What is adjusted gross income and how to calculate it?

Your adjusted gross income is the amount of income on which you must pay taxes. It’s a change in your gross income, which is the total amount of money you earn in a year.

If you’re saving for retirement in a qualified account, are self-employed, or meet various other criteria, you don’t have to pay tax on your total gross income. Instead, you get “over the line” deductions, which means they actually reduce your taxable income. Adjusted Gross Income (AGI) is the taxable amount you earned during the year.

When you prepare to file your tax return, your AGI is the first thing you need to determine. This is the starting point for determining your tax bill, including determining what tax bracket you fall into and whether you qualify for certain tax deductions and tax credits.

How do I calculate my AGI?

If you file your taxes online, the tax software you use will likely determine your AGI for you. But it’s helpful to understand how to calculate AGI, because there may be things you can do to lower it. And a lower AGI means you’ll have a lower tax bill.

Start with your gross income. This includes all of your income in a given year from all sources, which may include wages, dividends, alimony, capital gains, taxable interest income, royalties, rental and pension distributions.

Then you subtract any higher deductions you are entitled to. These deductions, called income adjustments, directly reduce your taxable income. Some of the most common include:

  • Contributions to qualified retirement plans, such as IRAs, Simple IRAs, and SEP IRAs

  • Half the self-employment tax

  • Contributions to a health savings account (HSA)

  • Alimony (deducted by the paying spouse but taxable for the recipient spouse)

  • Early withdrawal penalties imposed by financial institutions

  • Tuition, fees, and interest on student loans (with some exceptions and limitations)

  • Pay for jury duty that has been assigned to your employer

  • Certain business expenses for teachers, certain civil servants, reservists and performing artists.

It’s important to make sure you qualify for any income adjustments you plan to make. You can view the qualifications on the IRS website.

When you subtract the income adjustments you are entitled to from your gross income, the difference is your adjusted gross income. With this figure, you are ready to determine the amount of income tax you owe.

How do I report an AGI?

Adjusted gross income is reported directly on your Form 1040, the U.S. Personal Income Tax Return, when you file federal income taxes. If you are entitled to adjustments to your gross income, you will need to complete Schedule 1, which is an attachment to Form 1040.

On Schedule 1, you will indicate all the adjustments you are authorized to make and their amounts. Then you will enter this number on your Form 1040, subtract it from your gross income and enter it as your adjusted gross income. For tax year 2018, the most recent year for which tax forms were issued, AGI was reported on line 7 of Form 1040.

Why is AGI so important?

Your AGI is important because it determines your eligibility to claim a variety of available deductions and credits. Taxpayers with a lower AGI will be eligible for more deductions and credits.

This is because many deductions are calculated as a percentage of your AGI. For example, in 2019 the IRS allows all taxpayers to deduct medical expenses that exceed 10% of their AGI. So if you claim $20,000 in medical expenses and an AGI of $100,000, you will only be able to deduct $10,000 because that is the amount above 10% of the AGI. However, if your AGI is $50,000, you can deduct anything over $5,000, so you can deduct $15,000.

What can I do to lower my AGI?

There are several ways to lower your AGI. First, make sure you’re taking advantage of all the top deductions you’re entitled to. This means that if you work as an educator or performing artist, or if you are a reservist, make sure you understand the business expenses you can use to adjust your income and take advantage of them.

If you have student loans, you can slow down your repayment to lower your AGI. It’s generally a good idea to pay off your student loans as quickly as possible so you can save more of your money for other financial goals. But if you want to reduce your AGI, student loan interest is one of the qualified ways to reduce it. When you take your time paying off your student loans, more of your payment will be interest, and student loan interest can be deducted above the line, lowering your AGI.

Contribute to a Traditional IRA, Simple IRA, or SEP IRA or increase your contributions to these accounts. Every dollar you add to one of these IRAs is subtracted directly from your gross income, reducing your tax liability. The same goes for contributions to a Health Savings Account (HSA). If you have an HSA-compatible health insurance plan, you can contribute to the HSA up to $3,500 for individual coverage or $7,000 for a family plan each year. And every penny you pay reduces your AGI.

Also, if you sell stocks or other investments at a loss, it can lower your AGI. You can claim a net capital loss of up to $3,000 per year.

And if your employer sponsors a pre-tax retirement plan like a 401(k), you can defer some of your income to that plan and that income won’t even show up on your tax return. Your contribution amount is withdrawn before it even reaches the gross income line, so your AGI is reduced from the start.

Understanding adjusted gross income doesn’t just mean you understand an important line on your tax return. It also means you can actively work to lower your AGI and lower your tax bill in the process.

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