What Is Adjusted Gross Income [The Ultimate Guide]

The world of taxes is full of complicated terms and phrases. While you may think a particular word means something, it may reference something else altogether when it comes to taxes!

One popular concept that often confuses people is adjusted gross income. In this article, we will answer the most asked questions: what is adjusted gross income, how it is calculated, and how it’s different from other similar references. By the end of this guide, you will be more informed about the topic. Happy reading!

What Is Adjusted Gross Income?

To break it down into simple terms, the adjusted gross income is your total income minus any tax deductions offered by the Internal Revenue Service (IRS). The income tax that you end up paying is calculated after all deductions have been made. It is important that you keep track of all of your deductions, and what you qualify for, in order to reduce your taxable income.

How Adjusted Gross Income Works

Adjusted income works by subtracting certain types of expenses from your total income. These deductions are referred to as adjustments to income since it’s changing the total amount. Here is a list of all the deductions that can be subtracted from your gross income, which should help you determine what is your adjusted gross income.

• Medical and dental expenses
• Alimony
• Moving expenses for members of armed forces
• Certain foreign earned income
• Educator expenses
• Student loan interest payments
• Self-employed SEP, SIMPLE, and qualified plans
• Self-employment tax
• Self-employed health insurance payments
• Tuition and fees
• Retirement plan contributions
• Penalties on early withdrawal of savings
• Employee business expenses for armed forces reservists, fee-based state or local government officials, qualified performing artists, and employees with impairment-related expenses

Key Takeaways 

How to Calculate Your Adjusted Gross Income

In order to calculate your individual adjusted gross income, it’s important to understand the basic process of filing taxes under the United States tax code.

You must inform the IRS about all sources of your income, including income from foreign investments, wages, capital gains, rental income, U.S. savings bonds, and money earned from dividends. The 1099 form is used by taxpayers for this purpose; the document informs the IRS of all income methods over the year. Businesses also file a W-2 form that goes over salaries and wages paid to the people working in the company, which helps calculate business income, as well as the standard income of all employees.

Once the forms are collected, the next thing to do is inform the IRS about all the items from the AGI deductions list that you are eligible for. The 1040 form is used to calculate taxable income and the amount that the government returns in the form of a refund.

Most people opt for standard deductions, which provide an average amount of deductions for a taxpayer; this include attributes like 401(k) deductions. Some opt for itemized deductions instead, where the taxpayer independently informs the IRS of specific deductions. Either way, a tax deduction should not be confused with a tax credit. Tax credits do not reduce taxable income. 

Once all of your deductions are subtracted from your total income, you’ll receive your adjusted gross income; this number is what your taxes are based on. After you’ve filed your taxes, you also need to file your federal returns as proof.

Let’s go ahead and apply the AGI formula in the following example. If an unmarried person filing individually earns a yearly $50,000 salary and $20,000 through rental income, his total income is $70,000. This taxpayer can opt for certain adjustments they qualify for, such as $500 in student loan interest, $500 in medical expenses, and $7,000 as IRS contributions. Adding up the deductions gives us a total of $8,000. Subtract $8,000 from $70,000 to get their adjusted gross income of $62,000.

Keep in mind that this is just an example; deductions are usually higher than that. There are also certain changes depending on if the person is filing jointly or separately.

Gross Income vs Adjusted Gross Income vs Modified Adjusted Gross Income (MAGI)

There is a reason why taxes intimidate people! Tax season features so many complicated terms that sound alike, when they are actually different from one another. Let’s take a look at the three terms and see how they differ:

• Gross income: Gross income is the total amount of your annual earnings. This includes income through wages, investments, rental income, and more. Gross income is the actual amount of money you earn during the fiscal year.
• Adjusted gross income: This is the total of your annual earnings minus the tax deductibles that the IRS allows. You can find your adjusted gross income on a tax return on line 8b of your 1040 form.
• Modified adjusted gross income (MAGI): Finally, this is similar to an AGI, but it adds certain modifications like foreign income or tax-exempt interest. It is calculated after you’ve calculated your AGI and have forgotten to add certain income or adjustments on your tax return. Besides that, it is very similar to AGI.

Conclusion 

An adjusted gross income is the taxable amount of how much you earned in a financial year. The number is calculated by adding all your income and subtracting various adjustments (known as deductibles) offered by the IRS. Some of the items that qualify as deductibles include medical expenses, tuition fees, and retirement plan contributions. AGI is different from gross income and MAGI. Gross income is your total income before adjustments are made, whereas MAGI is similar to AGI; it is calculated after AGI if you’ve forgotten to add certain income or adjustments.