If you’re looking to save as much money as possible when filing your taxes this year, knowing this one number will help. Your adjusted gross income or AGI. Adjusted gross income is the starting point for your tax return.
It’s a common measure of income that the IRS uses and the government uses to determine how much money you’ve made over the course of the past year.
So to demystify your tax return, we break down how to calculate your AGI and how this one number impacts your finances.
Understanding Adjusted Gross Income (AGI)
The IRS defines adjusted gross income, or AGI, as your gross income minus adjustments to income. It’s commonly referred to as the line.
Above the line, you have two things. Your gross income and your adjustments. Your gross income is a combination of your wages, stock dividends, capital gains, and any other income you might have, like business profits.
Adjustments refer to things like interest on student loan payments, contributions to some retirement accounts, and expenses you may have as a teacher, just to name a few.
How to Calculate AGI
These adjustments are commonly referred to as above the line deductions. And once you subtract them from your gross income, you’ve got your AGI. So once you’ve calculated it, why does it matter?
Let’s take a look at Olivia and calculate her gross income. Olivia earned $60,000 a year from her day job as a chemist.
After subtracting her 401K contributions and health insurance premiums, which aren’t taxed, her taxable wage is $57,000 a year. She also rented out her extra bedroom, which brought in a net total of $6,000.
And lastly, Olivia bought and sold stocks within the past year, profiting $1,000. Because she held the stocks for only a few months, her profit is considered a short-term capital gain and is taxed at the ordinary income rate, meaning it’s less complicated for our purposes.
So all together, Olivia’s gross income comes out to $64,000. But remember, if you have other sources of income, like from freelancing or side hustles, you’ll need to add those to your gross income as well. Now, to find Olivia’s AGI,
she has to subtract the adjustments from her gross income. There are quite a few possibilities here like educator expenses and self-employed health insurance.
One of those adjustments is interest on student loan debt. Olivia has private student loan debt and made payments throughout the year, so she can subtract up to $2,500, bringing her AGI to $61,500.
This brings us back to why knowing your adjusted gross income matters. After your AGI has been calculated, you can check for any tax credits you may qualify for.
Why AGI Matters for Your Taxes
Adjusted gross income is used by Congress to set parameters for various tax breaks to basically ensure that they’re going to lower and middle-income people and then aren’t fully available to very high-income people.
There are a lot of tax credits available. For example, you have something called the saver’s credit, which is essentially a government match for retirement contributions, and you have the earned income credit, which is the government’s main program for assisting low and middle-income families.
Last year, 31 million eligible workers and families benefited from the earned income tax credit, averaging savings of more than $2,000. There are also tax credits with eligibility tied to AGI for students and parents, like the American Opportunity Tax Credit or Child Tax Credit.
However, these situations don’t apply to Olivia, so she doesn’t get to claim tax breaks based on AGI this year. After you calculate your tax credits, you can take deductions and determine your actual tax bill. The more you understand about how the tax code works,
how it keys off of this number, the easier it can be to figure out why you’re getting to the bottom line number you’re getting.
If you hire an accountant or use other tax services, you may not need to calculate your AGI to figure out how to save with it.
But no matter whether your taxes are in your hands or someone else’s, this little number on line 11 plays a key role in your financial life.