Adjusted gross income (AGI) is a taxpayer’s total income minus certain “above-the-line” deductions. It is a broad measure that includes income from wages, salaries, interest, dividends, retirement income, Social Security benefits, capital gains, business, and other sources, and subtracts specific deductions. Taxpayers can locate their AGI on their IRS Form 1040 tax return on line 11.
How Does Adjusted Gross Income (AGI) Work in Practice?
Functionally, AGI reduces the amount of income that faces the individual income tax by subtracting certain deductions, exclusions, and expenses from a taxpayer’s gross income. Some of the adjustments improve the structure of the individual income tax base, while other adjustments reflect policy choices.
Thirty-five states and the District of Columbia use federal AGI, with some additional modifications, to calculate an individual’s state income tax liability.
AGI can impact how much individuals can deduct from their taxes and determine eligibility for certain retirement plan contributions like Roth individual retirement accounts (Roth IRA). AGI can also be used as a benchmark for qualification for programs or benefits by banks, government agencies, and private companies. Qualification for income-driven student loan repayment programs is an example of a non-tax-related AGI application.
What Adjustments Are Made to Calculate AGI?
AGI is an essential part of determining tax liability—how much an individual or business is due to remit to the government in taxes for that year. First, taxpayers calculate their total income, which includes wages and compensation, interest, dividends, capital gains (or loss), business income (or loss), pensions, farm income (or loss), rents, royalties, Social Security benefits, retirement account distributions, etc. This is gross income.
Next, taxpayers subtract certain expenses. The most salient are deductions for tax-deferred retirement contributions, such as traditional 401(k)s and traditional IRAs. However, there are several other “above-the-line” deductions available, such as up to $250 of educator expenses, certain business expenses, health savings account and flexible savings account contributions, moving expenses for Armed Forces members, the deductible portion of self-employment tax, self-employed health insurance premium payments, the penalty for early withdrawal of savings, alimony payments for divorces that occurred prior to Dec. 31, 2018, up to $2,500 of student loan interest, and up to $4,000 of tuition and fees. Once these “above-the-line” deductions are accounted for, taxpayers have calculated their AGI.
Consider a married couple with $140,000 in combined W-2 wage income, as well as $2,000 in dividends and interest income from a brokerage account. They also cumulatively contribute $14,000 in traditional 401(k) retirement plans at work and contribute $2,000 to a health savings account (HSA). One spouse still has student loan debt and paid $1,000 in interest.
Going from Gross Income to Adjusted Gross Income
| Calculating Gross Income | |
|---|---|
| Pre-Tax Salary (W-2) | +$140,000 |
| Dividend and Interest Income | +$2,000 |
| Gross Income | $142,000 |
| Traditional 401(k) Contributions | - $14,000 |
| Health Savings Account (HSA) Contributions | - $2,000 |
| Student Loan Interest | - $1,000 |
| Adjusted Gross Income | $125,000 |
From AGI, taxpayers then subtract either the standard or itemized deductions, whichever is larger, and, if applicable, a deduction for any pass-through income. The total after these subtractions is called “taxable income” and is the amount subject to statutory income tax rates.
Taxpayers can locate their AGI on their IRS Form 1040 tax return on line 11.
Adjusted Gross Income (AGI) vs. Modified Adjusted Gross Income (MAGI)
Modified adjusted gross income (MAGI) is adjusted gross income plus certain deductions and tax penalties such as non-taxable Social Security benefits, untaxed foreign income, and tax-exempt interest.
Like AGI, MAGI can determine eligibility for certain programs and retirement contributions.
MAGI is usually close to a taxpayer’s AGI. But unlike AGI, MAGI does not appear on a Form 1040.
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