What Is Adjusted Gross Income (AGI) And How Does It Affect My Tax Return?

The IRS uses adjusted gross income (AGI) to determine your income tax liability for the year. We’re going to discuss how it’s calculated and how its results affect you and your finances.

Adjusted gross income, or AGI, refers to your total income minus IRS-recognized reductions known as adjustments to income. The most common of these adjustments is contributions made to a retirement account.

These are the IRS-recognized adjustments to income:

• Educator expenses
• Certain business expenses of reservists, performing artists and fee-basis government officials: Form 2106
• Health savings account deduction: Form 8889
• Moving expenses for members of the Armed Forces: Form 3903
• Deductible part of self-employment tax: Schedule SE
• Self-employed SEP, SIMPLE and qualified plans
• Self-employed health insurance deduction
• Penalty on early withdrawal of savings
• Alimony paid
• IRA deduction
• Student loan interest deduction
• Archer MSA deduction

In the category of “other adjustments,” the IRS includes:

• Jury duty pay
• Deductible expenses related to income from the rental of personal property engaged in for profit
• Nontaxable amount of the value of Olympic and Paralympic medals and USOC prize money
• Reforestation amortization and expenses
• Repayment of supplemental unemployment benefits under the Trade Act of 1974
• Contributions to section 501(c)(18)(D) pension plans
• Contributions by certain chaplains to section 403(b) plans
• Attorney fees and court costs for actions involving certain unlawful discrimination claims (see instructions)
• Attorney fees and court costs you paid in connection with an award from the IRS for information you provided that helped the IRS detect tax law violations
• Housing deduction from Form 2555
• Excess deductions of section 67(e) expenses from Schedule K-1 (Form 1041)

Calculating your adjusted gross income is easy on your own, but many online tax services can calculate your AGI for you if you prefer to have some guidance. The IRS publishes Schedule 1 to Form 1040 to allow taxpayers to both calculate their gross income, on page one, and their adjustments, on page two.

Calculate Your Gross Income: Page One

To calculate your AGI, you first need to combine your total income for the year in question. This includes wages as well as unemployment compensation, royalties, commission, property sale revenue and any other source of taxable income.

Subtract Adjustments To Your Income: Page Two

Adjustments to your income are all made “above the line,” meaning that the adjustments are taken off the top of your gross income to yield your adjusted gross income. The IRS treats you as a conduit for this income, as in the case of alimony, or is incentivizing you to save toward retirement or health care expenses, for example.

Adjustments to your gross income can vary depending on your unique situation and can be influenced by unexpected life events like jury duty, new employment, or a pandemic. Discuss your situation with a tax professional to make sure you can take full advantage of these adjustments.

For most taxpayers, the next decision they’ll need to make is whether to take the standard deduction or itemize their deductions. Once you figure out which one is greater, subtract it from your adjusted gross income to find your taxable income.

Standard Deduction

If your itemized deductions totaled are less than the standard deduction, take the standard deduction. It’s a no-questions-asked deduction meant to cover your basic costs of living.

For the tax year ending in 2022, the standard deduction has been adjusted for inflation. Many taxpayers could choose the standard deduction, and move on the tax rates to calculate the amount of tax owed.

Itemized Deductions

If your deductions are worth more than the standard deduction, you are free to itemize your deductions. Use Schedule A (Form 1040) to see if your itemized deductions exceed the standard deduction.

Before passage of the 2017 Tax Cuts And Jobs Act, there was a real tax preference for homeowners versus renters, because state and local taxes (SALT) – including property taxes – and the mortgage interest deduction usually outpaced the standard deduction.

The SALT deduction is now capped at $10,000, well below what many residents of high tax states pay in property and other SALTs. Residents of these states were definitely hurt by this change to the tax code. Otherwise, homeowners simply lost the advantages they held compared to non-homeowners. That same act, however, allowed taxpayers unlimited itemized deductions.  

For some tax benefits, taxpayers might need to meet a modified AGI requirement to qualify when they are trying to qualify for another tax benefit. How it’s calculated depends on the IRS benefit you’re seeking. For example, the earned tax, child tax or other credits each define their MAGI requirements. There are MAGI limits on contributions to retirement accounts and health savings accounts.

How much you’re allowed to contribute depends on your filing status, income and whether you’re covered by a retirement plan at work. To learn more, speak to your tax advisor or look to the IRS for more information on contribution limits for tax years 2021 and 2022.

MAGI For Education Tax Credits

There are two education credits that taxpayers might be eligible for.

American Opportunity Tax Credit (AOTC)

The American Opportunity Tax Credit (AOTC) is a credit for qualified education expenses paid for an eligible student for the first four years of higher education. A taxpayer can get a maximum annual credit of $2,500 per eligible student. If the credit brings the amount of tax you owe to zero, you can have 40 percent of any remaining amount of the credit (up to $1,000) refunded to you.

The amount of the credit is 100 percent of the first $2,000 of qualified education expenses you paid for each eligible student and 25 percent of the next $2,000 of qualified education expenses you paid for that student.

To claim the full credit, your modified adjusted gross income (MAGI) must be $80,000 or less ($160,000 or less for married filing jointly).

Lifetime Learning Credit

There is a credit available for students pursuing undergraduate, graduate or professional degrees or skills needed to advance your career. You can get a credit for up to $2000 of qualified educational expenses, with no cap, if you meet the requirements.

You can’t claim the credit if your MAGI is $69,000 or more ($138,000 or more if you file a joint return).

How Can I Lower My AGI?

The best way to lower your taxes by lowering your AGI is to sock money away in a retirement or health savings plan. Maxing out your contributions will lower your taxes year in, year out. More importantly, you’re not spending new money to save on taxes – you’re simply saving for your retirement.

Money added to a traditional IRA, Simple IRA, or SEP-IRA is taken out of your gross income prior to tax, and the same goes for money contributed to a health savings account (HSA). Not only can this strategy help lower your AGI, but it’s also just good practice to put more of your income toward health expenses and retirement.

Anything you can take off the top of your gross income translates into tax savings, so familiarizing yourself with IRS rules on how you can adjust your gross income is always a good idea. Remember, the more you can put away for the future and for health expenses, the less you’ll have to pay in taxes.

Are you interested in learning more about the tax advantages of homeownership? Use our Learning Center to find the answers to all your real estate-related questions.