What is Adjusted Gross Income? How to calculate it in 2022
Adjusted gross income is a tax term that everyone should understand. Also known as AGI, it has ramifications that extend beyond…
Adjusted gross income is a tax term that everyone should understand. Also known as AGI, it has ramifications that extend beyond tax season.
“People ask you for your adjusted gross income all the time,” says Paul Joseph, attorney and CPA at Joseph & Joseph Tax & Payroll in Williamston, Michigan.
Not only does this affect how much you pay in taxes, but it can also be the basis for decisions about eligibility for assistance programs and loans.
Keep reading for everything you need to know about how AGI is calculated and ways to reduce it.
[READ: Tax Prep Checklist: Collect These Forms Before Filing Your Taxes.]
What is Adjusted Gross Income or AGI?
The IRS defines adjusted gross income as “gross income minus income adjustments”. It’s a number that’s included on your federal tax form, and many states use it for their own income tax calculations.
“Before you take any deductions or credits, you have your AGI,” says Edward Renn, a partner in the private client and tax team at international law firm Withers.
Almost all forms of income – with the exception of interest on municipal bonds – are taken into account in the AGI. There is also a long list of exclusions to the AGI. These are items that can be deducted to reduce a person’s adjusted gross income. Income and exclusions are specified on the Schedule 1 tax form.
Why is AGI important?
Your AGI is important for several reasons:
Taxable income: Your AGI is not the same as your taxable income, but it is the basis for determining this figure. Once your AGI is calculated, subtract a standard or itemized deduction to get your taxable amount. The lower your AGI, the lower your taxes will be. Where applicable, qualifying business income and charitable contributions may also be deducted to reduce taxable income.
Detailed deductions: If you use a Schedule A to itemize your deductions, AGI will determine the amount of certain expenses you can deduct. Specifically, there are the following limitations:
— Only medical and dental expenses above 7.5% of the AGI can be deducted.
— Deductions for charitable contributions are generally limited to 60% of AGI, although there may be lower limits in some cases.
— Only eligible damage and loss costs above 10% of the AGI can be deducted.
Program Eligibility: The AGI is also used to determine eligibility for certain tax credits and assistance programs. For example, the free application for federal student aid, known as FAFSA, asks the AGI to determine eligibility for student grants and loans.
How to calculate the AGI?
The AGI is calculated as follows:
Salaries, wages, tips + other income = gross income – adjustments to income = AGI
“Changes are usually going to be made in Schedule 1,” Renn says.
For 2021, there were 25 additional income categories that must be added when calculating gross income. They include, among others, the following:
– Business income.
– Unemployment benefits.
— Gambling income.
— Cancellation of the debt.
– Stock options.
Then, under income adjustments, there are two dozen categories that can be excluded, including:
— Educator’s fees.
— IRA deduction.
— Deduction of interest on student loans.
— Moving expenses of members of the armed forces.
— Health savings account deduction.
Many tax software programs make it easy to determine which additions and exclusions apply to your income. A tax preparer can also make sure you have calculated your AGI correctly.
[Read: How to File Taxes.]
What are examples of tax adjustments?
The income adjustments included in Schedule 1 mean a dollar-for-dollar reduction in what will ultimately be your taxable income.
“Let’s say you earn a salary of $50,000 and put $5,000 in a retirement account,” says Brian Copeland, partner and director of financial planning at Hightower Wealth Advisors in St. Louis, Missouri. Assuming the contribution is to a traditional 401(k), IRA, or similar account, this would drop a taxpayer’s AGI to $45,000.
Once your AGI is calculated, several other deductions can be made before you reach your taxable income. These include in particular the following:
— Flat-rate or itemized deduction.
— Charitable contributions of up to $300 for single taxpayers or $600 for married couples filing jointly, if the standard deduction is claimed.
— Deduction for eligible business income.
The resulting taxable income is used to determine the amount owed to the government. Taxpayers who are entitled to credits, such as the child tax credit or the earned income tax credit, can apply them to their tax bill to reduce the amount owing.
Find your adjusted gross income
If you’re looking for AGI from a previous year, it shouldn’t be hard to find. You will need a copy of your tax return, then look for it on Form 1040. The layout of the form sometimes changes, but for 2021 the AGI is on line 11.
You may also be wondering how to check your withholding tax to see if your employer is collecting the correct tax payments for your AGI. In this case, check a pay stub to see year-to-date totals for tax deductions and other payroll deductions. If you don’t have a payslip, contact your company’s human resources department.
How can I reduce the AGI?
This is a recurring question from taxpayers: how do I reduce my taxable income before the end of the year?
“Retirement is the best way to give it up,” Copeland says. Workers can contribute up to $20,500 to a 401(k) account in 2022 or $6,000 to an IRA. People aged 50 and over can make additional catch-up contributions. Within these limits, all contributions made to traditional retirement accounts will reduce a person’s AGI and therefore their taxable income.
Retirees have an additional way to reduce their taxes by making qualified charitable distributions, called QCDs. At age 72, the government orders retirees to start taking the required minimum distributions from traditional retirement accounts. This money is added to your taxable income, but not if you use it for a QCD. “If you donate to charity through a QCD, that reduces income before the AGI,” says Copeland.
QCDs must be sent directly from a retirement fund to the charity to be eligible for the tax benefit, so consult a financial professional if you are unsure of the process.
Other ways to reduce AGI include contributions to health savings accounts, paying off interest on student loans, or deducting expenses related to qualifying rental properties.
There’s little downside to lowering your AGI, and it shouldn’t affect your Social Security benefits, according to Renn. However, some lenders may consult your AGI when reviewing loan applications.
“It could impact your ability to borrow money,” says Joseph.
However, Renn notes that if lenders find that your AGI is low due to large pension contributions, it may not affect your application’s chances of being approved. In this case, they may assume that you can interrupt these contributions to make loan repayments, if necessary.
[READ: How Remote Work Could Affect Your Income Tax.]
What is the difference between AGI and Modified Adjusted Gross Income, or MAGI?
While AGI is important, Modified Adjusted Gross Income may be more important for those seeking assistance through programs such as Medicaid or the government health insurance marketplace.
“A lot of times it’s the modified AGI that’s taken into account,” says Renn.
Known as MAGI, Modified Adjusted Gross Income is calculated by adding certain deductions back to the AGI. For example, student loan interest and half of the self-employment tax are added to the AGI to determine the MAGI.
“A lot of people have the same number as both,” Copeland says.
This is because the deductions added to the AGI to create the MAGI are relatively rare. Still, it’s important to know this number because it not only affects eligibility for certain government programs, but also whether you’re able to contribute to Roth retirement accounts.
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What is Adjusted Gross Income? How to calculate it in 2022 originally appeared on usnews.com
Update 10/11/22: This story was published at an earlier date and has been updated with new information.