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Adjusted Gross Income is one of the key ideas in tax law (AGI). After deducting certain adjustments, AGI is the amount of income that is liable to federal income tax.
Your eligibility for several tax deductions, credits, and benefits, including the standard deduction, the earned income credit, and the child tax credit, is based on your AGI. Your taxable income, which is the sum of income that is actually subject to taxation at your marginal tax rate, is likewise impacted by your AGI.
You must start by determining your gross income in order to determine your AGI. Your gross income is the sum of all your sources of income, including wages, tips, interest, dividends, alimony, company income, rental income, pensions, annuities, and more. Gifts, inheritances, life insurance proceeds, municipal bond interest, and several types of fringe perks are examples of income that are legally excluded from gross income.
Once you have your gross income, you can subtract certain adjustments to arrive at your AGI. These adjustments are also known as above-the-line deductions because they are deducted before you reach the line for AGI on your tax return. Some of the most common adjustments are:
- Educator expenses: You may deduct up to $250 in unreimbursed expenses for classroom supplies if you are a teacher or other qualified educator.
- Student loan interest: You can write off up to $2,500 of interest paid on a qualified student loan for the tax year.
- IRA contributions: You may deduct the amount you contributed to a traditional IRA up to the annual maximum of $6,000 ($7,000 if you are 50 years old or older).
- Health savings account contributions: If you have a high-deductible health plan and a health savings account (HSA), you can deduct the amount of your contributions to the HSA, up to the annual limit of $3,600 ($7,200 for family coverage).
- Self-employed health insurance: If you are self-employed and pay for your own health insurance premiums, you can deduct the amount of your premiums for yourself, your spouse, and your dependents.
- Self-employed retirement plan contributions: If you are self-employed and have a retirement plan such as a SEP IRA or a solo 401(k), you can deduct the amount of your contributions to the plan, up to the annual limit of 25% of your net self-employment income or $58,000 ($64,500 if you are 50 or older), whichever is lower.
- Self-employment tax: If you are self-employed and pay self-employment tax (which is equivalent to both the employer and employee portions of Social Security and Medicare taxes), you can deduct half of the amount of self-employment tax that you pay.
- Alimony paid: If you paid alimony to a former spouse under a divorce or separation agreement that was executed before 2019, you can deduct the amount of alimony paid during the year.
- Moving expenses for members of the armed forces: If you are a member of the armed forces on active duty and moved because of a permanent change of station, you can deduct your unreimbursed moving expenses.
These are not the only adjustments that can reduce your AGI. There are some other less common adjustments that may apply to your situation, such as tuition and fees deduction, penalty on early withdrawal of savings, jury duty pay given to the employer, and more. You can find a complete list of adjustments on Schedule 1 of Form 1040.
After subtracting all your adjustments from your gross income, you will get your AGI. Your AGI is an important number that affects many aspects of your tax situation. For example:
- Your AGI determines whether you can claim certain itemized deductions that are subject to phase-out or limitation based on your income level. These include deductions for medical expenses, state and local taxes (SALT), mortgage interest, charitable contributions, casualty and theft losses, and miscellaneous expenses.
- Your AGI determines whether you can claim certain tax credits that are subject to phase-out or limitation based on your income level. These include credits for child and dependent care expenses, education expenses, retirement savings contributions, earned income credit, child tax credit, and adoption credit.
- Your AGI determines whether you have to pay the alternative minimum tax (AMT), which is a parallel tax system that applies to certain taxpayers with high incomes and certain preferences or adjustments. The AMT has its own set of rules and rates, and may result in a higher tax liability than the regular tax system.
- Your AGI determines whether you are eligible for certain tax benefits that are not subject to phase-out or limitation, but have income thresholds for qualification. These include the student loan interest deduction, the tuition and fees deduction, the health savings account deduction, and the IRA deduction.
