Adjusted Gross Income

What Is Adjusted Gross Income and Why Does It Matter?

If you are a taxpayer in the United States, you may have heard of the term adjusted gross income, or AGI, and wondered what it means and how it affects your taxes. In this article, we will explain what AGI is, how to calculate it, and why it matters for your tax situation.

What Is Adjusted Gross Income?

Adjusted gross income is the figure that the Internal Revenue Service (IRS) uses to determine your income tax liability for the year. It is calculated by subtracting certain adjustments from gross income, such as business expenses, student loan interest payments, and other expenses. After calculating your AGI, the next step is to subtract deductions to determine your taxable income. The IRS also uses other income metrics, such as modified AGI (MAGI), for specific programs and retirement accounts.

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Gross income includes all the money you earned in a year, such as wages, salaries, tips, dividends, interest, capital gains, rental income, alimony, retirement distributions, and other sources of income. Some income is not included as gross income, such as income from tax-exempt bonds, gifts, inheritances, and certain benefits.

Adjustments to income are expenses that you can deduct from your gross income to lower your AGI. Some of the most common adjustments are:

• Educator expenses: If you are a teacher or educator, you can deduct up to $250 of unreimbursed expenses for classroom supplies.
• Student loan interest: If you paid interest on a qualified student loan, you can deduct up to $2,500 of interest paid.
• Alimony payments: If you paid alimony to a former spouse under a divorce or separation agreement executed before 2019, you can deduct the amount of alimony paid.
• Health savings account (HSA) contributions: If you have a high-deductible health plan and contribute to an HSA, you can deduct your contributions up to the annual limit.
• Self-employed health insurance: If you are self-employed and pay for your own health insurance premiums, you can deduct the cost of your premiums.
• Self-employment tax: If you are self-employed and pay Social Security and Medicare taxes on your net earnings, you can deduct half of the tax amount.
• Retirement plan contributions: If you contribute to a traditional IRA or a qualified retirement plan, such as a 401(k) or 403(b), you can deduct your contributions up to the annual limit.
• Moving expenses: If you moved for work-related reasons and meet certain requirements, you can deduct your moving expenses. This deduction is only available for members of the armed forces.

These are some of the most common adjustments to income, but there are others that may apply to your situation. You can find a complete list of adjustments on Schedule 1 of Form 1040.

How to Calculate Adjusted Gross Income

To calculate your adjusted gross income, you need to add up all your sources of gross income and subtract all your eligible adjustments. You can use the following formula:

AGI = Gross income – Adjustments to income

For example, suppose you have the following sources of income and adjustments for the year:

• Wages: $50,000
• Interest: $500
• Dividends: $1,000
• Capital gains: $2,000
• Rental income: $10,000
• IRA distribution: $5,000
• Student loan interest: $1,500
• HSA contribution: $3,000
• IRA contribution: $6,000

Your gross income would be:

Gross income = Wages + Interest + Dividends + Capital gains + Rental income + IRA distribution

Gross income = $50,000 + $500 + $1,000 + $2,000 + $10,000 + $5,000

Gross income = $68,500

Your adjustments to income would be:

Adjustments to income = Student loan interest + HSA contribution + IRA contribution

Adjustments to income = $1,500 + $3,000 + $6,000

Adjustments to income = $10,500

Your adjusted gross income would be:

AGI = Gross income – Adjustments to income

AGI = $68,500 – $10,500

AGI = $58,000

Why Does Adjusted Gross Income Matter?

