What Is Adjusted Gross Income & Why Does It Matter?
Some technical terms you have to deal with throughout your life can be difficult to understand. Some of the most common terms that pop up mainly in regard to taxes include gross income, adjusted gross income (AGI) and modified adjusted gross income (MAGI).
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Knowing the difference between gross income versus adjusted gross income will help you better understand how your taxes and finances work. And, once you understand that, you’ll be more fit to navigate all this.
What Is Adjusted Gross Income?
Your gross income, according to the Internal Revenue Service, consists of all your income from all sources. Gross annual income includes obvious sources of income, such as your wages, bonuses, self-employment income and passive income, which includes rental income, capital gains, interest and dividends.
So, what is AGI? Your AGI is your gross income minus all the adjustments to income you claim on your tax return.
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How To Calculate AGI
You don’t need an adjusted gross income calculator to figure out your AGI. It’s very straightforward — for instance, if your gross income is $47,000 and you claim $2,000 in adjustments to income, your AGI is $45,000.
You won’t find your AGI on your W-2, but you can find it on Line 37 of Form 1040. Learning how to calculate your adjusted gross income enables you to determine which of the income tax brackets you’re in and what your federal income tax rate will be.
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What Is an Adjustment to Income?
An adjustment to income is a tax deduction you can take whether you claim the standard deduction or itemize your deductions. Sometimes, adjustments to income are referred to as “above the line deductions” because they reduce your gross income even if you don’t itemize.
Expenses that qualify as adjustments to income include traditional IRA contributions, HSA contributions, student loan interest, educator expenses and any penalties you paid for early withdrawals from a CD. For example, if you made a $1,500 deductible contribution to your traditional IRA and paid $500 in student loan interest, you would have $2,000 worth of adjustments to income.
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What Is Modified Adjusted Gross Income?
Different tax deductions and credits affect what modified AGI means for everyone. For example, if you’re calculating your MAGI to see if you qualify to deduct your traditional IRA, you first have to add back your IRA deduction, student loan interest, tuition and fees and several other adjustments to your income. If you’re calculating your modified adjusted gross income to see if you qualify for the lifetime learning credit, however, you don’t have to add back any amounts you claim as IRA or student loan interest deductions.
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Why Do AGI and MAGI Matter?
AGI and MAGI matter because many tax deductions and credits are available only if your AGI or MAGI falls below a certain number. In addition, Social Security uses your adjusted gross income to help calculate how much of your Social Security benefits are taxable. Planning ahead can help you time your expenses to qualify for as many tax breaks as possible — and maximize your refund.
This article is part of GOBankingRates’ ‘Economy Explained’ series to help readers navigate the complexities of our financial system.
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Chris Jennings contributed to the reporting for this article.
This article originally appeared on GOBankingRates.com: What Is Adjusted Gross Income & Why Does It Matter?
