Adjusted Gross Income (AGI) takes into account adjustments that reduce your taxable income and help determine your tax liability for the year.
When filing your taxes, your annual salary and income are just a starting point. What the Internal Revenue Services (IRS) is actually concerned with every year is your adjusted gross income (AGI). Your AGI takes into account adjustments that reduce your taxable income. This results in the number that is used to file your tax return and determines how much tax you or your company owe to the government each year.
What is Adjusted Gross Income?
The IRS officially defines AGI as “gross income minus adjustments to income.” Gross income accounts for all money you earned during the year, including wages, dividends and earnings from business or property. Gross income does not include things like Social Security benefits or life insurance proceeds, which are not considered income by the IRS.
Adjustments to income are deductions that reduce your taxable income amount, allowing you to take advantage of a lower tax bracket and other tax credits. The IRS permits specific deductions for business, performing arts, school teachers, retirement savings, pensions, higher education expenses and health savings accounts, just to name a few.
You can find the full list of allowable credits and deductions, and the requirements to take each, on the IRS website.
How to Calculate Adjusted Gross Income
To calculate your AGI, it’s easiest if you have all of your annual tax forms handy. You will first need to calculate your total annual income from all sources, including salary reported on a Form W-2, self-employment income, taxable interest from bank accounts or other sources, unemployment earnings, and dividends and capital gains. These forms are typically mailed to you early in the year so that you have enough time to file your taxes before the deadline.
Calculating your AGI means subtracting allowable deductions from your total income for the year. The tax form you use will walk you through the allowable adjustments including those mentioned above. Each tax form is slightly different so it helps to read through everything closely.
Example of Adjusted Gross Income
A simple AGI calculation looks like this: If you earned a salary of $60,000 and interest income of $5,000, your total income for the year is $65,000. If you paid $3,000 in student loan interest and contributed $5,000 to your retirement account, you would have $8,000 in adjustments. That would bring your AGI to $57,000.
It’s the $57,000 figure that is used to determine your tax liability. Generally, the lower your AGI, the more deductions and credits you are eligible to receive.
While the calculation above seems relatively straightforward, calculating your AGI is not always that simple. It’s best to work with a tax professional to make sure you haven’t overlooked anything, and that you are actually eligible for the adjustments you are seeking.