Whether you’re a small business owner, sole proprietor, or an employee, you need to know your income when you file taxes. Your income is what determines your tax rate and the amount you owe the IRS (or how much of a tax return you’ll receive).
Sounds simple right?
Well, the IRS has a few ways of calculating income, and each of them serves a different purpose. Your adjusted gross income is used to figure out how much income tax you owe.
Keep reading to learn how to calculate adjusted gross income and where to use it when filing your state and federal tax return.
What Is Adjusted Gross Income?
Adjusted gross income (AGI) is your total annual income minus certain deductions, known as “adjustments to income” or “above the line deductions.” These deductions include contributions to a health savings account and 401(k) retirement plan.
When filing taxes, you’ll use your adjusted gross income to calculate your taxes and figure out whether or not you’re eligible for certain deductions and credits that can reduce the amount you owe to the IRS.
Above-the-Line vs. Below-the-Line Deductions
You may hear the terms “above-the-line” and “below-the-line,” which refer to the two main types of tax deductions.
Above-the-line deductions are claimed first and include items such as 401(k) retirement contributions and interest paid on student loans. These deductions apply to most tax filers, and you subtract them from your gross income to find your adjusted gross income.
Once you reach your adjusted gross income, you can claim the standard deduction, a fixed amount that depends on your filing status (single or married).
Some filers may claim below-the-line deductions (also known as itemized deductions) instead of the standard amount. This is more common for high-income households with large qualifying expenses, such as charitable donations and home mortgage interest payments.
For most people, the standard deduction will give them the lowest taxes.
How To Calculate Adjusted Gross Income
To calculate your AGI, start with your gross income and subtract all eligible above-the-line deductions.
Your gross income includes your wages and other forms of income like business income, pensions, interest paid to you, dividends, tips, and earnings from rental properties you own.
If you are a salaried employee, you can find your gross income from wages on the final pay stub of the year and on the W-2 form sent to you by your employer. If you also earn money from sources outside of your job, you should add those amounts too.
On the other hand, if you are an independent contractor, you will receive a 1099-NEC form from any client who paid you more than $600 during the year. Your gross income from your wages will be there.
If you had a client who paid you only $500 in the year, you wouldn’t receive a 1099-NEC, but you still need to report that income on your tax return. So it’s best to track your earnings throughout the year.
Once you have your gross income amount, it’s time to claim your above-the-line deductions—so you can get your adjusted gross income.
What Are the Most Common Deductions I Can Take on My Adjusted Gross Income?
Here are the most common deductions you can claim when calculating your AGI.
- Alimony payments
- Early withdrawal penalties on savings accounts
- Educator expenses (capped at $250)
- Health Savings Account (HSA) deductions (Form 8889)
- Self-employed health insurance
- Self-employment tax (half of your total SE tax is deductible)
- School tuition fees (capped at $2,500)
- Student loan interest (capped at $2,500)
AGI Sample Calculation
Let’s do a sample AGI calculation for a sole proprietor who also earns rental income and makes student loan payments.
- Income from business: $61,000
- Income from rental unit: $13,500
- Estimated self-employment taxes paid during the year: $17,200
- Self-employed health insurance payments: $5,000
- Interest paid on student loans: $2,000
Their gross income would be their wages ($61,000) plus rental income ($13,500), which comes out to be $74,500.
From the $74,500, you subtract (or claim) above-the-line deductions, which include interest paid on student loans, self-employed health insurance payments, and half of the amount paid for self-employment taxes.
So, you have:
- AGI = $74,500 - ($2,000 + $5,000 + $8,600)
- AGI = $74,500 - $15,600
- AGI = $58,900
Their adjusted gross income, in this case, comes out to $58,900.
Using IRS Form 1040 To Calculate AGI
It may seem complicated to remember how to calculate your adjusted gross income, but the tax documents you fill out when filing your income tax return form will walk you through the process.
