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Understanding The Adjusted Gross Income

Modified: September 6, 2023

Written by: Leo Lete

Adjusted gross income consists of profits, rents, salaries, wages, and other forms of earnings before deductions or taxes. All of your questions answered in this guide.

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Adjusted Gross Income (AGI) is an individual’s total gross income subtracting specific deductions. It includes wages, dividends, alimony, capital gains, business income, retirement distributions, and other income.

Payments such as student loan interest, contributions to a traditional individual retirement account, health savings account, moving expenses if you’re an active-duty service member, and self-employment taxes.

AGI can directly impact the deductions and credits you’re eligible for. This will lead to a reduction in the amount of taxable income you report on the return. AGI is more useful than gross income for individual tax activities.

The deductions that change gross income to adjusted gross income are all above the line. Meaning that they are taken into account before tax exemptions for military service, dependent status.

Above the line deductions are also taken into account before any standard deductions, or before itemized deductions taken by a taxpayer on the Schedule A.

What Is Schedule A?

Schedule A is an income tax form that U.S. taxpayers use to report their deconstructed deductions. This can help reduce their federal tax liability.

Schedule A asks taxpayers to list their deductible expenses within six designated categories.

Medical and Dental Expenses
Taxes You Paid
Interest You Paid
Gifts to Charity
Casualty and Theft Losses
Other Itemized Deductions

Like the standard deduction, the itemized deductions on Schedule A are subtracted from a taxpayer’s adjusted gross income (AGI). This is done to determine one’s taxable income.

Using Schedule A to break down your deductions allows you to claim a number of personal expenses. However, it may not make sense to do so since you give up the standard deduction.

Schedule A is for itemizers who choose to select from the multitude of individual tax deductions instead of taking the flat-dollar standard deduction. Itemizing saves you money if the sum of your itemized deductions is greater than the standard deduction.

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How Can Adjusted Gross Income Affect Me?

Your adjusted gross income (AGI) is important. It is the total taxable income calculated before itemized or standard deductions, exemptions, and credits are taken into account. It dictates how you can use various tax credits and exemptions. AGI affects the amount you can claim for dependent care credit and child tax credit.

Your AGI is vital in calculating your tax bill. From your AGI, you’ll make various adjustments and subtract your allowable deductions to find the amount on which you’ll pay tax. The final sum will be your taxable income.

Adjusted gross income will be the basis of deductions and credits. You may be able to deduct unreimbursed medical expenses. However, this only applies when it’s more than 7.5% of your AGI. So the lower your AGI, the greater the deduction.

AGI influences a taxpayer’s eligibility to claim many of the deductions and credits available on the tax return.

Lower AGI = Higher Deductions

Some of your adjustments to income are subject to AGI limitations. Those deductions are necessary to calculate your AGI. If you’re looking to refund some of your tuition payments, your modified adjusted gross income (MAGI) determines whether you qualify.

Many U.S. states base a filer’s total tax bill on a calculation starting with adjusted gross income. State-specific deductions and credits are factored in to determine an individual’s taxable income.

Other Levels Of Income Relevant To AGI

Net income is the final amount of profit or loss including all expenses. If you own a business, your taxable income depends on your net income after expenses, rather than on your gross income.

It is also known as net profit or net earnings. It is the amount earned after subtracting taxes and other deductions from the gross income. For a business, net income is the amount of revenue left after subtracting all expenses, taxes and costs.

The Modified adjusted income (MAGI) is your AGI with some deductions. Tax codes use MAGI to determine if you qualify for certain tax breaks.

It determines the value you can contribute to a Roth IRA. It also dictates if you can deduct your traditional IRA contributions. Eligibility for premium tax credit also depends on your MAGI

The difference is that MAGI adds back some of the deductions you’re allowed to make when calculating AGI. Your MAGI and AGI might have the same value, but it’s normal.

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Calculating The Adjusted Gross Income

Lenders need the gross income of an individual when deciding whether or not to advance credit. The same applies to landlords when deciding whether a potential tenant will be able to pay the rent on time. It is also the starting point when calculating government owed taxes.

Your AGI will never be greater than the total income you report on the first lines of your tax return. In many cases, it will actually be lower. Total income includes all of your annual earnings that are subject to income tax

Calculating For Annual Salary Employees

If you receive an annual salary, the calculation is quite easy. Since gross income refers to the total amount you earn before tax, and so does your annual salary, take the total amount of money you’re paid for the year, and then divide this amount by 12.

Calculating For Hourly Salary Employees

For hourly employees, the calculation is more complicated. First, to find your yearly pay. Multiply your hourly wage by the number of hours you work each week. Then multiply the sum by 52. This is your annual gross income. Divide it by 12 to find the monthly amount.

After calculating AGI, the taxpayer can then apply the standard federal tax deductions to reach their taxable income. If eligible, the taxpayer can itemize their expenses and receive itemized deductions instead. This can be better for the taxpayer in some situations.

A comprehensive list of the requirements for possible deductions from gross income can be found in the Internal Revenue Code (IRC) or on the Internal Revenue Service (IRS) website.

Many of the requirements are very specific. And an individual must look very carefully at the federal tax code to make sure they are eligible prior to taking any deductions.

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How Can You Use Your AGI?

After finding out the exact amount of your AGI, you can see if you can avail certain tax credits and deductions to lower your taxable income.

Once you decide whether you’ll take the standard deduction or convert your deductions, you’ll subtract that total deduction amount from your AGI to get your taxable income.

The state you live in might ask you to file an income tax and you need to file a state return. You’ll also use your AGI as the starting point for your state return. You’ll then apply any state-based deductions, adjustments and credits to get your state taxable income.

If you live in a state that requires you to file annual income tax returns, your AGI can also impact your state taxable income. This is because many states use your federal AGI as the starting point for calculating your state taxable income.

If you claim a tax credit, such as the lifetime learning credit, for school expenses, the IRS requires that your MAGI be below certain thresholds in order to claim the credit.