What is adjusted gross income

Adjusted gross income (AGI) is the total income you earn from all sources minus specific adjustments that the IRS allows. “Gross” is an old accounting term, and it simply means the total of something. In this case, the total is all of your income sources.

• Wages: Income you earn as a W-2 employee, such as your salary, hourly wages, bonuses, and tips.
  
  
• Business income or 1099 income: Profits from a business or payments made to you as an independent contractor ( ex. as a freelancer or gig worker)
• Capital gains: Profits from selling investments, like stocks, bonds, or real estate
• Dividends and interest: Income earned from investments in stocks (dividends) and savings accounts or bonds (interest)
• Rental income: Income you receive from tenants, whether residential or commercial (including short-term rentals like Airbnb)
• Income from other sources: Alimony payments, Social Security and unemployment benefits, gambling winnings, life insurance benefits

All these sources combined make up your gross income, which you can then adjust with above-the-line deductions. Some income sources, like most gifts, tax-free mileage reimbursements, or money received from a charitable organization are non-taxable — that means you don’t need to count them toward your gross income.

Expenses that count as income adjustments

Adjustments to income are particular deductions that you can take to reduce your gross income and calculate your AGI.

These adjustments are often called "above-the-line" deductions, because they are deducted from your gross income before you decide whether to take the standard deduction or itemize your deductions.You can deduct these amounts from your gross income to arrive at your adjusted gross income number. 

• Student loan interest: You can deduct up to $2,500 of interest paid on student loans.
  
  
• IRA contributions: Contributions to a traditional IRA may be deductible, depending on your income and filing status.
  
  
• Health savings account (HSA) contributions: Contributions to an HSA are deductible if you have a high-deductible health plan.
  
  
• Self-employment tax: If you're self-employed, you can deduct the employer-equivalent portion of your self-employment tax.
  
  
• Alimony payments: For divorces finalized before 2019, alimony payments are deductible.
  
  
• Educator expenses: Teachers can deduct up to $300 of unreimbursed classroom expenses.

Steps to calculate your adjusted gross income

Once you know your gross income and which adjustments you’re making, you can calculate your AGI.

Gross income – adjustments = adjusted gross income (AGI)

Let’s say you earned $60,000 in wages, picked up an extra $5,000 in freelance gigs, and received $2,000 in dividends. That brings your total income to $67,000.

Now, if you contributed $3,000 to a traditional IRA and paid $1,000 in student loan interest, you’d subtract these $4,000 worth of adjustments.

Here’s how it looks:

• Total income: $67,000
• Adjustments: $4,000
• AGI: $67,000 - $4,000 = $63,000

So, your AGI would be $63,000. This figure is what you’ll use to determine your eligibility for deductions and credits on your taxes. 

How AGI works for tax benefits

Now you know how to figure out your AGI and what it is. But we haven’t yet talked about what it means for your taxes. 

The IRS uses your adjusted gross income to determine eligibility for different tax credits. Generally speaking, the lower your AGI, the more likely you are to qualify for them. 

Here are some of the key tax credits that your AGI influences:

• Earned Income Tax Credit (EITC): This credit is designed to benefit low- to moderate-income workers. Your AGI must be below certain thresholds to qualify, and the amount of the credit increases as your AGI decreases within those limits.
  
  
• Child Tax Credit: The Child Tax Credit is available to taxpayers with qualifying children, but the amount of the credit begins to phase out as your AGI exceeds a certain level. The higher your AGI, the less credit you can claim.
  
  
• Education Credits: There are a couple of education-related tax credits, such as the American Opportunity Credit and the Lifetime Learning Credit. Both of these credits have income limits, meaning your AGI needs to be below a certain threshold to qualify. As your AGI increases, the amount of credit you can claim decreases.
• Premium Tax Credit: This credit helps lower the cost of health insurance purchased through the Health Insurance Marketplace. Your eligibility for this credit is based on your AGI, with the credit amount decreasing as your AGI increases.
  
  
• Saver’s Credit: This credit is designed to encourage low- and moderate-income individuals to save for retirement. Your AGI must fall below certain thresholds to qualify, and the credit percentage decreases as your AGI rises.
  
  
• Adoption Credit: If you’ve adopted a child, you may be eligible for a tax credit to cover some of the adoption-related expenses. However, this credit phases out for higher AGI levels, so your income needs to be below a certain threshold to qualify.

After you’ve deducted credits, your AGI also plays a key role in determining your taxable income. This is where any business expenses, including mileage deductions come into play. 

These deductions are applied to your AGI and the remaining amount is treated as taxable income. Understandably, most tax payers benefit from adding all the deductions they are eligible for. 

If you’re self-employed and deduct mileage on taxes, be sure to keep records of every drive, including addresses and trip purpose. Using a mileage tracking app is the easiest way to do that — most of this information is tracked for you, all you need to do is click and download a report.