What is Adjusted Gross Income and How is it Calculated?

If you’ve ever done your own taxes, you’ve seen the term adjusted gross income, or AGI. It’s calculated by subtracting — or deducting, in tax speak — certain expenses you had during the year from your gross income.

The IRS requires tax filers who self-prepare their returns to provide their prior-year AGI as a security measure. So you’ll need that number handy if you use online tax software or fill out Form 1040 by hand. You can find it on Line 11 of your most recently filed tax return or in your online IRS account, if you have one.

AGI is also the number used to determine how much you can claim for certain itemized deductions; whether you can contribute to a Roth IRA and how much; whether your traditional IRA contributions are deductible; your eligibility for tax credits; and ultimately, how much income tax you owe.

Here’s how to calculate AGI and why it’s so important.

Adjusted Gross Income (AGI) Definition

Adjusted gross income is the number you get after deducting some of your expenses related to education, retirement savings, healthcare, and operating a business from your gross income.

Gross income is the sum of your wages, tips, capital gains, taxable interest, dividends, business and self-employment income, and retirement distributions before taxes are taken out.

Generally, the lower your AGI is, the lower your tax bill is. If you use online software to do your taxes, the platform will calculate AGI for you once you input all your income and answer a few questions about your expenses for the year.

Read More: 11 Tax Changes for 2022

How Do You Calculate AGI?

The formula for calculating AGI is as follows:

Adjusted gross income = gross income – above-the-line deductions

Above-the-line deductions are the specific expenses the IRS lets you subtract from your gross income to get your AGI. Theses are the most common deductions (note that most are subject to annual maximums that may be adjusted each year):

  • Student loan interest
  • Educator expenses
  • Alimony paid on a divorce settled prior to 2019
  • Contributions to a health savings account
  • Contributions to a qualified retirement plan or traditional IRA
  • The employer portion of self-employment taxes
  • Premiums for health insurance if you’re self employed
  • Penalty on early withdrawals from certificate of deposits
  • Some rental property expenses
  • Moving expenses for active military members

For more details about each of these line items for the 2021 tax year, see this IRS guide.

Here’s an example:

Jill, a teacher, has a $65,000 salary, $2,000 of side hustle profit, and $4,000 in capital gains for the year. Her gross income is $71,000.

She contributed $5,000 to her workplace retirement plan and spent $200 on supplies for her classroom. Because pre-tax retirement contributions and educator expenses are eligible deductions, she can make adjustments to her gross income.

$71,000 (gross income) – $5,000 (contributions to a qualified retirement plan) – $200 (educator expenses) = $65,800 AGI

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How Does Adjusted Gross Income Affect Deductions?

Your ability to claim certain itemized deductions may be limited by your AGI.

The medical expense deduction is a common itemized deduction that many people with average incomes don’t qualify for because of AGI limits. There’s a high floor for eligibility — your total medical expenses need to exceed 7.5% of your AGI, and then only the amount over 7.5% is deductible.

For example, a single person with $65,000 AGI and $5,000 in qualifying medical expenses could deduct only $125 as an itemized deduction (0.075 floor x $65,000 AGI = $4,875 allowable deduction). Total itemized deductions need to exceed the standard deduction — for a single filer in 2021 that was $12,550 — in order for a taxpayer to claim them. So the medical expenses deduction in this example ends up being just a drop in the bucket.

Charitable contributions are another type of itemized deduction affected by AGI. Generally, taxpayers can claim a deduction equal to up to 60% of their AGI for cash contributions to qualifying charities. During the pandemic, however, the limits were suspended and the IRS has allowed taxpayers to deduct contributions equal to 100% of their AGI, at least through the 2021 tax year.

Read More: Tax Credit vs. Tax Deduction: What’s the Difference?

AGI vs. MAGI vs. Taxable Income

AGI and gross income aren’t the only versions of your income you need to pay attention to for taxes. There’s also modified adjusted gross income, or MAGI.

MAGI is calculated by adding back in some of the deductions you took to get your AGI. There isn’t one formula for calculating MAGI because the add-back items vary depending on the specific credit, deduction, or contribution you’re checking eligibility for.

Tax credits that use a version of MAGI for eligibility:

  • Child Tax Credit
  • American Opportunity Credit (education)
  • Lifetime Learning Credit (education)
  • Premium Tax Credit (healthcare)

Tax credits that use AGI for eligibility:

MAGI is also used to determine whether your contributions to a traditional IRA are deductible, and whether you’re eligible to make any Roth IRA (non-deductible) contributions.

Taxable income is another version of income that’s important. It’s the number you get after subtracting either the standard deduction or your total itemized deductions from your AGI. This income figure is what you apply to the tax brackets to calculate your tax liability.

Frequently Asked Questions

When Determining AGI, What Are the Adjustments to Consider?

There are around two dozen adjustments to income, also known as above-the-line deductions, for AGI, but only about half of them are commonly used. They include items like student loan interest, retirement contributions, health savings account contributions, and business expenses for self-employed people.

Where Do I Find Adjusted Gross Income on W-2 or 1040?

Your adjusted gross income is calculated when you prepare your tax return (Form 1040). You need to use Part II on Schedule 1 to tally the adjustments to income that apply to you. Report that number on Line 10 of Form 1040 and calculate your adjusted gross income on Line 11.

AGI is not listed on your W-2. That’s a wage and tax statement provided by your employer showing how much you earned and paid in taxes during the year.

Is Adjusted Gross Income Before or After Taxes?

Adjusted gross income is a version of your income before taxes. Once you’ve calculated your AGI, you can claim the greater of the standard deduction or your total itemized deductions to arrive at your taxable income.

What Reduces Your Adjusted Gross Income?

Your AGI will be lower if you spent money out-of-pocket during the tax year on certain eligible adjustments to income, such as contributions to a 401k or traditional IRA, interest on student loans, health insurance premiums if you’re self-employed, and moving expenses if you’re an active member of the military.

Another way to reduce your AGI by way of reducing your gross income is to use a strategy called tax-loss harvesting. This is when you sell some investments at a loss to offset any that have gained substantial value, with the goal of reducing your net capital gain (one of the items that makes up your gross income). So if you had an annual loss of $6,000, for example, and a gain of $10,000, only the difference ($4,000 capital gain) would be includable in your gross income.

 

 

Author is not a client of Personal Capital Advisors Corporation and is compensated as a freelance writer. The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. Compensation not to exceed $500. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money. Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.

Tanza Loudenback, CFP®

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