Adjusted Gross Income: Understanding the Basics
As a taxpayer, it’s important to understand your Adjusted Gross Income (AGI). Your AGI is a crucial number that determines how much tax you owe or if you’re eligible for certain credits and deductions. In this post, we’ll discuss what AGI is, why it matters, and how you can calculate it.
What is Adjusted Gross Income (AGI)?
Your Adjusted Gross Income (AGI) is your total income minus any adjustments made to arrive at a taxable income figure. The IRS defines AGI as “gross income minus adjustments to income.” These “adjustments” are certain types of expenses that are allowed by the IRS to be deducted from your gross income before taxes are calculated.
Why Does Your AGI Matter?
Your AGI plays an essential role in determining your tax liability. It’s used as the starting point for calculating several other tax-related numbers, including your taxable income, standard deduction, itemized deductions, personal exemptions, and eligibility for certain credits.
How Do You Calculate Your AGI?
Calculating your AGI requires adding up all of your sources of taxable income for the year and then subtracting any adjustments. Some examples of adjustments include:
– Contributions to traditional IRAs
– Certain education expenses
– Alimony payments
– Health savings account contributions
– Student loan interest payments
Once you’ve subtracted these adjustments from your total gross income amount, you’ll have arrived at your adjusted gross income figure.
What Is Included in Your Gross Income?
Your gross income includes all money earned during the year from various sources such as:
– Wages/salary/paychecks
– Tips/gratuities/ bonuses/commissions/overtime pay
– Interest/dividends/capital gains/rental property earnings
– Social Security benefits/retirement plan distributions
– Unemployment compensation/alimony received
It’s important to note that not all income is taxable. Some types of income like gifts, inheritances, and life insurance proceeds are not considered taxable by the IRS.
Why Are Adjustments Made To Gross Income?
The adjustments to gross income are expenses that Congress has determined taxpayers should be able to deduct before they calculate their taxes. The idea behind these deductions is to help alleviate some of the tax burden for taxpayers who have incurred certain costs during the year.
What Is Modified Adjusted Gross Income (MAGI)?
Modified Adjusted Gross Income (MAGI) is a variant of AGI used in specific situations such as determining eligibility for certain tax credits or deductions. It includes your AGI plus any tax-exempt interest you earned during the year, plus other adjustments required by law.
How Can Your AGI Affect Your Taxes?
Your AGI can impact how much you owe in taxes or how much of a refund you’ll receive. For example, if you have a high AGI, you may be subject to additional taxes like the Net Investment Income Tax or Phase-Outs on itemized deductions/personal exemptions/credits; however, if your AGI falls below certain thresholds, you may qualify for various credits and deductions that could reduce your overall tax liability.
What Credits/Deductions Are Affected By Your AGI?
Several tax credits and deductions have phase-out limits based on an individual’s AGI; this means that as your income rises above certain thresholds, your ability to claim these benefits will decrease over time until it phases out entirely once it reaches a specific level. Examples include:
– Student Loan Interest Deduction
– Retirement Savings Contributions Credit
– Child Tax Credit/Additional Child Tax Credit
– Earned Income Tax Credit
It’s important to keep track of where your adjusted gross income falls within these phase-out ranges so that you can plan accordingly when filing your taxes.
How Can You Lower Your AGI?
There are several ways to reduce your AGI, which can ultimately lower your tax liability. Some examples include:
– Contributing to a traditional IRA or 401k
– Making HSA contributions
– Paying student loan interest
– Donating to charity
By taking advantage of these and other deductions, you can reduce your taxable income and thus lower your AGI.
In Conclusion,
Your Adjusted Gross Income is an essential number that plays a crucial role in determining how much tax you owe or if you’re eligible for certain credits and deductions. Understanding what it is, how it’s calculated, and why it matters are all vital aspects of being financially savvy as a taxpayer. By keeping track of your AGI throughout the year and taking advantage of deduction opportunities, you can help minimize the amount you owe come tax time.