Adjusted gross income (AGI) is a tax term for your gross income minus tax deductions that are allowable whether or not you itemize deductions when you file your tax return. It is the determiner for many of the deductions and credits you will receive, as well as any taxes you will owe when you file your tax return.
There are several types of expenses that can be deducted to arrive at your adjusted gross income. Knowing what these are will help you make sure you are paying your taxes correctly.
Definition and Example of Adjusted Gross Income
When filing your taxes, your adjusted gross income is simply your gross income minus any adjustments. AGI is the figure that will be used to guide many other calculations and thresholds, such as for credits and deductions, which is important because the lower it is, the less tax liability you'll have.
To find AGI, after you have added up your full taxable income (gross income), you can take several "above-the-line" deductions to lower that taxable amount. These are called "above the line" because they apply whether you itemize your deductions or take the standard deduction. They're also called "adjustments to income," and they're calculated on IRS Schedule 1.
For example, if you are a school teacher who purchases necessary classroom supplies, these can be deducted as an expense. Using these deductions will allow you to lower your adjusted gross income, potentially resulting in a tax refund.
- Acronym: AGI
Adjustments to income are deducted from your gross income. Itemized or standard deductions are then deducted from your AGI to arrive at your final taxable income.
How Adjusted Gross Income Works
Your AGI is calculated on the first page of your U.S. federal tax return (Form 1040), using information from Schedule 1. Calculating AGI is an important first step because it serves as the foundation for determining the deduction and credits for which you may qualify and the income tax you owe. To determine your AGI, start with your gross income and subtract qualifying items to reduce the amount. Common items can include:
- Educator expenses, such as supplies paid for by teachers
- Moving expenses for members of the armed forces
- Health care savings account deduction
- College tuition and fees or student loan interest
- Contributions to certain retirement accounts
- SEP-IRA, SIMPLE IRA, and 401(k) deductions for the self-employed
- Penalties from financial institutions for early withdrawal of savings
- Alimony payments
If you're doing your own taxes, tax software can automatically calculate your AGI. The use of software can help you avoid any mathematical errors. The software will accurately do all the tax calculations as it walks you through the tax interview. Otherwise, if you don't understand the difference between AGI and gross income or how to calculate it, you may pay more than you need to in income taxes.
Adjusted Gross Income vs. Gross Income
Before you calculate your adjusted gross income, you must determine your gross income—the total income on Form 1040—that you earned for the tax year in which you're filing. Gross income includes all money you have made on your paychecks before payroll taxes. However, it isn't limited to your paycheck—it includes money you earn from other sources, too.
Gross income can include other employment earnings in addition to salaries (bonuses, for example), as well as interest and dividends, long- and short-term capital gains and losses, interest, dividends, alimony, pensions and annuities, rental property income, royalties, and any revenue derived from operating a business.
Also, if you sold any items on eBay, Craigslist, or another online store, you have gained income from profits by selling goods. Gross income also includes net gains on disposal of assets, such as selling a home or car, or any money obtained through self-employment, consulting, side jobs, and other sources of income. All of these income sources are accounted for on the first few lines of Form 1040 and Part I of Schedule 1.
It's important not to confuse gross income with net income. Net income refers to take-home pay or the amount of money earned after payroll withholding, such as state and federal income taxes, Social Security taxes, and pretax benefits like health insurance premiums.
The list of items that contribute to your total gross income is extensive, and you may need help determining what's considered income for this purpose. Tax software will help you identify all earnings that need to be reported to the government by asking questions in the tax interview, or you can ask an accountant for advice.
- Your adjusted gross income (AGI) is your taxable income after removing any adjustments to your gross income.
- It is used to determine any deductions and credits you will receive. It also determines the taxes you will have to pay.
- Your AGI is calculated before you take itemized or standard deductions.
Frequently Asked Questions (FAQs)
What is included in adjusted gross income?
Your AGI is an adjustment of your gross income, so it includes all sources of income (wages, dividends, capital gains, business income, retirement distributions, etc.) but it then reduces the full amount with any above-the-line adjustments you are eligible for. These will depend on your situation but may include educator expenses, student loan interest, alimony payments, or contributions to a retirement account.
Are AGI and taxable income the same thing?
No, but your AGI is a step on the way to reaching your taxable income. Once you have taken adjustments from your gross income to reach your AGI, you can then apply credits and deductions to reach your taxable income.