Posted by Income Taxes and Bookkeeping LLC

The Concept of Adjusted Gross Income (AGI)

The Concept of Adjusted Gross Income (AGI)

TAXES!

 

You may not enjoy getting those tax deductions, but you must understand how the system works to file correctly and avoid penalties. The AGI is a vital aspect of personal income tax, and to determine how much income tax you owe annually, the Internal Revenue Service will need your AGI. So what does the adjusted gross income mean? 

Adjusted gross income is an amount of money derived from your gross income minus some adjustments. The gross income is a combination of individual earnings, such as your business income, wages, dividends, royalties, and other income. Simultaneously, the adjustments include items such as student loan interests, alimony, and educator expenses. Through the AGI, some adjustments are made to your gross income such that your tax liability is easily calculated. 

Besides individuals, some states in the United States utilize the AGI from their residents' federal returns to ascertain how much they are expected to pay for state income tax. The income items removed from your gross income to calculate your AGI are called "Adjustments" made to your income, and you are expected to report these adjustments on Schedule 1 of your tax returns when submitting your tax filings. 

Some standard adjustments you may find that applies to the AGI include: 


  • Tuition and fees 

  • Alimony 

  • IRA Deductions 

  • Student loans and interests deductions 

  • Self-employed health insurance deduction

  • Educator expenses 

  • Early withdrawal penalties on your savings 


How to calculate your AGI

You can calculate your AGI with the software used to prepare tax returns, but you can also calculate it yourself by adding your income for a year, including income from your job as shared with the IRS by your employer. Other income sources to include while preparing your AGI yourself includes dividends and other sundry income. Please note that if you file your taxes electronically, the IRS will request the AGI for the previous year to authenticate your identity. 

The next step entails subtracting the adjustments (some are mentioned above) from your total income and what you get is your adjusted gross income. If you are unsure of your adjustments, the IRS has a list of all deductions and the requirements for claiming such tax deductions on their website. 


Now you may be wondering why is all these important? Well, your AGI influences your qualification for other deductions and credits you may get from your tax returns. The lower your AGI, the more considerable the number of deductions you will be qualified to claim, and this also means you can reduce your tax bill by a significant amount. The AGI is also essential because it helps you determine if you can deduct your medical expenses. 

While considering your AGI, it is also essential to learn about your modified adjusted gross income (MAGI). MAGI is a combination of your AGI and a few adjustments added back, and the IRS uses this to ascertain your eligibility for some deductions or retirement plans. Just as it is with your AGI, your MAGI also influences your credits or other deductions. So if your MAGI is too high and your employer offers access to a sponsored retirement plan, you cannot deduct or make contributions to your individual retirement account (IRA). 


Taxes are just as necessary as your income, and this is why you must dedicate time to learning how the system works. This realization explains why so many people pay attention to their AGI because no one wants to pay more than they should in taxes. Finally, given the AGI's advantages, you should know how it works for your financial benefit, and this article has provided all the answers.


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