Understanding Adjusted Gross Income

At tax time, you’ll see reference to “adjusted gross income (AGI)” many times throughout your forms. Many credits and deductions apply income thresholds and brackets which are dependent on your AGI, so it’s important to know how to determine your adjusted gross income.

First, you’ll have to know your gross income. From that amount, you’ll need to subtract any payments you made that aren’t taxable, such as alimony or contributions to a traditional IRA.

The amount that remains is your adjusted gross income. Once you have that number, you can begin to calculate your tax bill. Next, you’ll subtract deductions and exemptions from your adjusted gross income to determine the income amount in which you will be taxed on. This is your taxable income.

For taxpayers who live in states that require a state tax return to be filed, you’ll need to use your federal AGI as the starting point to file. You’ll use state-specific credits and deductions to figure out your state taxable income.

One other important note: AGI is often used as the base for different deductions and credits. One example is the allowable deduction for unreimbursed employee business expenses, which is limited to the expense amount that exceeds 2% of your AGI. Since the deduction is relevant to the amount of your AGI, the lower your adjusted gross income, the less you’ll be able to deduct.

Most tax software will calculate your AGI for you, saving you the trouble of having to do all the math. The full range of credits and deductions which lower your AGI are available to taxpayers who file Form 1040. These include certain moving expenses and after-tax contributions to a Health Savings Account.

Those who file Form 1040A are still able to take some of the credits, but not as many as those who file Form 1040. The available adjustments change from year to year, though they can include the following:

  • Contributions to certain retirement plans
  • Tuition and fees
  • loan interest you paid
  • Educator expenses

Filing Form 1040EZ means you are unable to make any adjustments. That leaves your gross income and your adjusted gross income the same.

Some deductions you itemize are limited by your AGI amount for those who file either 1040 or 1040A. For example, any dental or medical expenses can be deducted in amounts greater than 10% of your AGI. The lower your AGI, the lower your deductible threshold. Miscellaneous itemized expenses are also limited by your AGI.