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What is Adjustable Gross Income (AGI)?


Before filing your taxes, you must understand what adjusted gross income (AGI) is so you can potentially lower your taxable income. That means you’ll pay less in taxes. That’s a win in our book. In this article, we will talk about AGI, Deductions, and Tax Credits.

What is Adjusted Gross Income (AGI)?

Your adjusted gross income is the starting point for calculating income on which you’ll pay taxes. To get to this number, you will need to make subtractions from your gross income. Your gross income is all of the money you made or acquired during the year. Your gross income is not just limited to your job income but also includes dividends, capital gains, retirement distributions, and other income sources.

How Does Adjusted Gross Income Work? 

Let’s dive deeper into how adjusted gross income works. Just like it sounds, your AGI is your gross income (the total amount of money you made or acquired over the year) adjusted. The allowable adjustments depend on your financial situation. That said, below are some common adjustments: 

  • Retirement account contributions
  • Educator expenses
  • Student loan interest paid
  • Alimony 

You can report each of these when you file your annual income tax return. These ‘above the line’ adjustments are subtracted from your gross income and result in your adjusted gross income. 

What About Deductions? 

While adjustments are commonly called deductions, there is a distinct difference between them. While adjustments get subtracted from your gross income, deductions get subtracted from your adjusted gross income. You can think of deductions as “step two” in your process of finding your final taxable income.

The IRS has a complete list of deductions, and these change often. You can choose to take the standard deduction or complete an itemized deduction. Common deductions include: 

  • Charitable contributions 
  • Home mortgage interest paid 
  • Health Savings Account (HSA) contributions 
  • Medical expenses 

Do Tax Credits Work the Same Way As Deductions or Adjustments?

Tax credits do not work like adjustments or deductions. They are a “credit” back to the taxes you owe. The number of tax credits you can claim is dependent on your adjusted gross income. For example, childcare or the care of a dependent provides a certain amount of tax credit to individuals. This tax credit is based on your income levels.

Adjustments vs. Deductions vs. Credits

In summary, adjustments get subtracted from your gross income and result in your adjusted gross income. Then, deductions get subtracted from your AGI, and you can choose to itemize deductions or claim the standard deduction. Finally, tax credits provide you with a credit back to the total taxes you owe. All three of these components will reduce how much you owe in taxes for a given year. 

How Do I Calculate Adjusted Gross Income?

The formula for adjusted gross income is as follows: 

Gross Income – Adjustments = Adjusted Gross Income 

Example of Calculating AGI 

Let’s look at an example of how this might work. Lara Finch is reporting a total of $56,000 for her gross income. She also contributed $3,000 to a tax adjustable retirement account like an IRA. Also, she paid $250 in student loan interest. This means Lara Finch can subtract both of these qualified adjustments from her gross income resulting in an AGI of $52,750. 

$56,000- $3000- $250 = $52,750

She can further reduce her taxable income by claiming deductions and credits where she is eligible. 

How Do I Report My AGI? 

You will report your adjusted gross income when you file your income tax return each year. Most tax filing platforms will calculate this number for you based on the information you provide. Your final AGI will appear on the tax form, but where it appears depends on the type of tax form you complete. 

For example, on the tax forms 1040 and 1040-SR, you can find your AGI on line 11. The line your AGI appears does change when the forms change, so your AGI for other years may be in different places.  The IRS makes tweaks and updates to its forms each year.

If you need to find your previous adjusted gross income, you will need to review your tax return for that year. You can request this through the IRS.

What Is the Best Way To Lower My AGI? 

One of the best ways to lower your AGI and benefit in the long term is by contributing more to your retirement accounts. In the example above, Lara Finch lowered her AGI by adjusting for student loan interest paid and retirement contributions. The student loan interest paid is great because she reduces her debt; however, the retirement contributions will set her up for long-term wealth.

If you are looking for ways to lower your AGI, focus first on your retirement plan, and see where you can increase your contributions.

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