Think of adjusted gross income (AGI) as your overall income that has been adjusted somewhat, depending on your financial situation. And it also excludes some types of tax-exempt income. For example, you could deduct charitable contributions, self-employment expenses, student loan interests, retirement account contributions and foreign income, among others. It is worth noting, though, that some deductions are not permitted from the adjusted income.
An AGI will always be equal to or less than your gross income. However, it can never be more.
How to Calculate AGI
Below are the steps you need to take to determine your adjusted gross income.
1. Figure the Combined Income
Your gross income is a necessary aspect of your AGI. Therefore, you need to determine the total you have earned or received throughout the year.
You may have to include the following:
- Social Security benefits
- Alimony payments
- Bank account interest
- Capital gains
- Gambling winnings
- Retirement distributions
- Unemployment benefits
If you have no idea how to calculate your earnings, refer to your IRS forms or speak to a tax professional. For example, if you are an independent contractor, refer to your Form 1099-NEC. On the other hand, if you are employed, you should take a look at your Form W-2.
2. Subtract Tax-Exempt Income
Some types of income are exempt from federal taxes under specified conditions. As a result, they are not used in the calculation of AGI. If you earn these kinds of income, you could subtract them from your combined income.
- Qualified ABLE account distributions
- Wrongful incarceration compensation
- Foreign source earned income
- Paralympic and Olympic medals and United States Olympic Committee winnings
- Qualified Medicaid waiver payments
- Survivor benefits due to a dead officer
- Qualified payments due to you from military action or terrorist actions against you
Read More: Form 1040: What You Need to Know
3. Deduct Qualified Expenses
Once you arrive at the preliminary adjusted income, you can deduct the qualified expenses to arrive at the AGI. These are sometimes known as above-the-line deductions because they are taken out of your income before you determine the AGI within your Form 1040.
Below are some of the deductions you can make:
- Health Savings Accounts (HSA) contributions
- Qualified retirement account distributions, such as IRA contributions
- Self-employment health insurance premiums
- Alimony payments
- Armed forces moving expenses
- Educator expenses
- Early withdrawal penalties related to CDs or other savings accounts
- Higher education expenses
- Student loan interest
- Qualified performing artist and military members’ expenses
- Jury duty payments
- Discrimination lawsuit costs
- Property sale or exchange losses
- Real estate and royalty deductions
Remember, in some cases, the IRS sets a cap on how much of a deduction you can take. For example, eligible educators can only deduct up to $250 worth of expenses. On the other hand, you could deduct as much as $2,500 in qualified student loan interest.
Read More: What Are Above-the-Line Deductions?
How Important Is AGI?
You need to know your adjusted gross income for various reasons.
Determines Tax Brackets
Your AGI will help you to determine your tax bracket and, subsequently, how much taxes you end up paying. That’s because your taxable income is partly based on your AGI. However, you must first remove other allowable deductions, which could be the standard deductions or itemized ones, before arriving at the final value that is subject to taxation.
Determines Credits You Get
In addition, your AGI may determine what kind of additional deductions and credits you qualify for. That is why the term AGI threshold is commonly used during tax time.
If your AGI is too high, you may end up missing some or all of the credits others qualify for. For example, you can claim deductions for any reimbursed medical expenses exceeding 7.5 percent of your AGI. On the other hand, if you have three children, file as single, but your AGI is more than $51,464, you cannot enjoy earned income tax credit for the tax year 2021.
You should not underestimate what your AGI means to you as a taxpayer. The higher it is, the less likely you are to claim additional deductions and credits. So, take the time to ensure it is as accurate as possible. And don’t forget to deduct any tax-exempt income while claiming all allowable deductions to arrive at your final AGI.
- IRS.Gov: Definition of Adjusted Gross Income
- IRS.Gov: 1040(and 1040-SR) Instructions
- IRS.Gov: Publication 525 (2020), Taxable and Nontaxable Income
- Policygenius: What is adjusted gross income?
- FindLaw: 26 U.S.C. § 62 - U.S. Code - Unannotated Title 26. Internal Revenue Code § 62. Adjusted gross income defined
- IRS.Gov: Topic No. 456 Student Loan Interest Deduction
- Debt.Org: 2020-2021 Tax Brackets
- IRS.Gov: Topic No. 502 Medical and Dental Expenses
- IRS.Gov: Earned Income and Earned Income Tax Credit (EITC) Tables
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