Adjusted Gross Income: Definition, Calculation and Examples

The clock is ticking, and tax season is right around the corner. As you gear up to confront the daunting task of filing your taxes, it's essential to have an understanding of critical but complex terms such as Adjusted Gross Income (AGI).

Understanding AGI can have a significant impact on your tax payments and potential refunds. If you don't fully understand the calculation of taxable income, 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 and your eligibility for 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. In contrast, itemized deductions and credits that affect your income tax later on in the process are below-the-line adjustments. 

How to calculate Adjusted Gross Income

IRS Form 1040 is the place to start calculating 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.

To calculate your Adjusted Gross Income (AGI), you need to subtract your eligible adjustments from your total gross income. Tax deductions work as tax write-offs, and you'll encounter these at various points during the year. This increases the importance of efficient and accurate bookkeeping. If your books are a mess you could end up missing out on deductions you're entitled to. 

What is Included in AGI? 

Your AGI includes all forms of income subject to income tax, including:

Job wages or earnings

Self-employment income

Bank interest and dividends

Alimony

Capital gains

Social security benefits

Other retirement account withdrawals 

How to Lower Your AGI 

Various payments made throughout the year can be deducted from your taxable income. Since these payments aren't counted as income, they can help to reduce your AGI. Some above-the-line tax deductions that can lower your AGI include: 

Retirement plan contributions to an IRA or a self-employed retirement plan

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 also important. You won’t be reporting this number directly. Still, 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? 

Imagine that in 2023, you have the following income and expenses:

Total income was $60,000 from your job and $2,000 in IRA distributions.

During that year, you spent $2,500 paying off student loan interest and $3,000 as an IRA contribution.

Here's how you would calculate AGI based on the information provided above:

1. Gross Income: Add up all your income. This includes the income from your job and any IRA distributions.$60,000 (job income) + $2,000 (IRA distributions) = $62,000
2. Total Deductions: Add up all the above-the-line deductions. In this case, the student loan interest and the IRA contribution are deductible. Moving expenses are not deductible for the tax year 2023. $2,500 (student loan interest) + $3,000 (IRA contribution) = $5,500
3. Adjusted Gross Income: Subtract your total deductions from your gross income. $62,000 (gross income) - $5,500 (total deductions) = $56,500

So, your AGI for 2023 would be $56,500.

It's important to keep in mind this is a simplified example and calculations can be much more complex due to various factors.

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 finish everything well. 

If you’re running out of time to file your taxes with the care and precision you want, you can file for a business tax extension with the IRS. This will get you six more months to gather and turn in the proper paperwork. Don’t hesitate to partner with a tax professional, they can ensure you're saving as much money as possible.