Definition
Adjusted Gross Income (AGI) is a measure of income calculated from your gross income and used to determine how much of your income is taxable. It’s found on your federal tax return, and it includes income from all sources minus certain deductions. These deductions can include things like student loan interest, alimony paid, retirement contributions, and certain expenses related to business or rental activities.
Phonetic
The phonetics of “Adjusted Gross Income (AGI)” is as follows:Adjusted – ə-ˈjəs-tədGross – grōsIncome – ˈin-ˌkəmAGI – /ˌeɪˈdʒiˈaɪ/
Key Takeaways
<ol><li>Adjusted Gross Income (AGI) is a measure of income calculated from your gross income and it is used to determine how much of your income is taxable. It includes wages, dividends, alimony, capital gains, business income, rental income and any other income sources, adjusted by deductions like student loan interest, alimony payments, retirement contributions and others permitted by the IRS.</li><li>AGI is significant because it’s the starting point for calculating your tax bill. It not only influences your tax bracket, but also impacts your eligibility for numerous tax credits and deductions that could greatly reduce your taxable income. For instance, several tax rules have income limits, and your AGI is the benchmark for these cutoffs.</li> <li>Understanding your AGI can help you strategically manage your financial obligations. By correctly calculating your AGI and understanding its impact, you can make decisions that reduce your tax burden, such as increasing retirement contributions, making deductible expenses before the end of the year, or delaying income to a future year.</li></ol>
Importance
Adjusted Gross Income (AGI) is an important term in business/finance as it signifies an individual’s total gross income minus specific deductions. It is crucial for determining a taxpayer’s overall tax liability. AGI serves as a basis in calculating an individual’s taxable income, which is used to figure out how much one owes in federal and various state taxes. Additionally, it is used to determine eligibility for certain tax credits and deductions, such as those for retirement contributions and student loan interest. Thus, lower AGI can potentially lead to substantial tax savings. Overall, understanding and accurately calculating one’s AGI is vital for effective tax planning and management.
Explanation
Adjusted Gross Income (AGI) serves as a critical measure in the calculation of a person’s tax liabilities. It is basically the sum of all your incomes – earned or unearned – minus allowable deductions. The purpose of AGI is to provide a standardized measure that the IRS can use to determine a taxpayer’s eligibility for certain tax benefits. It provides a more accurate representation of an individual’s ability to pay taxes than merely looking at total income. This is because it reflects the taxpayer’s income after accounting for specific adjustments, hence giving a more realistic perspective on the taxpayer’s financial capacity. Another critical purpose of AGI is that it is used as a baseline to determine the applicability and extent of many deductions and credits. Different tax rules and exceptions apply depending on a person’s AGI. For instance, certain deductions like medical expenses are only possible if they exceed a certain percentage of your AGI. Therefore, accurately calculating AGI can help taxpayers maximize their deductions and minimize their tax liability. Moreover, many IRS forms require taxpayers to state their AGI from the previous year; this can affect the taxpayer’s eligibility for various credits and deductions in the current year.
Examples
1. Self-Employment: Victor is a freelance designer. He earned $80,000 in 2021. However, he had business expenses including the purchase of a new computer and software, leasing office space, and travel expenses for client meetings, totalling to $20,000. Victor’s Adjusted Gross Income (AGI) would be his total income of $80,000 minus the $20,000 in business expenses, or $60,000. 2. Retirement Contributions: Lisa is a school teacher making $50,000 per year. Every year, she contributes $3,000 to her traditional IRA (Individual Retirement Account). In this case, Lisa’s AGI would be her gross income of $50,000 reduced by the $3,000 contribution to her IRA, totaling $47,000.3. Alimony Payment: James is an engineer making $100,000 per year. He pays $15,000 per year in alimony to his ex-spouse as stated in their divorce agreement. Under the prior tax law, James could deduct this from his income. Thus, his AGI would be his gross income of $100,000 minus the $15,000 alimony payment, resulting in an AGI of $85,000. Note: The tax treatment of alimony changed as of January 1, 2019, with the enactment of the Tax Cuts and Jobs Act, and such payments are no longer deductible for divorce agreements established or altered after this date.
Frequently Asked Questions(FAQ)
What is Adjusted Gross Income (AGI)?
Adjusted Gross Income (AGI) is a measure of income calculated from your gross income and used to determine how much of your income is taxable. It’s found on your 1040 form and you can calculate it by taking your gross income from wages, interest, dividends, etc., and subtracting specific deductions.
How is the Adjusted Gross Income used?
Your AGI is used to determine your eligibility for certain tax credits and deductions. It is also used to calculate your taxable income, which is the income you’re actually taxed on.
How do I calculate my AGI?
You calculate your AGI by first determining your gross income, which includes all your earned income (salary, wages, tips, etc.), unearned income (interest, dividends, etc.), and other income. Then, you subtract specific allowable adjustments, including certain types of business expenses, student loan interest, contributions to certain retirement accounts, and more.
Can the AGI affect my eligibility for financial aid?
Yes, your AGI can affect your eligibility for financial aid. Colleges, universities, and the federal government will look at your AGI when determining your financial need for assistance like grants, loans, and work-study jobs.
What’s the difference between Gross Income and Adjusted Gross Income?
Gross income includes all income you receive in the form of money, goods, property, and services that are not exempt from tax. On the other hand, Adjusted Gross Income is gross income minus adjustments to income such as contributions to a qualified IRA, certain education expenses, student loan interest, and more. These adjustments help to lower your overall tax burden.
How can I lower my AGI?
There are several ways to lower your AGI, including contributing to retirement accounts, taking deductions for student loan interest, medical expenses, and certain business expenses, among others. Speak with a tax professional to understand all options available to you.
Is the Adjusted Gross Income the same as taxable income?
No, taxable income is calculated by subtracting personal exemptions and itemized or standard deductions from your AGI. The AGI is thus a step in the direction of determining your final taxable income.
Related Finance Terms
- Taxable Income
- Itemized Deductions
- Standard Deduction
- Filing Status
- Business Expenses
Sources for More Information
