Adjusted gross income (AGI) is the starting point for calculating how much income tax you owe to the IRS. Your AGI is determined by taking your gross income and reducing it by certain deductions.
The government uses AGI as a basis to determine eligibility for many tax credits and deductions so it is usually the most relevant income figure for individuals. It can also have retirement planning implications.
How AGI is Calculated
In order to calculate your AGI, you will first need to calculate your gross income. This includes wages, salaries, bonuses, interest, dividends, rents, royalties, business income, alimony, pensions, annuities, share of income from partnerships and S corporations and income tax refunds.
Once you calculate your gross income, you will reduce the number by any of the following costs you incurred during that tax year. These items are the adjustments to income.
- Medical expenses
- Moving expenses
- Student loan interest
- Contributions to a healthcare savings account (HSA)
- Losses realized from the sale of property
- Unreimbursed business expenses
- Contributions to a retirement plan
These are only the most common adjustments to income – there are several more that apply to less common situations. The number resulting from these adjustments to gross income is your adjusted gross income.
Why AGI Matters
Generally, the lower your AGI is, the more tax credits and deductions you will be eligible for. That’s why it’s very important to make sure you claim all of the adjustments to income that apply to you. If you need help, a qualified tax accountant can help you make sure you’re claiming everything you can.
Many states also base their tax taxable income guidelines on adjusted gross income, so lowering it as much as possible can help you with your state taxes as well as your federal ones.
Also, don’t confuse it with MAGI, or modified adjusted gross income. The MAGI calculation adds back certain deductions, such as tax-exempt interest, foreign-earned income and portions of Social Security benefits. MAGI is an important figure for certain purposes, but AGI is the star of the show in most cases.
AGI in Retirement Planning
AGI can certainly play a key role in planning for retirement, especially for those who plan to receive Social Security benefits.
To determine how much to tax of your Social Security benefit, the IRS looks at your “provisional income”. This number is your AGI plus nontaxable interest income and half of your Social Security income.
For individuals, if your provisional income is less than $25,000, then you won’t pay taxes on your Social Security benefits. If that number falls between $25,000 and $34,000, you may be liable for tax on up to 50% of your benefits. If your provisional income exceeds $34,000, you could have taxes on up to 85% of your benefits.
These income brackets vary for joint filers, but it is clear to see how your adjusted gross income can affect your tax bill.