Your adjusted gross income (AGI) is the starting point for determining which tax bracket you’ll be in and how much you’ll be taxed.
In other words, the lower your AGI, the lower your overall taxable income will be. It’s also the number the IRS uses to determine if you qualify for certain tax credits and deductions.
If you live in a state that has an income tax, your AGI will generally also be the starting point for calculating your state taxes.
How do I calculate my AGI?
Start by taking your total income from all sources. Hint: look at lines 7-22 on Form 1040.
Then, subtract all the adjustments you qualify for. (We’ll go over these in a moment, but they’re found on lines 23-35 of Form 1040.)
So, what are adjustments to income?
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Adjustments are basically certain expenses that can reduce your total income.
Quick note: while some adjustments have the word “deduction” in their name, they’re not the same as itemized deductions or the standard deduction, which are deductions from income, or commonly known as “below the line” deductions.
The adjustments to income we’re talking about here are known as “above the line” deductions.
The IRS updates the list of adjustments available each year. Some adjustments, however, appear consistently on tax forms every year.
Here are some common adjustments you may be able to take when calculating your AGI:
Penalty on early withdrawal of savings: Needed some cash? If you withdrew money from a certificate of deposit or similar account before it matured, you can deduct any penalty the bank or credit union charged you for the early withdrawal.
Deductible portion of self-employment taxes: If you’re self-employed, you can deduct half of the self-employment taxes you paid during the year.
Self-employed health insurance premiums: Similarly, you may be able to deduct health insurance premiums for you, your spouse, and your dependents if you are self-employed.
Contributions to self-employed SEP, SIMPLE, and qualified plans: Here’s another perk for the self-employed. If you contribute to one of these retirement plans, you may be able to deduct the contributions you made for yourself and/or your employees, depending on your business entity type. (Qualified plans include pensions and 401(k) plans, among others.)
Individual retirement account (IRA) contributions: If you contributed to a traditional IRA during the year, you may be able to deduct some or all of your contributions, depending on your MAGI (modified adjusted gross income).
Student loan interest: If you have student loans, you may be able to deduct some or all of the amount you paid in interest on those loans during the year, up to $2,500. Whether and how much you’re eligible for depends on your tax filing status and MAGI.
Again, the more adjustments you qualify for, the lower your AGI. This is good because it can result in a lower tax bill.
Wait, what’s MAGI?
Ah yes, modified adjusted gross income (MAGI). Some of the adjustments used in calculating your AGI mention its cousin, MAGI.
MAGI doesn’t affect your taxable income directly. Instead, it determines your eligibility for certain AGI adjustments, which in turn can affect your taxable income and your overall tax bill.
Basically, you can figure out your MAGI by taking your AGI and adding in certain adjustments.
As with AGI, the list of MAGI adjustments can change year over year. A few common ones that the IRS has consistently included are IRA contributions, student loan interest payments, and foreign earned income.
And yes, the list of AGI and MAGI adjustments can overlap.
Can I get an example of how this works?
Sure! Calculating AGI and MAGI can be complicated, especially with IRS changes every year.
Here’s an example to help shed some more light on how it works.
Let’s say you’re filing your taxes as a single person. Your total income in 2018 is $120,000, and you take the following adjustments when calculating your AGI:
- HSA contributions: $3,000
- Self-employed health insurance premiums: $12,000
- One-half of self-employment taxes: $15,300
- Student loan interest: $450
Your adjustments total $30,750. Subtract that from $120,000 and your preliminary AGI is $89,250.
But, that’s not the final number. You also have to calculate your MAGI to see if you are actually eligible to take all those AGI adjustments.
As mentioned earlier, student loan interest payments are one of the common MAGI adjustments. For the sake of this example, assume it is the only MAGI adjustment you have.
So you would take your AGI and add back in the student loan interest amount to calculate your MAGI, which would be $89,700. The 2018 MAGI limit for the student loan interest adjustment for single filers is $80,000, so you would not qualify.
That means you have to add $450 back, making your AGI the same as your MAGI: $89,700.