Everything You Need to Know About Adjusted Gross Income Before Tax Time

March 11, 2020
Man sitting at a desk with a laptop and smartphone reading about adjusted gross income on tax documents

Tax day is right around the corner. Many people have already started thinking about their taxes – what they need in order to file. Handling your taxes yourself can be confusing and stressful. The terminology can seem purposefully confusing, and sometimes even a Google search can’t give you a palatable explanation. One of those very important but complex terms is Adjusted Gross Income. 

As you prepare for tax season this year, take time to also study how the process works and figure out what Adjusted Gross Income is and how it will affect your tax burden and possible tax refunds. If you don’t fully understand how taxable income is assessed, you could end up paying more or less than legally required. 

What is Adjusted Gross Income?

Adjusted Gross Income (AGI) is the primary number used to determine how much money you owe in federal income taxes, as well as any if you qualify for any tax credits or deductions.

When filing your taxes, you don’t necessarily have to pay a percentage of every single dollar you make. Certain adjustments to income can lower your taxable income before your tax burden is calculated. These deductions affect your tax return differently than the itemized or standard deductions you calculate later. 

Deductions and other elements that affect your Adjusted Gross Income are called above-the-line adjustments, whereas itemized deductions and credits that affect your income tax later on in the process are below-the-line adjustments. 

How is AGI Calculated? 

IRS Form 1040 is the place to start to calculate your AGI. In the section marked “income,” you’ll begin by adding up your gross, or total, income. This is your total income subject to income tax. Lines 7-22 on Form 1040 will help you count everything that’s included in your income.

Then, to calculate AGI, you’ll adjust your gross income by subtracting any and all qualifying adjustments. Tax deductions work as tax write-offs, and you run into them throughout the year, so you’ll need efficient and accurate bookkeeping to ensure you get all the deductions you’ve earned.   

What is Included in AGI? 

Your AGI includes every form of income subject to income tax. This includes:

  • Wages or earnings from a job 
  • Self-employment income 
  • Bank account interest and dividends 
  • Alimony 
  • Capital gains 
  • Social security benefits 
  • Other withdrawals from retirement accounts. 

What Lowers Your AGI? 

Many payments you make for various things throughout the year can be taken out of your taxable income as deductions. These are taken out because the money you used to make those payments is not counted as income in your tax year. Here are just a few of the above-the-line tax deductions that can lower your AGI

  • Retirement plan contributions to an IRA or a self-employed retirement plan do not count as taxable income until taken out of the plan at a later date. 
  • Health savings account contributions
  • Health insurance costs for self-employed individuals
  • Other employment taxes paid by self-employed individuals
  • Student loan interest payments
  • Qualified educator expenses 
  • Moving expenses for the armed forces
  • Alimony payments for divorces in effect before 2018 

Determining Eligibility

Your Adjusted Gross Income will affect your ability to claim other tax credits and below-the-line deductions. It also determines your basic level of tax bracket

Modified Adjusted Gross Income (MAGI) is a similar but subtly distinct number that is important as well. You won’t be reporting this number directly, but it will determine if you can contribute to a Roth IRA, if your other IRA contributions are tax deductible, and if you’re eligible for the premium tax credit on public healthcare exchanges. 

To calculate your MAGI, you take your adjusted gross income and add back in a few certain deductions that are not considered for the MAGI. You have to add back IRA contributions, social security payments, student loan interest payments, any foreign income you left out, half of your self-employment taxes, and a few other deductions that aren’t claimed very often. 

What is an AGI Example? 

Here’s an example to help you make sense of how it all works. Imagine that in 2019 your total income was $50,000 from your job and $1,000 in IRA distributions. During that year, however, you spent $500 for moving expenses, $2,000 paying off student loan interest, and $300 as an IRA contribution. 

  • Gross Income: $50,000 + $1,000 = $51,000
  • Total deductions: $500 + $2,000 + $300 = $2,800
  • Adjusted Gross Income: $51,000 – $2,800 = $48,200

This number affects many different features of your tax liability as well. For example, when itemizing deductions below-the-line, your deductible medical expenses are reduced by 10 percent of your AGI. If your AGI is $50,000, then that means reducing your medical deduction by $5,000. With an AGI of $45,000, then the reduction would be only $4,500.    

Maximizing Your Refund at Tax Time

Now that you understand adjusted gross income a little better, you’re well on your way to finishing up your tax return carefully and accurately. The stakes are high, so make sure you give yourself enough time to get everything done well. 

If you’re running out of time to file your taxes with the care and precision you want, you can ask for an extension of time to file with the IRS and get six more months to turn in the proper paperwork. Don’t hesitate to get professional help as well if you’re struggling to meet the IRS deadlines.

This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. 1-800Accountant assumes no liability for actions taken in reliance upon the information contained herein.