Schedule 1 has dedicated lines for each additional income or adjustment type, so you don’t have to remember all the deductions that apply to your adjusted gross income.
Once you add up your total income and subtract the adjustments, you’ll report your adjusted gross income on IRS Form 1040 Line 11.
Can You Find Adjusted Gross Income on Your W-2?
If you’re a salaried employee, income from your employer gets reported and sent to you on a W-2 form. In Box 1, you’ll find your total “wages, tips, and other compensation.” However, it’s important to note that this amount is not your adjusted gross income.
Box 1 of your W-2 form is your total taxable income from that employer. It doesn’t consider certain above-the-line deductions that go into calculating your adjusted gross income. For example, your total “wages, tips, and other compensation” don’t account for the money you pay for school tuition or interest toward student loans.
If you work part-time for two employers or you switch jobs during the year, you’ll receive multiple W-2 forms (one for each employer). You may also have sources of income that aren’t reported on a W-2, such as income from a rental property that you own.
Comparing AGI With Other Income Calculations
The IRS uses several different income tax calculations, which may make the process complicated.
Here’s how adjusted gross income compares with three other income measurements you may encounter.
AGI vs. Gross Income
Gross income (also known as total income) refers to the total income you receive during the year, including wages, tips, interest, dividends, rent, and pension. You use your gross income as the starting point when calculating your adjusted gross income.
In other words, gross income doesn’t account for any adjustments. Once you subtract the income adjustments from your gross income, you get the adjusted gross income. So your adjusted gross income should be less than your gross income.
You can find total income on IRS Form 1040 Line 9.
AGI vs. Taxable Income
Taxable income is the amount that remains after you subtract below-the-line deductions from your adjusted gross income.
For below-the-line deductions, you have two options: take the standard deduction or use Schedule A to claim itemized deductions.
Ultimately, you want to choose the calculation method that lowers your taxable income value. Having a lower value can put you in a lower tax bracket, which means you’ll be taxed at a lower rate.
For most individuals, the standard deduction is the best option. However, in some cases, such as high-income households, you might get a bigger deduction when you itemize.
Large itemized deductions include uninsured dental or medical expenses, mortgage interest, property taxes, and significant charitable contributions.
If you’re unsure which deduction is best for your tax situation, you can speak with a tax preparation professional or use Schedule A to add up your itemized deductions and see if the amount is greater than the standard deduction for your filing status.
You can find taxable income on IRS Form 1040 Line 15.
AGI vs. Modified Adjusted Gross Income
Modified adjusted gross income (MAGI) is your adjusted gross income plus some deductions added back into your equation (i.e. not deducted anymore). The IRS uses MAGI to determine if you qualify for certain tax deductions, credits, or retirement plans.
Adjustments that get added back to calculate MAGI include:
- Deductions for IRA contributions
- Taxable social security payments
- Education deductions
- Student loan interest deduction
- Excluded foreign income
- Half of your self-employment tax
- Loss or gain from passive income sources
- Loss from rental properties
For instance, if you deducted $8,600 of self-employment tax payments when calculating your AGI, you would add that amount back to your AGI when calculating your modified adjusted gross income.
There are several tax benefits (such as credits, deductions, and retirement plans) that use MAGI to determine if you are eligible. Those include:
- Traditional IRA
- Roth IRA
- Net Investment Income Tax
- Premium Tax Credit/Marketplace healthcare
- Education Credit
- Child Tax Credit
In most cases, your MAGI needs to be below a particular threshold for you to take advantage of the benefit. When you apply for certain retirement accounts or tax credits, you’ll typically be walked through the process of calculating your MAGI.
How to Find AGI if You E-File
If you e-file using online tax software such as TurboTax or H&R Block, you’ll probably be asked to provide your previous year’s AGI as a verification step before submitting your returns.
Your AGI from the previous tax year can be found on IRS forms 1040 and 1040-NR on Line 11. So, even if you file electronically, it’s best to save a copy of your tax return for help with filing the following year.
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