Calculating Adjusted Gross Income
The IRS defines AGI as “gross income minus adjustments to income.” That’s not exactly a helpful definition. It doesn’t tell you what gross income is or what adjustments must be subtracted.
Your gross income is simply the total amount you receive in a given year. It is not limited to wages or salary. It includes wages, salary, bonuses, dividends, royalties, interest, business income, pensions and annuities, capital gains, and alimony you’ve received.
Turning to adjustments, here’s a brief list and description of common adjustments accounted for in your AGI:
- Certain expenses incurred by performing artists
- 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 property
- Some costs associated with rental income or royalties
- Qualified retirement savings
- Jury duty pay remitted to your employer
- Clean fuel vehicle deductions
- Moving expenses
- Student loan interest
- Higher education expenses
- Health savings accounts
Why AGI Matters
Why does your AGI matter? 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 that exceed 7.5% of your adjusted gross income. In another example, qualifying for the Earned Income Tax Credit means falling under the income limit that applies to you, and all are based on adjusted gross income.
There’s yet another term you might hear thrown about, one used for a few other tax calculations: Modified Adjusted Gross Income (MAGI). MAGI refers to your AGI with modifications. What these modifications are can vary and the tricky thing is that there’s not a single MAGI—there are various MAGIs used for different purposes. And each comes with its own set of modifications. A few common modifications include tax exempt interest and the excluded portion of Social Security payments.
You should be cognizant of what you expect your AGI to be at the end of the year, particularly if you receive income throughout the year that you do not initially pay taxes on. Knowing what you AGI will turn out to be will help you plan for the coming tax bill. If your tax situation is simple, this probably won’t require much attention. If you and your spouse are both income earners, your AGI will be roughly the sum of your salary less retirement savings.
If, on the other hand, you work an income earning job, pay alimony, run a small business part time and own a rental property, it’s a good idea to think ahead about what your expected AGI is. This will help you know your marginal tax bracket and plan for tax expenses. The last thing you want is unexpected tax bill you can’t pay.