Adjusted gross income matters because it affects how much tax you owe and what tax benefits you qualify for. Here are some ways that AGI impacts your taxes:

• Tax brackets and rates: Your AGI determines which tax bracket and rate apply to your taxable income. The higher your AGI, the higher your tax bracket and rate may be.
• Standard deduction and itemized deductions: Your AGI affects how much of the standard deduction or itemized deductions you can claim. The standard deduction is a fixed amount that reduces your taxable income based on your filing status. Itemized deductions are expenses that you can deduct from your AGI, such as mortgage interest, state and local taxes, charitable contributions, and medical expenses. However, some itemized deductions are subject to limitations based on your AGI. For example, you can only deduct medical expenses that exceed 7.5% of your AGI.
• Tax credits: Your AGI affects your eligibility and amount of certain tax credits, which are direct reductions of your tax liability. Some tax credits are refundable, meaning that they can result in a tax refund if they exceed your tax liability. Some tax credits are nonrefundable, meaning that they can only reduce your tax liability to zero. Some of the most common tax credits are the child tax credit, the earned income tax credit, the American opportunity tax credit, and the lifetime learning credit. However, some of these credits have income limits or phaseouts based on your AGI.
• Other tax benefits: Your AGI affects your eligibility and amount of other tax benefits, such as the student loan interest deduction, the tuition and fees deduction, the deduction for IRA contributions, and the exclusion for employer-provided educational assistance. These benefits have income limits or phaseouts based on your AGI.

As you can see, adjusted gross income is an important figure that influences many aspects of your taxes. By understanding what AGI is, how to calculate it, and why it matters, you can better plan your finances and optimize your tax situation.

Itemized deductions are tax deductions that you take for various expenses you incurred during the tax year. They can sometimes exceed the standard deduction, meaning that itemizing on your tax return can lower your taxable income and save you money on taxes. However, not all expenses are deductible, and some deductions are subject to limitations or phaseouts based on your income level.

Some of the most common itemized deductions are:

• Medical and dental expenses: You can deduct the amount of your medical and dental expenses that exceed 7.5% of your adjusted gross income (AGI). This includes payments for the diagnosis, cure, mitigation, treatment, or prevention of disease, as well as payments for insurance premiums, prescription drugs, and medical equipment¹.
• State and local taxes: You can deduct the amount of state and local income taxes or sales taxes that you paid during the tax year, as well as the amount of real estate taxes and personal property taxes that you paid on your home, car, boat, etc. However, the total deduction for state and local taxes is limited to $10,000 ($5,000 if married filing separately)¹.
• Mortgage interest: You can deduct the amount of interest that you paid on a mortgage loan secured by your main home or a second home, as long as the loan was used to buy, build, or improve the home. The deduction is limited to interest paid on up to $750,000 ($375,000 if married filing separately) of mortgage debt incurred after December 15, 2017. For mortgages taken out before that date, the limit is $1 million ($500,000 if married filing separately)¹.
• Charitable contributions: You can deduct the amount of money or property that you donated to qualified charitable organizations during the tax year. The deduction is limited to 60% of your AGI for cash donations and 30% of your AGI for noncash donations. You must have a written acknowledgment from the charity for any donation of $250 or more¹.
• Casualty and theft losses: You can deduct the amount of losses that you suffered from a fire, storm, flood, earthquake, theft, or other casualty event that affected your personal property. However, the deduction is only available for losses that occurred in a federally declared disaster area and that exceed 10% of your AGI plus $100 per event¹.
• Miscellaneous expenses: You can deduct certain miscellaneous expenses that are not subject to the 2% of AGI floor that applied before 2018. These include gambling losses (up to the amount of gambling winnings), unreimbursed employee expenses related to certain occupations (such as performing artists, reservists, and fee-basis government officials), and impairment-related work expenses for disabled taxpayers¹.

To claim itemized deductions, you need to file Schedule A with your Form 1040 and list all your deductible expenses in the appropriate categories. You also need to keep records and receipts of your expenses in case the IRS audits your return.

Itemizing deductions may be beneficial for you if your total deductions are more than the standard deduction for your filing status. However, you should also consider other factors that may affect your tax situation, such as your eligibility for tax credits and other tax benefits. You may want to compare both methods and choose the one that results in the lowest tax liability for you.

Tags: Adjusted | Gross | Gross Income | Income