When it comes to filing taxes, your Adjusted Gross Income (AGI) plays a central role in determining what you owe - or what you may get back.
But what exactly is AGI, and why is it so important?
What is Adjusted Gross Income (AGI)?
Adjusted Gross Income (AGI) is your total income for the year minus certain adjustments or deductions, such as student loan interest, retirement contributions, or educator expenses. AGI is calculated using IRS Form 1040 and is a key number that influences your tax liability, eligibility for deductions, credits, and even certain benefits.
How Is AGI Calculated?
To calculate AGI, you start with your gross income, which includes:
Wages, salaries, and tips
Business income
Rental income
Capital gains
Dividends and interest
Unemployment compensation
Alimony (for agreements prior to 2019)
From that amount, you subtract specific adjustments to income, such as:
IRA contributions
Health savings account (HSA) contributions
Student loan interest deduction
Moving expenses for active-duty military members
Educator expenses
Example Calculation:
Gross Income: $85,000
Adjustments: $5,000 (IRA contributions and student loan interest)
AGI: $80,000
Why Does AGI Matter?
AGI influences multiple aspects of your tax return, including:
Tax Bracket
AGI determines your tax bracket and, subsequently, how much tax you owe.
Tax brackets determine the percentage of tax you pay on different portions of your income. The U.S. tax system is progressive, meaning as your income increases, so does the tax rate applied to each income range or “bracket.” Each bracket has a specific tax rate, and only the income that falls within that range is taxed at that rate. This structure is intended to make higher earners pay a higher percentage of their income in taxes than lower earners.
Eligibility for Tax Credits
Certain credits, like the Earned Income Tax Credit (EITC) and Child Tax Credit, have AGI limits. Exceeding these limits can reduce or eliminate your eligibility to earn these tax credits.
Deductions
Many tax deductions, such as medical expenses and charitable contributions, are calculated as a percentage of AGI. Lowering your AGI can increase your deduction amount.
Good to Know:
Your AGI is not the same as your Modified Adjusted Gross Income (MAGI). MAGI further adjusts AGI by adding back certain deductions like tax-exempt interest. It is often used to determine eligibility for specific credits, deductions, and benefits, such as Roth IRA contributions. MAGI is a slightly adjusted version of AGI that gives the IRS a more comprehensive view of your income for tax purposes.
Pro Tip: Review your income and potential deductions before the end of the year to identify ways to lower your AGI. Contributions to retirement accounts, HSAs, or charitable donations can all help reduce your AGI and potentially save you money come tax season.
The tax professionals at AMG Finance can help you maximize deductions to lower your AGI. Contact us to schedule an appointment with the pros at your local office.
