What is Adjusted Gross Income?

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Definition:

Adjusted gross income is calculated by subtracting qualified expenses or certain retirement account contributions from your gross income to determine your taxable income.

🤔 Understanding adjusted gross income

Adjusted gross income (AGI) is one piece of the puzzle when it comes to your personal income taxes. You begin by reporting your gross income (all money received during the year) on your tax return. From there, the IRS allows you to subtract certain items from your gross income to get your AGI. These adjustments are called “above the line” adjustments and are different than deductions by the IRS. AGI is the number used to calculate most tax deductions or credits, so a final tax burden (tax liability) can be found.

Example

Let’s take a look at Marie Doe, whose gross income for 2018 is $65,000. She made IRA contributions of $1,000 and paid student loan interest of $500. Subtracting those two qualified items from her gross income leaves $63,500 as her adjusted gross income (AGI).

Takeaway

Adjusted gross income is similar to an expertly tailored pair of slacks. A tailor measures and adjusts the length and the side seams of the slacks so they fit. In fact, the fabric is there, just hidden. This is like your AGI, where specific monies are removed to fit the tax regulation allowances. AGI doesn't mean you made less money; it only puts some of it to the side for the purposes of tax calculations.

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How does gross income compare to adjusted gross income (AGI)?

Adjusted gross income (AGI) is comparable to gross income, like a paper snowflake is comparable to a blank piece of paper. You must cut parts of the paper to create the snowflake. Gross income is the total amount of money you’ve received before taxes and adjustments (not just income from a job). It’s like a starting point from which you must subtract amounts to reach AGI.

Each individual’s finances are different, so not every person will subtract every allowable amount from their gross income to calculate AGI. Some may only have a few (or none) of the qualified adjustments allowed by the IRS. Adjustments vary by year and may be subject to limits based on your tax filing status. A few of the most common adjustments include:

  • Half of your self-employment taxes
  • Alimony payments made
  • Contributions to tax-qualified retirement accounts (such as IRAs)

Other adjustments include:

  • Health care savings account (HSA) contributions
  • Moving expenses (for military)
  • Early withdrawal penalties
  • School tuition

What are deductions?

A deduction is the amount that can be subtracted from your adjusted gross income (AGI), thereby lowering your taxable income and the income tax owed to the IRS. The IRS can change allowed deductions yearly and can be dependent on the amount of the deduction when compared to your AGI total. For example, deductions for medical expenses must generally be at least 10% of your AGI, or they cannot be deducted from your taxable income.

The IRS sets deductions for individuals under several classifications:

  • Work-related deductions, such as mileage or home office deductions
  • Itemized deductions, such as property taxes and charitable contributions
  • Education deductions, such as teacher expenses or student loan interest
  • Health care deductions, medical expenses, and HSAs
  • Investment-related deductions, such as IRA contributions or bad debt

Some of the most common deductions are a home office, charitable contributions, gambling loss, home mortgage interest, student loan interest, and teacher expenses.

What are credits?

Similar to deductions, credits also reduce the amount of income tax owed. But there’s one key difference: Credits reduce the tax owed directly rather than your AGI. An income tax credit is an amount credited against your tax debt. If you owe fewer taxes than your tax credits, you might receive the credits as an income tax refund –- But only if they’re considered“refundable.” Nonrefundable credits cannot be received as a refund.

Tax credits are often subject to limitations on AGI totals (these vary by the tax credit in question) and may change yearly as the tax code also changes. Some of the most commonly known tax credits are:

  • Childcare: a credit to offset childcare or dependent care costs at certain income levels
  • Earned income: a credit available at certain low-income totals
  • Adoption: a credit that offsets some costs of adopting a child depending on income

How do you calculate AGI?

To figure out your adjustable gross income (AGI), you’ll need several bits of information. First, you'll need to know your gross income, which means you'll need to gather records of all your income received through the year (including your W2s). You also need to know the type of tax form you'll use to file, as some deductions may not be available later if you are filing simplified forms, such as the 1040EZ. Finally, you'll need to be up to date with the current tax code and know which adjustments to income you qualify for. For this step, an accountant or tax preparer may be helpful to consult.

Next, add up all your income to get your gross income. Then, subtract your qualified adjustments to get your AGI. If you are filing form 1040 with Schedule A, you’ll need to note that Schedule A is for itemized deductions, not adjustments to income, and will affect your taxes owed, not help you find your AGI from your gross income.

What is modified adjusted gross income (MAGI)?

At some point, you may come across the term modified adjusted gross income (MAGI). This refers to your AGI with tax-exempt interest income and some adjustments/deductions previously taken added back in. The calculation of MAGI is the starting point for figuring out if you can contribute to Roth IRAs and if you can deduct contributions to other IRAs on taxes. This number is also used to determine your eligibility or ineligibility for health plan subsidies on the Health Insurance Marketplace. What’s even more, MAGI affects some tax credit eligibility – Some credits use MAGI for determining eligibility instead of AGI. As with most figures relating to income taxes, an accountant or tax preparer may be helpful in determining your specific situation.

Some items that must be added back to AGI to reach MAGI are:

  • IRA contributions
  • Adjustments for taxable Social Security payments
  • Deductions previously taken for student loan interest/tuition
  • Previously excluded foreign income
  • Half of the self-employment taxes
  • Qualified tuition expenses
  • Rental losses
  • Previously excluded adoption expenses

How does your W2 affect AGI?

Your wage and tax statement (W2) is your statement of earnings from an employer. Your employer is required to file this form and provide a copy to you each year if you reach a certain income threshold. However, earning less than the income threshold for the form does not mean your income is tax-exempt. The W2 shows the earnings your employer reported to the IRS, along with other information needed for filing taxes. Some of the items displayed on the W2 are:

  • The taxes withheld
  • FICA (Federal Insurance Contributions Act) taxes paid by your employer (Social Security and Medicare taxes)
  • State and local income taxes paid
  • Tips, non-qualified contributions
  • Certain benefits or tax-exempt income

If you’re filing your income taxes on paper, enclose a copy of the W2 even if the IRS already received the W2 information from your employer. When filing electronically, a digital version is attached to the filing.

Your AGI is not part of form W2. However, much of the information on a W2 goes towards calculating your gross income, and sometimes your AGI. Your wages are part of the total that makes up your gross income. Some tax-exempt income may be part of what is adjusted out as part of your AGI calculations, for example.

How does your 1099 affect AGI?

Much like a W2, a 1099 is a record of income. It does not directly affect AGI but provides part of your income record. Unlike a W2, a 1099 is a record of income from a non-employer. For example, if you work as a freelancer or on a contractor basis with a company, you may receive a 1099-MISC instead of a W2. A 1099 does not have taxes withheld as you are responsible for paying payroll taxes for yourself as a self-employed person. A 1099 is not required to be sent to you if you earned under $600 for that tax year.

A 1099 has several versions, all having to do with different non-employee income:

  • The 1099-MISC is income from contract/freelance work.
  • A 1099-DIV is for banks and other financial institutions to report interest and dividends paid to you during the tax year.
  • A 1099-G shows tax refunds and other government payments.
  • 1099-R is for retirement account payout reporting.
  • 1099-C shows when you have had some amount of debt canceled as that canceled debt may be subject to income tax.

Like a W2, your AGI is not on a form 1099, but the 1099 is used to figure out your gross income. And gross income is your starting point for calculating AGI.

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