Definition
Adjusted Gross Income (AGI) is an individual’s gross income minus certain allowable deductions. It’s a crucial figure in the U.S. tax system, as it is the basis for calculating various other tax deductions, credits, and limitations. AGI is calculated on Form 1040, U.S. Individual Income Tax Return.
| Gross Income – Above-the-Line Deductions = Adjusted Gross Income (AGI) |
Understanding Adjusted Gross Income
Gross income represents all income received from various sources throughout the year, including:
- Wages, salaries, and tips
- Interest income
- Dividend income
- Capital gains
- Business income
- Rental income
- Retirement distributions (some)
- Other income
Certain “above-the-line: deductions are subtracted from this gross income to arrive at AGI. These deductions are called “above-the-line” because they are taken before calculating itemized or standard deductions.
Calculating Adjusted Gross Income
| Gross Income – Above-the-Line Deductions = Adjusted Gross Income (AGI) |
Importance of AGI in the U.S. Tax System
AGI is a critical figure because it is used to determine eligibility for many other tax benefits, including:
- Itemized Deductions: Certain itemized deductions, such as medical expenses and miscellaneous itemized deductions (generally suspended for tax years 2018-2025), are limited based on a percentage of AGI.
- Tax Credits: Some tax credits, like the Child and Earned Income Tax Credit, have income limitations based on AGI.
- Contribution Limits: Contribution limits for certain retirement accounts may be affected by AGI.
- Phaseouts: Certain tax benefits begin to phase out (gradually decrease) as AGI exceeds certain thresholds.
Example:
Let’s say an individual has the following:
Their gross income would be $60,500 ($60,000 + $500).
Their AGI would be $57,500 ($60,500 – $2,000 – $1,000).
Relationship to Other Tax Calculations
After calculating AGI, taxpayers then choose to either take the standard deduction (a fixed amount based on filing status) or itemize their deductions (listing individual deductible expenses such as mortgage interest, state and local taxes (subject to limitations), and charitable contributions). The result of this choice (AGI less the standard deduction or itemized deductions) is their taxable income, which is then used to calculate their tax liability.
Adjusted Gross Income is essential in the U.S. federal income tax system. It represents gross income reduced by specific deductions and is the basis for calculating many other tax benefits and limitations. Understanding AGI is essential for accurate tax preparation and planning.
