When it comes to doing your taxes, you’ll no doubt run into a slew of acronyms. Most of us quickly learned about FICA. That first official paycheck in the working world taught us that our money had responsibilities long before it reached our hands.
Now that we’ve worked a few years, our focus is on keeping as much of our hard-earned money as possible. That’s where adjusted gross income, or AGI, comes in.
In this post, I’ll boil down AGI to show you what it means, how it works, how to calculate it, and how it influences deductions and credits. Of the many acronyms you’ll encounter, AGI is one of the most impactful during tax time.
What Is Adjusted Gross Income?
AGI is the monetary figure the IRS uses to determine your tax bill and establish your eligibility for certain credits, deductions, and programs. It’s a subset of your total (gross) income – a benchmark that determines what portion of your income is taxable.
To determine your AGI, you’ll need to add up your income received from all sources, such as:
- Employment income reported on a W-2 or 1099
- Taxable interest payments
- Profits from real estate holdings or sales
- Federal unemployment benefits
- Distributions from pensions or annuities
- Taxable IRA distributions
- Capital gains from investments
- Social security benefits (excluding supplemental security income)
- Income from awards, sweepstakes, or gambling
Of course, there are always exceptions, since some people don’t meet income requirements to file taxes. However, if you’re required to file, the next step to determining AGI involves making qualified deductions.
How Is AGI Calculated?
If you use tax software programs, AGI is calculated as you enter your financial data such as income, expenses, and losses. You may see AGI referred to as the result of “above-the-line deductions” or “adjustments to income.” This just means that certain income deductions can be taken before you itemize or take the standard deduction.
Some common above-the-line deductions include:
- Retirement plan contributions
- Health savings account (HSA) contributions
- Education expenses for teachers and qualified instructors
- Student loan interest
If you’re self-employed, you may also figure in deductions for paying health insurance self-employment tax (SECA). Depending on other unique circumstances, you may be able to deduct alimony payments and certain moving expenses, but in most cases, you’ll have to meet stringent requirements to be able to claim these deductions due to tax reforms outlined in the Tax Cuts and Jobs Act (TCJA) in recent years. For example, no alimony payments may be deducted for divorces that occurred after 2019.
Once you tally your gross income and subtract all qualified above-the-line deductions, you’ll know your AGI. Here’s an tax calculator to help.
How Does AGI Impact Deductions and Credits?
Once you’ve calculated your AGI, you can further reduce your tax debt by itemizing deductions or taking the standard deduction based on your filing status. You can consult the tax program you use or your tax professional on which option is more advantageous. Your AGI will also reveal credits that can further drive down your tax burden or possibly boost your refund amount.
Your AGI will also help to determine your modified adjusted gross income (MAGI), which will be equally as important when qualifying for certain deductions or credits. Your MAGI will also determine if contributions to an IRA are deductible. To learn more about MAGI, check out this helpful explanation from TurboTax, a leading self-directed tax software platform.
AGI and Qualified Deductions
Remember those above-the-line deductions I mentioned? Well, there are below-the-line deductions, too. On a tax return, it’s any deduction below the line where your AGI is entered.
In general, you’ll itemize deductions if they are greater than the standard deduction. Some commonly used itemized deductions include breaks for paying state and local taxes, property taxes, charitable contributions, mortgage interest, and sales tax. Some filers can’t use the standard deduction:
- If you are married filing separately and your spouse itemizes
- If you change your accounting method and file a tax return that covers less than 12 months as a result
- If you are a nonresident alien or dual status alien during the year unless you married a U.S. citizen or resident alien and choose to be treated as a U.S. resident for tax purposes
- If you are filing taxes for an estate, trust, common trust fund, or partnership
Your qualified below-the-line deductions are subtracted from your AGI to help ease your tax burden. Taking time to explore every possible deduction helps and also prepares you to be in a position to take advantage of more deductions in the future.
AGI and Qualified Credits
Some credits, such as the Earned Income Tax Credit (EITC), are available if your 2019 income falls within AGI limits and your investment income was $3,600 or less. You may be able to qualify for EITC without a qualifying child. For tax year 2019, the AGI thresholds for claiming the credits are:
Filing single, head of household, or widowed:
- No qualified children: $15,570
- One qualified child: $41,094
- Two qualified children: $46,703
- Three or more qualified children: $50,162
Married filing jointly:
- No qualified children: $21,570
- One qualified child: $46,884
- Two qualified children: $52,493
- Three or more qualified children: $55,952
For a complete list of deductions and credits, check out the following IRS resources:
- IRS Topic 500 – A list of all available itemized deductions
- IRS Topic 501 – Advice on itemizing or taking the standard deduction
- Credits and deductions for individuals – Provides a list of deductions and credits for individual filers and outlines the qualifying data
- Credits and deductions for businesses and the self-employed – This IRS resource breaks down deductions and credits that are specific to businesses.
AGI and Free Tax Filing
The IRS offers programs to tax filers based on AGI such as Free File, a free federal tax prep and e-file benefit for taxpayers. If your AGI is $69,000 or less, you can take advantage of free support to file your taxes electronically. There are also many tax preparation software programs, such as FreeTaxUSA, that offer free tax filing as well.
Understanding AGI: Key Takeaways
To recap, here are a few main points to remember to help you understand AGI and how it affects you at tax time:
- AGI is the total amount of income you received in a calendar year minus qualified above-the-line deductions.
- AGI is reported on IRS Form 1040 and used as a basis for determining tax liability.
- AGI is a key deciding factor in eligibility for deductions and credits to further reduce tax debt.
- MAGI, which may be identical to or more than AGI, is also used to determine access to certain deductions and credits.
If you missed out on some deductions or credits last year, learn more about AGI and position yourself to qualify for more tax advantages in 2020.