Adjusted Gross Income (AGI) is the measure of an individual’s taxable income. AGI is calculated using the filer’s gross income. The AGI forms the basis for much of a filer’s tax bill and is used to determine deductions and credits.
Adjusted Gross Income Explained
An individual’s gross income is the sum of many parts, including wages, dividends, alimony, capital gains, business income, retirement income, and various other forms of income. AGI factors in and subtracts various payments (adjustments) one may have made throughout the year, such as:
- Contributions to a retirement plan savings accounts (IRA, SIMPLE IRA, SEP IRA, etc.)
- Student loan interest payments
- Healthcare savings account contributions
- Losses incurred from the exchange or sale of property
- Various business-related expenses for performing artists, teachers, and various other occupations
- Certain moving expenses (Since 2018, on applicable to active duty military due moved on orders)
- One half of the self-employment tax
- Early-withdrawal penalties imposed by financial institutions
Many of the requirements for these deductions are very strict and specific, so close attention must be paid when determining if you are eligible.
You can choose to itemize your expenses and use itemized deductions rather than the standard deductions, which are advantageous in some situations. Additional tax forms beyond IRS form 1040 may be necessary if this path is taken, however.
Some deductions that are itemized, such health expenses not reimbursed by insurance, are limited to 10% of total adjusted gross income. If an individual’s AGI was $100,000 and their health expenses amounted to $15,000, they would have to lower their deduction by $10,000 (10%), with the reduction only ending up being $5,000.
However, if the individual’s income were $50,000, they would lower their deduction by $5,000 (10%), with the total reduction being $10,000.
If one has a high enough AGI, there are certain deductions and credits that they will become ineligible for. This is generally referred to as the “adjusted gross income threshold”. Examples of the AGI threshold include:
- Charitable contribution deductions can only be deducted for up to 50% of your AGI
- You can only claim unreimbursed medical expenses (dental, hospital, therapeutic) if they account for 7.5% or more of your total AGI.
- Miscellaneous expenses, which can only be deducted if they account for 2% or more of your AGI.
How To Calculate Adjusted Gross Income
$$Adjusted\: Gross\: Income = Gross\: Income - Deductions - Credits$$
When calculating adjusted gross income, your starting point will be any reported income for the given year. In addition to reported income, any other taxable income from the year must be added.
Examples of other taxable income include but are not limited to: unemployment compensation, Social Security payments, pensions, profits from the sale of a property, and any other income received.
Once your total has been determined, subtract any applicable deductions listed above and the resulting number is your final AGI.
Adjusted Gross Income vs Modified Adjusted Gross Income
Modified Adjusted Gross Income, or MAGI, is adjusted gross income that is modified further by adding back items such as tax-exempt student loan interest, costs for higher education outside of student loans, half of any self-employment tax, foreign earned income, any passive income, rental losses, retirement contributions, or any loss from a publicly traded partnership.
MAGI can be used in the calculation of various other tax benefits, credits, or exclusions. A lot of people have no deductions to add back, resulting in an identical AGI and MAGI. If your MAGI reaches a certain level, your deduction for IRA contributions can be phased out.
Adjusted Gross Income Conclusion
- Adjusted Gross Income = Gross Income – Deductions & Credits
- Any and all taxable income must be reported when calculating Adjusted Gross Income
- Adjusted Gross Income is used as the basis for an individual’s tax bill in the United States
- Various deductions applicable to one’s Adjusted Gross Income are defined by the United States government
- Adjusted Gross Income and Modified Adjusted Gross Income can be very different, ensure that one is not being confused for the other.
- AGI is reported on U.S. federal individual income tax return form 1040.