Adjusted gross income (AGI) is your total income from all sources minus deductions and credits. Then, you can assess whether you qualify for certain contributions and credits such as Roth IRA contributions.
Let us discuss what is AGI, how it is calculated, and its important considerations with it.
What is Adjusted Gross Income (AGI)?
The adjusted gross income (AGI) is your annual income that is adjusted for deductions and credits for tax filing.
It is the first step when calculating your tax liability for the year. You’ll include all sources of taxable income and deduct allowed expenses and credits.
Once you know your taxable income or the AGI for the year, you can easily calculate the tax payable.
If you meet the IRS income threshold, you’ll need to file for taxes. Even if you don’t need to file taxes, you should file the returns as suggested by the IRS.
Filing taxes would enable you to claim some tax credits even when you are a non-filer.
You can use the IRS income estimator to figure out if you meet the minimum taxable income requirement.
How to Calculate the Adjusted Gross Income (AGI)?
Before you start calculating AGI for the year, consider your tax filing status. Determine whether you file as an individual, self-employed, small business owner, or other status depending on how you earn money.
Then, you can follow these steps listed below to determine your adjusted gross income for the year and finally calculate your tax liability before filing the returns.
Remember, your adjusted gross income cannot exceed the total income you earn in a tax year. It will always be adjusted for credits and deductions and will be lower than your gross annual income.
Compile Your Income Statements
The first step is to compile your income statements. It simply means gathering all your sources of income in one place.
Your tax liability includes income from all types of sources whether through a salary or the sale of a property.
Your typical annual sources of income include:
- Your salary or wages from work reported on a Form W-2
- Income from self-employment, which is calculated on Schedule C
- Taxable interest earned and dividends
- Taxable alimony payments you receive from a former spouse
- Capital gains
- Rental income
- Any other payment you receive during the year
You’ll report each type of income on the relevant IRS Form. For instance, you’ll use Form 1099-INT for taxable interest and 1099-DIV for dividends received.
Similarly, you’ll use Form 1099-S from proceeds received through real estate transactions during the year.
You should also include other or miscellaneous sources of income in the calculations.
Some of these sources may include:
- Jury Duty Fee
- Business Income
- Farm Income
- Taxable refunds, credits, and local income tax offsets
- Gambling wins, lotteries, awards, etc.
- Back payments from lawsuits or other sources
- Earnings from royalties, patents, partnerships, and other sources
You’ll report the miscellaneous sources of income on Form 1099-MISC and they will be calculated in your AGI for the tax year.
Excluding Non-Taxable Income
You can exclude certain sources of income as non-taxable income from the AGI calculations.
Some of these income sources include:
- Child support payments
- Reimbursements for qualified adoption expenses
- Gifts, bequests, and inheritances
- Cash rebates from a dealer or manufacturer for an item you buy
- Welfare benefits
- Damage awards for physical injury or sickness
- Meals and lodging for the convenience of your employer
Also, remember that some types of income sources may or may not be taxable income. It will depend on the terms allowed by the IRS.
- Scholarships and fellowships
- Life Insurance
- Awards from employees
- Fringe benefits
- Sick pay leave
- Social security benefits
- Worker’s compensation benefits
- Nonqualified deferred compensation plans
- Nonqualified deferred compensation plans of nonqualified entities
You should check the rules according to the situation and determine whether they should be included in the AGI calculations or excluded.
Deductions and Expenses
The next step is to deduct certain expenses and adjust your income for credits. Some broadly used credits are mentioned below.
Family and Dependent Credits
Common tax credits in this category include childcare tax credits (CTC), tax credits for other dependents, and advance payments for the childcare tax credit.
You can check whether you qualify for the adoption credit and other dependent tax credits as well.
Income and Savings Credits
Some common types of income and savings credits include retirement saving contribution credit (Saver’s Credit), foreign tax credit, credit for tax on undistributed capital gains, and credit for the previous year’s minimum tax payment.
Healthcare Credits
Healthcare tax credits include the premium tax credit and health coverage credits. Check for the qualification criteria and allowed limits for adjustments.
Education Credits
You can deduct the American Opportunity Credit and Lifetime learning credit for your qualified educational expenses under this section.
Some widely used deductions for individuals include the following.
Work-Related Deductions
These expenses include your business expenses, business use of car and home, employee business expenses, and so on.
You can also qualify for work-related educational expenses in some cases.
Itemized Deductions
You’ll consider the itemized or standard deductions for these expenses first. Then, deduct the following expenses where applicable:
- Deductible taxes
- State and local tax deduction limit
- Property tax and Real estate tax
- Sales tax
- Charitable contributions
- Gambling loss
- Miscellaneous expenses
- Interest expense
- Home mortgage interest
- Moving expenses
Health and Education Deductions
Your health deductions include expenses for medical and dental costs. You can also deduct the HSA contributions.
Your educational expense deductions include interest paid on a student loan, work-related educational expenses, and teacher educational expenses for classrooms and schools.
Modified Adjusted Gross Income (MAGI)
In some cases, taxpayers may need to use the modified adjusted gross income (MAGI) instead of AGI.
Your modified adjusted gross income helps IRS to determine whether:
- You qualify to contribute to a Roth Individual Retirement Plan (IRA) if your income does not exceed a certain level.
- You can deduct traditional IRA contributions when you and your spouse have retirement plans at work like a 401(k).
- You can deduct the premium tax credit (PTC) on a health insurance plan purchased from the state or a federal health insurance marketplace.
It is important to determine your AGI limit first and then calculate the MAGI. It will then determine whether you can deduct the Roth IRA or IRA contributions if you and your spouse already have a retirement plan at work.
Why Calculating AGI is Important?
Calculating AGI will determine your itemized deductions, calculate MAGI, and determine your final payable tax amount as well.
For example, if you itemize your medical expenses set at 7.5% of your AGI, you can work it out in the following way:
If your AGI is $80,000 and the medical expense is $9,000, you’ll reduce the deduction by $7,500. But if your AGI is $50,000, you’ll reduce the deduction by only $3,750.
Important Considerations when Calculating the AGI
Some deductions are a percentage of your calculated AGI. For example, your medical expenses (10%) as mentioned above and charitable donations (60%) of your AGI.
Other deductions are set figures with limits set by the IRS. Thus, calculating AGI is useful in several ways to correctly apply deductions and tax credits.
Once you have adjusted and correctly calculated the adjusted gross income, you’re ready to file your tax returns through e-filing or a tax preparer.
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