If you’ve ever wondered whether you’re eligible for tax deductions and credits, you’ve probably heard of Adjusted Gross Income (AGI).
This figure also determines your eligibility for retirement accounts like IRA contributions.
Many people pay more attention to their gross income -- the sum of all their W-2 and 1099 forms. However, as you complete your tax return, the IRS asks about several other things you did during the year.
- How many dependents do you have?
- Did you get married or divorced?
- Did you make contributions to your retirement accounts?
- Did you pay interest on student loans?
How Does Gross Income Become Adjusted Gross Income?
Add up all of your gross income. That includes money from:
- Job wages
- Side gigs
- Commissions or royalties
- Retirement income
- Unemployment income
- Rental income
- Capital gains
Then you can subtract any permitted deductions to arrive at your Adjusted Gross Income.
What is Special About AGI?
When you can reduce your AGI, it reduces your taxable income. However, your AGI can also help qualify you for other deductions.
For example, your AGI can help you qualify for specific tax credits that place a maximum limit on AGI.
What Does “above the line” Deduction Mean?
The deductions you’re allowed to take before calculating your AGI are called “above the line” deductions. AGI is “the line” to which they refer. above the line, deductions reduce your gross income to determine your AGI.
Often, they are the most valuable deductions on your tax return. Usually, they can directly increase your tax refund. Consequently, your AGI determines your tax bracket.
Deductions reduce your total income directly. Some taxpayers can subtract expenses, like:
- Self-employment taxes (half)
- IRA contributions
- Health saving account
- Military moving expenses
- Early withdrawal penalties
- Tuition and fees
- Educator and business expenses
- Self-employed health insurance
Taxpayers can deduct these items to arrive at their AGI. The tax code considers these circumstances before the itemized, and standard deductions are applied.
“Below the line” Deductions
While above the lines directly reduce your AGI, “below the line” deductions occur after your AGI is calculated.
Typically, below the line deductions are calculated as a percentage of your AGI.
After you determine your AGI, you can deduct itemized expenses like:
- Mortgage interest
- Specific taxes
- Charitable contributions
- Medical expenses
- Gambling losses
- Investment interest
- Student loan interest
If you don’t have much to deduct, you can opt for the standard deduction instead. You do not need any receipts to take the standard deduction.
The amount of your standard deduction depends on your filing status: single, married filing jointly, etc.
How to Calculate Your Adjusted Gross Income
Suppose you earned $36,000 of taxable income from your regular job last year. Plus, you earned $14,000 from side gigs. You also earned $2,000 from your investments.
Your gross income is $52,000.
Now, subtract any of the above the line deductions for which you qualify. In your case:
- $7,000 self-employed health insurance premiums
- $5,000 deductible contribution to your IRA account
- $1,071 for self-employment taxes paid for the side gigs
- $500 for student loan interest
Finally, subtract $13,571 from $52,000 to arrive at an AGI of $38,429.
Now that you reached your AGI, you can factor in the below the line deductions.
Since the standard deduction is more significant than your itemized deductions, the IRS permits you to choose the larger amount. As a single filing taxpayer, the standard deduction is $12,400 in 2020.
Your taxable income is $26,029. In the tax year 2020, your income falls in the 12% tax bracket. The first $9,875 is taxed at 10%, and the remaining $16,154 at 12%. Therefore, your total tax due would be $2925.98.
At this point, you can apply for tax credits. Tax credits directly reduce your tax bill.
If you have qualifying dependents or any other tax credits to apply, it might reduce your tax bill to $0. Even better, some tax credits are refundable. So if they exceed your taxes due, the IRS will pay you the difference as a refund.
AGI is An Important Figure
Adjusted Gross Income is one of the most important numbers on your tax return. It helps you qualify for deductions, credits, financial aid, and many other helpful benefits.
The IRS provides helpful resources to understand AGI. They may also use your prior year’s AGI as a PIN for your follow tax return year.
For more help with Adjusted Gross Income, contact a CPA or Enrolled Agent in your area. Or call the IRS hotline and speak with an authorized representative who can answer your questions.