To find AGI, after you have added up your full taxable income (gross income), you can take several “above-the-line” deductions to lower that taxable amount. These are called “above the line” because they apply whether you itemize your deductions or take the standard deduction. The standard deduction is an amount that the IRS sets each year that you can deduct from your taxable income, meaning a portion of your income isn’t taxed, lowering your tax bill. In other words, if you had specific expenses or saved money to a qualified account, the IRS allows you to deduct the amounts from your gross income to produce your adjusted gross income (AGI). These deductions are also called “adjustments to income,” and they’re calculated on IRS Schedule 1.
Example of Adjusted Gross Income
Let’s say you are a school teacher who earned $40,000 in gross income from your salary. However, during the year, you purchased $2,000 worth of classroom supplies. You also contributed $1,500 to your individual retirement account (IRA). Educator expenses and IRA contributions qualify as a deduction to your taxable income, meaning they can be deducted as an expense. As a result, your AGI would be calculated as follows:
$40,000 gross income - $2,000 in educator supplies - $1,500 IRA contributionAGI = $36,500
Using adjustments to your gross income—commonly called deductions—allows you to lower how much of your income is taxed, potentially resulting in a tax refund.
Types of Adjustments to Income
Your AGI is calculated on the first page of your U.S. federal tax return (Form 1040) using information from Schedule 1. Calculating AGI is an important first step because it serves as the foundation for determining the deduction and credits for which you may qualify and the income tax you owe. To determine your AGI, start with your gross income and subtract qualifying items to reduce the amount. Common items can include:
Educator expenses, such as supplies paid for by teachers Moving expenses for members of the armed forces Health savings account deduction Student loan interest Contributions to certain retirement accounts SEP-IRA, SIMPLE IRA, and 401(k) deductions for the self-employed Penalties from financial institutions for early withdrawal of savings Alimony payments
If you’re doing your own taxes, tax software can automatically calculate your AGI. The use of tax software can help avoid mathematical errors since it will perform the tax calculations as it walks you through the tax interview. Otherwise, if you don’t understand the difference between AGI and gross income or how to calculate it, you may pay more than you should in income taxes.
Adjusted Gross Income vs. Gross Income
Before you calculate your adjusted gross income, you must determine your gross income—the total income on Form 1040—that you earned for the tax year in which you’re filing. Gross income includes all money you have made on your paychecks before payroll taxes. However, it isn’t limited to your paycheck—it includes money you earn from other sources, too. Gross income can include other employment earnings in addition to salaries (bonuses, for example), as well as interest and dividends, long- and short-term capital gains and losses, interest, dividends, alimony, pensions and annuities, rental property income, royalties, and any revenue derived from operating a business. Also, if you sold any items on eBay, Craigslist, or another online store, you have gained income from profits by selling goods. Gross income also includes net gains on the disposal of assets, such as selling a home or car, or any money obtained through self-employment, consulting, side jobs, and other sources of income. All of these income sources are accounted for on the first few lines of Form 1040 and Part I of Schedule 1. The list of items that contribute to your total gross income is extensive, and you may need help determining what’s considered income for this purpose. Tax software will help you identify all earnings that need to be reported to the government by asking questions in the tax interview, or you can ask an accountant for advice.
