credits you are eligible for
- Contribute to retirement savings plans
- Make sure you are claiming all of your dependents
- Choose the right filing status
What are some of the things I should keep in mind about AGI?
AGI is an important number for a number of reasons. It is used to determine your eligibility for certain tax credits and deductions, and it also affects the amount of taxes you owe. It is important to understand how AGI is calculated and what factors can affect it so that you can minimize your tax liability.
