When you file your annual tax return with the IRS, one of the key figures you’ll need to report is your adjusted gross income, or AGI. This helps the IRS to figure out your income tax liability, so it’s important to provide an accurate figure. Find out more about adjusted gross income on tax returns and why this number is so useful below.
Adjusted gross income explained
While gross income represents every cent of income you’ve earned throughout the year, you’ll only pay income taxes on your adjusted gross income. So, what is adjusted gross income exactly? This number represents your total (or gross) income, minus any eligible adjustments or deductions.
If you don’t adjust your income with adjustments, you’d need to pay taxes on your full gross income. Gross income takes every source of income into account, not only including your salary and wages, but also capital gains, interest income, rental income, retirement payments, royalties, and dividends. However, most people are eligible for deductions on many of these sources of income at both the state and federal level.
Adjusted gross income is usually calculated on the IRS form 1040, which is used by both individuals and households to file annual taxes.
Why is adjusted gross income important?
Adjusted gross income not only provides the basis for taxable income, but it’s also used to calculate the total deductions, or adjustments, that you’re eligible for. AGI shows the IRS:
Your tax brackets
Your taxable income
Credits and exemptions
An adjusted gross income calculator subtracts eligible deductions from your gross income. The more deductions that are made, the less tax you’ll pay due to a lower taxable income and tax bracket.
Adjusted gross income vs modified adjusted gross income
When looking at adjusted gross income on tax returns, you might also see references to modified adjusted gross income, or MAGI. While AGI uses gross income as a starting figure, MAGI uses AGI as its starting figure. It adds back some items to your AGI, such as student loan interest deductions. This modified AGI is used to determine specific calculations, such as your eligible income for health insurance under the Affordable Care Act. If your tax situation is uncomplicated, AGI and MAGI might be identical.
How to calculate adjusted gross income
To use any adjusted gross income calculator, you’ll need to know your total income and any other relevant financial details. You can then figure out how to calculate adjusted gross income using this formula:
AGI = Gross Income – Adjustments to Income
The first step is to calculate your gross income. To do this, you’ll need to add up the sum of all your income sources, including the following:
Salary, wages, and tips
Self-employment or business income
Interest and dividend payments
Social security payments
Alimony or spousal support payments
Real estate and rental income
Pension payments and IRA distributions
Awards and winnings
You should assume that all your income is taxable unless it’s explicitly labelled as non-taxable as in the case of inheritance and child support payments.
The next step is to subtract your adjustments to income from your gross income. When filing your tax return, you’ll see areas for “below the line” and “above the line” deductions. Above the line deductions are claimed first as adjustments, including things like:
Health insurance premiums
Contributions to retirement plans
Student loan interest
These are just a few examples of deductions you might be eligible for; it’s worth using tax preparation software to cover all possibilities. Once you’ve subtracted these above the line deductions, you’ll arrive at your AGI.
However, you can still make further deductions on things like business expenses to reduce your taxable income. These qualify as the below the line deductions, also including the standard deduction for individuals and married couples. Many of these are determined by your AGI, which is why it’s so important to work out first.
When in doubt, use tax preparation software or consult with your business accountant to make sure you’re taking advantage of all relevant deductions.
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