When you file a tax return, you will always see a line to figure out your adjusted gross income, or AGI, before arriving at your taxable income number. The AGI calculation depends on the tax return form you use; some forms allow you to take more adjustments to income than others.
Reporting total income
Your AGI will never be more than the total income you report on the first lines of your tax return, and in many cases, it will actually be lower. Total income includes all of your annual earnings that are subject to income tax. This typically includes:
- Your wages from work reported on a Form W-2
- Income from self-employment, which is usually calculated on Schedule C
- Taxable interest and dividends
- Taxable alimony payments you receive from a former spouse
- Capital gains
- Rental income
- Any other payment you receive that isn’t specifically exempted from the income tax
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Deductions for AGI
Throughout your tax return form, there are many opportunities to take deductions, some of which reduce your total income to determine AGI, and some that are taken in later parts of the return.
The deductions you take to calculate AGI are referred to as “adjustments to income.” These are specific expenses that the IRS allows you to use to effectively reduce your total income to arrive at your AGI. You’ll sometimes hear these referred to as “above the line” deductions.
Tax laws change every year, but some examples of adjustments to income include:
- Expenses you incur as an educator to purchase supplies and materials for the classroom.
- Student loan interest and tuition payments.
- Contributions to your IRA accounts.
Deducting your eligible adjustments from your total income results in your AGI.
Significance of AGI
The amount of your AGI directly influences your eligibility to claim many of the deductions and credits available on your tax return.
If you itemize deductions and report medical expenses, for example, you must reduce the total expense by 7.5% of your AGI for 2019 (10% beginning in 2020).
- So, if you report $10,000 in medical expenses and an AGI of $100,000; you must reduce your deduction by $7,500.
- But, if your AGI is $50,000, the reduction is only $3,750.
Generally speaking, the lower your AGI, the greater the deductions and credits you’ll be eligible to receive.
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Modified Adjusted Gross Income (MAGI)
Throughout your return you’ll notice that the IRS also uses modified adjusted gross income, or MAGI. Your MAGI is your AGI increased or decreased by certain amounts that are unique to specific deductions.
For example, you must calculate your MAGI if you want to deduct some of your student loan interest payments. For this deduction, your MAGI will be your AGI plus certain exclusions and deductions you’ve claimed for residency outside of the United States, such as the foreign earned income exclusion.
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