What is Adjusted Gross Income (AGI)?

What is Adjusted Gross Income (AGI)?
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If you’ve read a bit about personal finance, chances are you’ve heard the term “adjusted gross income.” A lot of tax considerations are based on AGI, so it helps to familiarize yourself with the term. Here’s a quick introduction to AGI and when you might need to consider yours.

Adjusted gross income

Calculate the total income by completing lines 7 through 21 of Form 1040 and adding the numbers.

Complete lines 23 through 35 of Form 1040. This covers expenses such as health savings, moving, self-employment costs and health insurance, alimony, and student tuition. Add these amounts.

Subtract these amounts from total income to produce adjusted gross income.

Calculation of adjusted gross income

The IRS defines AGI as “gross income fewer adjustments to income”. That’s not exactly a useful definition. It does not tell you what gross income is or what adjustments should be subtracted.

Your gross income is simply the total amount you receive in a given year. It is not limited to wages or salaries. It includes salaries, wages, bonuses, dividends, royalties, interest, business income, pensions and annuities, capital gains, and alimony that you have received.

As for tweaks, here is a brief list and description of common tweaks considered in your AGI:

  • Certain expenses incurred by performers
  • Certain expenses paid by teachers for books, supplies, and other equipment
  • Certain travel expenses paid by members of the reserve components of the armed forces
  • Losses from the sale or exchange of goods
  • Certain costs associated with rental income or royalties
  • Qualified retirement savings
  • Pension
  • Jury duty paid to your employer
  • Deductions for clean-fuel vehicles
  • moving expenses
  • student loan interest
  • Graduate fees
  • Health savings account

Why AGI Matters

Why is your AGI important? Well, the IRS uses your AGI to determine whether or not you qualify for certain deductions and credits. For example, the IRS allows you to deduct medical expenses greater than 7.5% of your adjusted gross income. In another example, earned income tax credit eligibility is the income limit that applies to you, and all are based on adjusted gross income.

There’s yet another term you might hear used for a few other tax calculations: Modified Adjusted Gross Income (MAGI). MAGI refers to your AGI with modifications. These modifications can vary and the problem is that there is no single MAGI. And each comes with its modifications. Some common modifications include tax-exempt interest and the excluded portion of social security payments.

You should be aware of what you expect from your AGI at the end of the year, especially if you receive income throughout the year on which you do not initially pay taxes. By knowing what you are going to do, AGI will help you plan for the next tax bill. If your tax situation is simple, this probably won’t require much attention. If you and your spouse are both salaried, your AGI will be roughly the sum of your salary minus retirement savings.

  • If, on the other hand, you work at a paid job, pay child support, run a part-time small business, and own rental property, it’s a good idea to think about what your AGI should be. This will help you know your marginal tax bracket and plan your tax expenditures. The last thing you want is an unexpected tax bill that you can’t pay.

Special Considerations for the MAGIs

Roth IRAs

  • To contribute to a Roth IRA, your MAGI must be below the limits specified by the IRS. If you are below the income threshold, the actual amount you can contribute is also determined by your MAGI. If your MAGI exceeds the authorized limits, your contributions are phased out.

Note that if you contribute more than you are allowed, you must remove the excess contributions. Otherwise, you expose yourself to a tax penalty. Excess contributions are taxed at a rate of 6% per year as long as the excess remains in your IRA.

Traditional IRAs

  • Your MAGI and whether you and your spouse have retirement plans at work determine whether you can deduct traditional IRA contributions. If neither spouse is covered by a workplace pension plan, you can deduct all of your contributions, up to your contribution limit. However, if one spouse has a workplace pension plan, your deduction may be limited.


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