What is Adjusted Gross Income? And How to calculate?
As long as you do something to earn money, then you have to report several different types of income. It is critical to understand the concept of adjusted gross income when preparing your own tax return. Adjusted gross income is known as a determining factor for many tax rules and privileges.
In this blog, we would like to go through the foundation of adjusted gross income.
Table of contents
- What is Adjusted Gross Income?
- How to calculate Adjusted Gross Income
- The implications of Adjusted Gross Income
- Bottom line
What is Adjusted Gross Income?
In short, adjusted gross income (AGI) is an individual gross income minus certain deductions. Calculating adjusted gross income is an essential step for determining taxable income.
Individual gross income is the total income from all sources such as salaries, wages, interest, dividends, etc. before taxes and other deductions. When you apply adjustments that are referred to as above-the-line deductions to this figure, then you get the adjusted gross income.
Adjusted gross income is also sometimes considered as a midpoint between your gross income and your taxable income. Your total income minus certain expenses and deductions result in AGI. Subtracting further deductions from AGI gets you to your taxable income.
Due to the changes in tax laws every year, the adjustments applied to calculate adjusted gross income also change. However, some deductions appear consistently year after year. These deductions, including retirement plan contributions, student loan interest, and some health insurance premiums, etc. are represented in the income tax return form.
Adjusted gross income is a critical number that helps determine your tax liabilities and your eligibility for tax credits and tax exemptions. The government also limits some deductions based on a percentage of adjusted gross income. Therefore, your adjusted gross income levels will affect the number of deductions. In most cases, a lower adjusted gross income leads to a higher number of deductions and credits applicable to an individual.
How to calculate Adjusted Gross Income
The calculation of adjusted gross income is represented on the first page of the individual tax return form. Finding AGI is considered as the first step to determine the deductions and credits you qualify for and the income tax you owe.
Knowing how to calculate your adjustable gross income typically helps you finish your tax-preparation process smoother.
Simply put, adjusted gross income is calculated by the following formula:
- Adjusted Gross Income (AGI) = Gross income - Adjustments
The first thing you have to do is to determine your gross income. This is the total income earned throughout the year.
For example, you have earned annual income from the following sources:
$36,000 from your full-time job $24,000 from renting out your real estate properties $2,500 in interest from your savings account.
Your gross income can be calculated as follows:
Gross Income = 36,000 + 24,000 + 2,500 = $62,500
After finding your gross income, you will refer to the “Adjustments to Income” section. There is a list of all the possible adjustments, which are also called “above-the-line deductions you can take.
Common items may include:
- Educator expenses, such as supplies paid for by teachers
- Business expenses including gas mileage or equipment rental fees
- Moving expenses
- Health care savings account deduction
- College tuition and fees
- Student loan interest
- Contributions to certain retirement accounts
- Penalties from financial institutions for early withdrawal of savings
- Jury duty pay sent directly to the juror’s employer
- Alimony payments
From your gross income, you subtract sums of your qualified deductions, and you get adjusted gross income.
We will continue with the above example, you have earned a total income of $62,500. You also incurred $500 in moving expenses, $2,000 in student loan interest.
So, deducting the above expense from your gross income gets you to your adjusted gross income.
AGI = $62,500 – $500 – $2,000 = $60,000
Your adjusted gross income is $60,000
The implications of Adjusted Gross Income
First and foremost, adjusted gross income is used as the starting point to calculate your taxable income for an individual. After getting your adjusted gross income, you can subtract either the standard deduction or the total of your itemized deductions, whichever you find more worth, to get your taxable income. So finding your AGI is an essential task for getting your taxable income.
Your adjusted gross income exerts impacts on which deductions and credits you are eligible to take to reduce your taxable income.
Let’s take an example of the effect of adjusted gross income on medical and dental expenses for an individual. A taxpayer who itemizes can reduce only the amount of qualified medical and dental costs that are higher than a specific percentage of their adjusted gross income. Generally, if the amount you spend on medical and dental services doesn’t exceed 10% of your AGI, you probably won’t be able to subtract them at all.
Deductions for tuition and charitable contributions can also be restricted by adjusted gross income. You cannot deduct qualified charitable contributions unless the deduction amount reaches 50% of your AGI.
It is obvious that your adjusted gross income has a significant effect on the number of deductions and credits and how much of them you can take.
For 2020 only, we are going through an unprecedented situation with significant impacts of the COVID-19 pandemic. And governments around the world are rolling out financial relief programs. Most taxpayers are eligible for the stimulus payment. The stimulus payment is typically based on adjusted gross income from your federal tax return.
As we have discussed, understanding the concept of adjusted gross income is obviously essential. Calculating your adjusted gross income is a critical step to get your taxable income.
We hope that with today’s article, you have had a basic knowledge of adjusted gross income, and you will be able to prepare your income tax return form more smoothly.