Understanding Adjusted Gross Income: Key points to remember

tax return

What is Adjusted Gross Income (AGI)?

Adjusted Gross Income (AGI) is the Internal Revenue Service’s figure for determining your income tax for the year. It is calculated by subtracting certain adjustments from gross income, such as business expenses, student loan interest payments, and other expenses.

After calculating the AGI, the next step is to subtract the deductions to determine the taxpayer’s taxable income. In addition, the IRS also uses other measures of income, such as the Modified AGI (MAGI) for specific programs and retirement accounts.

Key points to remember

  • The Internal Revenue Service uses your adjusted gross income (AGI) to determine the amount of income tax you owe for the year.
  • AGI is calculated by taking all of your income for the year (your gross income) and subtracting certain “income adjustments”.
  • Your AGI can affect the number of your tax deductions as well as your eligibility for certain types of retirement plan contributions, such as a Roth IRA.
  • Modified Adjusted Gross Income is your AGI with some otherwise allowable deductions added. For many people, AGI and MAGI will be the same.
  • Among the items subtracted from your gross income when calculating your AGI are alimony payments and education expenses.

Understanding Adjusted Gross Income (AGI)

As prescribed in the United States tax code, adjusted gross income is a modification of gross income. Gross income is simply the sum of all the money you have earned in a year, which can include salaries, dividends, capital gains, interest income, royalties, rental income, alimony, and pension distributions. AGI makes certain adjustments to your gross income to reach the figure on which your tax payable will be calculated.

Many US states also use the AGI of federal returns to calculate how much individuals owe in state income taxes. States can further modify this number with state-specific deductions and credits.

Items subtracted from your gross income to calculate your AGI are called income adjustments and you report them on Schedule 1 of your tax return when you file your annual tax return. Some of the more common adjustments are listed here, along with the separate tax forms on which some of them are calculated:

  • Alimony payments
  • Early withdrawal penalties on savings
  • Educator expenses
  • Employee business expenses for armed forces reservists, skilled entertainers, state or local government officials paid on a fee basis, and employees with disability-related work expenses (Form 2106)
  • Health Savings Account (HSA) Deductions (Form 8889)
  • Moving Expenses for Members of the Armed Forces (Form 3903)
  • SEP, SIMPLE and qualified schemes for the self-employed
  • Deduction for self-employed health insurance
  • Self-employment tax (the deductible part)
  • Student loan interest deduction
  • Tuition and Fees (Form 8917)

What is the difference between AGI and Modified Adjusted Gross Income (MAGI)?

AGI and MAGI are very similar, except that MAGI add some deductions. For this reason, MAGI would always be greater than or equal to AGI. Common examples of deductions that are added back to calculate MAGI include income earned overseas, income earned on US savings bonds, and losses resulting from a publicly traded partnership.

What is the meaning of annual net income?

Annual net income is the money you take home one year after all deductions have been made, including taxes, pension contributions and healthcare costs.

How is Adjusted Gross Income (AGI) calculated?

To calculate Adjusted Gross Income (AGI), you need to start with your gross income (all the money you earned in a year) and subtract all allowable deductions. These deductions can be found on Schedule 1 of Form 1040.

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By Michael Caine

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