Adjusted Gross Income (AGI): Defined & Explained
4-minute readOctober 07, 2020
Knowing about your income and how it’s defined is part of being responsible with your money. Broadening your financial literacy is a big part of setting yourself up for success. By understanding how different parts of your finances affect your taxes, you can save money.
Adjusted Gross Income (AGI) is a tax term every tax return-filing American should understand. It’s located on your IRS 1040 form and has a large role in determining your taxes.
What Is Adjusted Gross Income (AGI)?
AGI is your total gross income minus specific deductions defined by the IRS. It’s used to calculate taxable income and how much tax is owed. A lower AGI can translate to more tax deductions, credits and qualify you for more benefits.
How To Calculate AGI
To calculate AGI, you first must figure out the amount of your gross income. This includes your total income from a variety of sources, such as:
- Capital gains
- Business income
- Retirement distributions
- Any other passive income sources
Add all these sources together. Once you have that number, subtract the following applicable deductions:
- Student loan interest payments
- Traditional IRA deductions
- Health savings accounts
- Health insurance premiums for the self-employed
- Losses from the sale or exchange of property
- Employer portion of self-employment taxes
- Penalties on early savings withdrawals
- Alimony paid on divorces settled prior to 2019
- Moving expenses for active military members and their pets
With these numbers subtracted, you now have your AGI.
How Is AGI Used?
AGI determines whether the taxpayer qualifies for further deductions, tax credits or exemptions. It can help you decide whether to take the standard or itemized deduction, as well as determine if you qualify for exemptions.
Whether you qualify for tax credits, like the Earned Income or American Opportunity tax credit, is also calculated using your AGI. After all exemptions, deductions and credits are attributed, your AGI is used to find our how much tax you owe.
With any technical financial term and how it applies to you, there are always some questions. Keep on reading as we tackle some of the regularly asked questions around AGI.
What Is MAGI?
Modified Adjusted Gross Income (MAGI) is your AGI with certain deductions added back. If you don’t have these deductions, your AGI and MAGI are the same.
Your MAGI determines further potential benefits you may be eligible for. These include healthcare plan subsidies and deducting contributions to individual retirement accounts (IRAs). The higher your MAGI is, the fewer deductions you can take.
Here are some of the deductions added to your AGI to calculate your MAGI, according to the IRS:
- Student loan interest payments
- Qualified tuition expenses
- Tuition and fees deduction
- IRA contributions
- Non-taxable social security payments
- The exclusion for income from U.S. savings bonds
- Foreign earned income exclusion
- Losses on sold rental property
- Foreign housing exclusion or deduction
How Can MAGI Affect My Health Insurance?
If you’re paying for an individual health insurance plan, you’re shopping for it on the individual health insurance marketplace. You can use your MAGI to find out if you qualify for government subsidies to discount your marketplace plans.
You can also use your MAGI to determine if you qualify for Medicaid or if your children qualify for the Children’s Health Insurance Program (CHIP).
How Do I Maximize My Adjustments To Income?
The simplest way to maximize your AGI, and therefore maximize your tax benefits, is to keep good records of income and income-related expenses. Keep an organized file of receipts, statements and other records throughout the year. Pull from this when tax time comes – being organized will pay off.
To fully take advantage of deductions and tax credits, consider working with an accountant or qualified tax advisor. These people can advise you on how to fully take advantage of tax write-offs. The money you pay them can be easily justified with their ability to maximize deductions and minimize taxes.
How Do I Reduce AGI?
Since reducing your AGI can save you money on your taxes, you want to take full advantage of your ability to reduce your AGI. If you have investment losses, retirement accounts or a health savings account (HSA), you can use them to your benefit.
Stocks sold at a loss, IRA contributions and money saved in an HSA can all be deducted from your AGI. Make these changes before December 31 to be able to deduct them on your taxes.
Summary: Understanding AGI Can Help You Save
If you know how to calculate your AGI, you can use it to maximize the amount on your return and minimize the amount of taxes you pay. AGI is your total gross income minus deductions like HSA contributions and student loan interest payments, among the others listed above.
Your Modified Adjusted Gross Income (MAGI) takes your AGI and adds back certain deductions, like retirement account contributions. How much of your IRA contributions you can deduct depends on your MAGI. MAGI also defines what subsidies your qualify for on the health insurance marketplace.
By keeping track of your income and possible deductions throughout the year, you can lower your AGI. Through a little knowledge, planning and strategy, you can make the most of tax season and possibly save yourself some money.
Learn more about your personal finances on the Rocket HQSM Financial Learning Center.
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