Understanding Adjusted Gross Income (AGI) and How It Impacts Your Taxes

What Is Adjusted Gross Income (AGI)?

Adjusted gross income (AGI) is the number that the Internal Revenue Service (IRS) uses to determine your income taxes owed for the year. It represents your total taxable income after specific adjustments, influencing not only how much tax you owe but also your eligibility for certain tax deductions and credits. Understanding your AGI can help maximize your returns and ensure compliance with tax laws.

Breaking Down Adjusted Gross Income (AGI)

Gross income is all the money you earn in a year, like wages, dividends, capital gains, interest, and rental income, before taxes or deductions.

AGI makes certain adjustments to your gross income to reach the figure on which your tax liability will be calculated.

Many U.S. states use AGI from federal returns to decide state income taxes, often adjusting it with state-specific deductions and credits.

Typical Adjustments That Affect AGI

Adjustments to income are subtracted from your gross income to find your AGI, reported on Schedule 1 of your tax return. Some of the most common adjustments include:

• Early withdrawal penalties on savings
• Educator expenses
• Employee business expenses for armed forces reservists, qualified performing artists, fee-basis state or local government officials, and employees with impairment-related work expenses (Form 2106)
• Health Savings Account (HSA) deductions (Form 8889)
• Moving expenses for members of the armed forces (Form 3903)
• Some IRA contributions (Schedule 1)
• Self-employed Simplified Employee Pension (SEP), Savings Incentive Match Plan for Employees of Small Employers (SIMPLE), and qualified plans
• Self-employed health insurance deduction
• Self-employment tax (the deductible portion)
• Student loan interest deduction

Calculating Your Adjusted Gross Income: A Guide

Tax software calculates your AGI from your income. If you do it manually, add up all your income, such as job earnings on a W-2 form, as well as other sources like dividends and self-employment income from 1099 forms.

Then, add taxable income from other sources, such as profits from property sales, unemployment benefits, pensions, Social Security benefits, and IRA contributions. Many of these items are also listed on IRS Schedule 1.

Subtract Your Adjustments

Subtract your applicable adjustments to get your AGI.

To find your taxable income, subtract your standard or itemized deductions from your AGI.

The standard deduction for tax returns for married couples filing jointly is $29,200 for the 2024 tax year or $14,600 for single filers. Taxpayers whose itemized deductions exceed that amount would generally opt to itemize, while others would take the standard deduction.

The IRS provides a list of itemized deductions and the requirements for claiming them on its website. Your AGI also affects your eligibility for many of these deductions and tax credits.

The lower your AGI, the more significant the number of deductions and credits you'll generally be eligible to claim, and the more you'll be able to reduce your tax bill.

Example: When AGI Impacts Your Deductions

Let's say you had some significant dental expenses during the year that weren't reimbursed by insurance, and you've decided to itemize your deductions. You're allowed to claim an itemized deduction for the portion of those expenses that exceed 7.5% of your AGI.

This means that you can deduct the amount that exceeds $7,500, or $4,500, if you report $12,000 in unreimbursed dental expenses and have an AGI of $100,000. But the 7.5% reduction is just $3,750 if your AGI is $50,000, and you'd be entitled to deduct a larger amount, $8,250 in this case.

Comparing AGI and MAGI: What You Need to Know

Some tax calculations and government programs are based on your modified adjusted gross income, or MAGI. This figure starts with your AGI, then it adds back certain items, such as any deductions you take for student loan interest or tuition and fees.

Your MAGI determines how much, if anything, you can contribute to a Roth individual retirement account (Roth IRA) in any given year. Pre-tax contributions to traditional 401(k) funds help to reduce your AGI and MAGI taxable income. Roth IRA contributions are made with after-tax dollars and won't further reduce your AGI or MAGI.

It's also used to calculate your income if you apply for Marketplace health insurance under the Affordable Care Act (ACA).

Many people with relatively uncomplicated financial lives find that their AGI and MAGI are the same.

Distinguishing AGI, Gross Income, and Taxable Income

Your gross income is all the money you've earned in a year that isn't exempt from taxation. This income can be in the form of salary, wages, self-employment income, interest, dividends, or capital gains.

Your adjusted gross income is that amount minus certain qualified expenses and adjustments.

You then subtract either the standard deduction or the total of your itemized deductions for the year. You can't take both itemized deductions and the standard deduction.

The result is your taxable income.

The Bottom Line

Your Adjusted Gross Income (AGI) plays a crucial role in determining your taxable income and eligibility for various deductions and tax credits. Begin with your gross income, then subtract qualified adjustments to arrive at your AGI. These adjustments can include student loan interest and contributions to retirement accounts, which provide significant tax advantages. AGI affects both your federal and state taxes and can impact your eligibility for additional deductions and credits. Remember, your AGI can influence how much you owe or receive as a refund, so understanding how to calculate it properly is essential for optimized tax filing.