Definition
Adjusted Gross Income (AGI) is a measure of income calculated from your total gross income and used to determine how much of your income is taxable. It reflects your gross income minus specific deductions. The Internal Revenue Service (IRS) uses AGI to measure the amount of income that can be taxed.
Key Components of AGI
Gross Income
Gross income includes all income you receive in the form of money, goods, property, and services that are not exempt from tax. This includes wages, dividends, capital gains, business income, and retirement distributions.
Specific Deductions
Specific deductions, also known as “above-the-line” deductions, reduce your gross income to arrive at AGI. These can include:
- Educator expenses
- Student loan interest deduction
- Alimony payments (for agreements before 2019)
- Contributions to traditional IRAs
- Self-employment tax (half)
- Health Savings Account (HSA) contributions
- Tuition and fees
How to Calculate AGI
To calculate AGI, follow these steps:
-
Calculate Gross Income:
$$ \text{Gross Income} = \text{Wages} + \text{Dividends} + \text{Interest} + \text{Capital Gains} + \text{Rental Income} + \ldots $$ -
Subtract Specific Deductions:
$$ \text{AGI} = \text{Gross Income} - \text{Specific Deductions} $$
Formula
Special Considerations
Importance in Taxation
AGI is crucial for determining eligibility and limits for numerous tax credits and deductions such as the Earned Income Tax Credit (EITC), Child Tax Credit, and education credits. It also affects phase-out levels for itemized deductions and personal exemptions.
Adjustments for Different Taxpayers
Adjustments or deductions can vary significantly for different taxpayers. For example, a self-employed individual may have different deductible expenses compared to a salaried employee.
Examples
Example 1: Basic Calculation
- Total Gross Income: $75,000
- Retirement Contributions: $5,000
- Student Loan Interest: $1,500
AGI Calculation:
Example 2: Self-Employed Individual
- Total Gross Income: $120,000
- Health Insurance Deductions: $12,000
- Self-Employment Tax (half): $8,000
AGI Calculation:
Historical Context
The concept of AGI was introduced to ensure a fair taxation process by reflecting a taxpayer’s ability to pay based on their adjusted income. It evolved with various tax reforms to adapt to the changing economic landscape and policy objectives.
Comparisons
AGI vs. Gross Income
Gross Income includes all sources of income, whereas AGI subtracts specific deductions from the Gross Income.
AGI vs. Modified Adjusted Gross Income (MAGI)
MAGI is AGI further adjusted by adding certain items back to it. It is used to determine eligibility for specific tax benefits such as the ability to contribute to a Roth IRA or to determine the income phase-outs for certain deductions and credits.
Related Terms
- Gross Income: The total income earned by an individual before any deductions.
- Taxable Income: The amount of income that is subject to income tax, which is calculated as AGI minus either the standard deduction or itemized deductions.
FAQs
What is the significance of AGI in tax filing?
Can AGI be negative?
Is AGI the same for federal and state taxes?
References
- Internal Revenue Service. “Publication 17, Your Federal Income Tax.”
- Tax Policy Center. “Glossary: Adjusted Gross Income (AGI).”
- Investopedia. “Adjusted Gross Income (AGI).”
Summary
Adjusted Gross Income (AGI) is a critical figure in the tax system, reflecting an individual’s total gross income minus specific deductions. It informs eligibility for various tax credits and deductions and forms the basis for calculating taxable income. Through understanding AGI and its implications, taxpayers can better navigate their financial and tax planning.
