Last year, 14% of American taxpayers filed their taxes in January. Meanwhile, 36% did so in February, according to research from the personal finance site Bankrate. Whether you are starting to gather your paperwork to file early or you plan to wait until the last minute this year, there are some phrases you’ll want to understand.
For instance, one phrase you may hear, as well as seeing it on IRS Form 1040, is adjusted gross income, AGI.
Your AGI determines your tax bracket, which determines your marginal and effective tax rates, or how much you pay in taxes each year. In light of new tax bracket thresholds this year, your tax bracket and tax rate may have changed in 2023, even if your adjusted gross income remained the same.
Knowing your AGI, and how to find it, can give you a good idea of how much you might owe in taxes, or how much of a refund you’ll receive, for the 2023 tax year, even before you file your taxes.
Don’t worry if the calculations seem complicated. If you use tax software, the program will calculate your AGI automatically. But you still need to know what adjustments to income factor into your AGI.
Of course, when it comes time to file, it’s a good idea to consult with a tax professional to help you prepare your tax return. That way, you can be sure you are calculating your AGI correctly, taking all the deductions you deserve, and filing for all the credits you qualify for.
What Is AGI?
Your AGI, or adjusted gross income, is your income minus certain eligible deductions, or adjustments, that don’t count toward your taxable income.
Your AGI is important because it affects your federal income tax rate, the amount of taxes you owe for the year, and, ultimately, any tax refund you might receive.
What’s Included in Adjusted Gross Income (AGI)?
Your gross income includes any income, including wages, tips, interest (reported on form 1099-K), income as an independent contractor / self-employed, (reported on form 1099) dividends from investments, capital gains from the sale of property or investments, unemployment compensation, social security, rental income, and pension money that is not tax exempt.
How to Calculate Your AGI
You won’t find your AGI on your W-2 from your employer, but you will find your total annual wages there. If your job is your only source of income, that’s your total income, and your starting point for calculating AGI.
Otherwise, you’ll need to add other income sources, such as 1099 income, interest from investments (reported on a 1099-K form), capital gains, business income, and retirement distributions.
Then, add up all your tax deductions. These may include:
- Health Savings Account (HSA) contributions that are tax deductible
- Traditional IRA (Individual Retirement Account) contributions
- Student loan interest payments
- Expenses (as an educator)
- Moving expenses (for military personnel)
- Educator expenses
- Early withdrawal penalties for CDs
People who are self-employed with 1099 income to show may also be able to deduct:
- Half of your Social Security and Medicare contributions
- Self-employed IRA (SEP IRA) or SIMPLE IRA contributions
- Health insurance premium costs (including Medicare)
These deductions are known as “above-the-line” deductions. They apply whether you itemize deductions or take the standard deduction. And, every deduction contributes to reducing your AGI. Reducing your AGI may put you into a lower tax bracket and reduce the taxes you have to pay.
Add up your above-the-line deductions and then subtract that amount from your gross income. That number is your adjusted gross income, AGI.
So Gross Income minus Above-the-line deductions = Adjusted Gross Income
What Is MAGI?
Another confusing term you may hear in regard to personal finance is MAGI, or Modified Adjusted Gross Income. Your MAGI is often very close to your AGI.
Your MAGI equals your adjusted gross income plus tax-exempt interest, non-taxable social security benefits, and untaxed foreign income. MAGI won’t affect the taxes you owe or any tax refund you might receive. But it may affect benefits programs you might qualify for.
It’s important to note that MAGI doesn’t include Supplemental Security Income (SSI), which is a benefit people may receive from the Social Security Administration if they have very low or no income, a disability, blindness, or are above the age of 65. AGI, on the other hand, includes SSI income.
You won’t find your MAGI as a line-item on your tax return, but certain programs, including health insurance from the U.S. Marketplace, Medicaid, and the Children’s Health Insurance Program (CHIP) may use your MAGI to determine your eligibility.
Additionally, if you deduct healthcare expenses below the line, this amount cannot exceed 7.5 of your AGI.
If you aren’t sure if you should be reporting your adjusted gross income or MAGI, ask the organization requiring the information. On your taxes, you’ll want to report AGI, but other circumstances may require you to use your MAGI.
Taxable Income vs. AGI
Many people also confuse the terms AGI and taxable income. Here’s the difference between AGI and taxable income:
Your taxable income refers to your income after all deductions. That means any above the line deductions plus either the standard deduction or itemized deductions that you can declare. Neither your AGI or taxable income includes the child tax credit, as that’s taken after your deductions.
For many taxpayers, AGI, MAGI, and taxable income are exactly the same or very similar.
AGI vs. Gross Income
Your gross income is typically higher than your taxable income or your adjusted gross income. Your gross income is simply what you’ve earned all year and includes your W-2 income, 1099 income, 1099-K income from interest, investment income, capital gains, social security income, and taxable retirement income from a retirement account.
Should You Itemize Tax Deductions?
AGI is your first step to determining your taxable income. Many people have a higher AGI than they did prior to 2017 tax laws. The depth and breadth of above-the-line deductions has fallen in recent years.
However, the standard deduction increased, presumably to make up for the lack of above-the-line deductions. That makes it more beneficial for some people to take the standard deductions rather than going through the tedious process of itemizing deductions.
In recent years, 90% of taxpayers took the standard deduction, rather than itemizing deductions. Prior to 2017 tax laws and the increased standard deduction, only 70% took the standard deduction, according to Forbes Advisor.
The federal government made these changes, presumably, to make it harder for people to cheat on their taxes by itemizing deductions they couldn’t prove or taking above-the-line deductions that they didn’t really qualify for.
According to IRS Publication 529, some expenses you could previously deduct “above the line,” but can’t for the 2023 tax year include:
- Adoption expenses
- Funeral expense
- Home repairs
- IRA losses
- Investment management fees
- Credit or debit card convenience fees
- Depreciation on a home computer
- Tax preparation fees
- Safe deposit box rent
However, many of these costs may be deducted if you itemize expenses, file as an independent contractor, or own a business. It’s best to speak with a tax professional to determine if your deductible expenses exceed the standard deduction.
Ideally, with so few above the line deductions, anymore, you want to be able to claim as many legitimate itemized deductions as you can to exceed the standard deduction and reduce your tax bill. But if you don’t have a lot of deductions, it’s easier to save yourself the trouble – and the risk of an audit – and take the standard deduction.
A tax professional should be able to let you know which expenses you can deduct, which you can’t, and which deductions may signal a red flag and trigger an audit from the IRS. They can also help you determine if it pays to itemize or not.
Why AGI Matters
Your AGI is the key to determining how much you owe in federal taxes, or how much of a refund you might receive. Of course, your total tax bills takes into account deductions and credits. But AGI is your starting point.
Many states in the U.S. also use your AGI to determine you state income tax bill or refund. Some states might make additional adjustments in the calculation, providing additional deductions or tax credits.
Your AGI also determines your qualifications for certain tax deductions, such as deductible medical expenses.
Your AGI is an important figure in determining your taxes. Whether you do your taxes yourself by hand, use tax software, or hire a tax professional, you need to know all the elements that go into calculating your AGI in order to report them correctly.
If you need help filing your taxes, contact a tax professional. If you are behind on taxes or owe more than $10,000, a tax debt relief firm like Alleviate may be able to help. Contact us by phone at 888-859-TAX1 or message us here.