What Is Federal Adjusted Gross Income (AGI)?

Federal Adjusted Gross Income, or AGI, is a figure on your annual tax return. It represents your total income for the year after specific subtractions, known as adjustments, have been made. This number serves as an intermediate step for calculating your tax obligation, and the Internal Revenue Service (IRS) uses it to determine your eligibility for many tax benefits.

Determining Your Gross Income

Before you can calculate your adjusted gross income, you must first determine your total, or gross, income. This figure is the sum of all money and value you receive during the year. For most people, the largest component of gross income is the wages, salaries, and tips reported on a Form W-2 from an employer. It also includes other forms of earned income, such as money from self-employment, which is often reported on Form 1099-NEC.

Beyond earnings from work, gross income encompasses other financial inflows. This includes taxable interest from bank accounts, dividends from stock investments, and capital gains from selling assets. Other common sources that must be added are distributions from retirement accounts, rental income from properties, and unemployment compensation.

Understanding Adjustments to Income

Once gross income is established, the next step is to subtract specific, allowable expenses known as adjustments to income. These are sometimes referred to as “above-the-line” deductions because they are listed on Schedule 1 of Form 1040. These adjustments are available to all eligible taxpayers, regardless of whether they choose to itemize deductions or take the standard deduction. Taking these deductions directly reduces your AGI.

Several common adjustments can lower your gross income. One is the deduction for contributions to a traditional Individual Retirement Arrangement (IRA), subject to income limitations. Another adjustment is the student loan interest deduction, permitting you to subtract up to $2,500 of interest paid on qualified student loans. Taxpayers with a Health Savings Account (HSA) can also deduct their contributions.

For those who are self-employed, there are unique adjustments available. One is the ability to deduct one-half of the self-employment taxes paid during the year. This adjustment accounts for the employer’s portion of Social Security and Medicare taxes that self-employed individuals must pay themselves. Additionally, self-employed individuals can deduct the premiums they paid for their own health insurance. Other adjustments include penalties on the early withdrawal of savings and certain expenses for K-12 educators, who can deduct up to $300 of unreimbursed classroom costs.

How AGI Influences Tax Credits and Deductions

The AGI figure is a threshold that the IRS uses to manage the tax system. Your AGI directly determines your eligibility for a wide range of tax credits and other deductions. Many of these tax benefits are designed to assist lower- and middle-income taxpayers, and AGI acts as the gatekeeper, phasing out or eliminating benefits as income rises. A lower AGI can increase the number and amount of tax breaks you qualify for.

For example, eligibility to contribute to a Roth IRA is directly tied to your income. As your AGI surpasses certain thresholds, the amount you are allowed to contribute is reduced and eventually eliminated. Similarly, the amount of the Child Tax Credit a family can receive is limited by AGI. If your income exceeds the established limits, the credit amount begins to decrease.

The impact of AGI extends to other deductions as well. For instance, taxpayers who itemize can only deduct medical expenses that exceed 7.5% of their AGI. A higher AGI means this threshold is harder to meet, reducing the potential deduction.

Distinguishing AGI from Taxable Income

Adjusted gross income is an intermediate figure, not the final amount on which your tax is calculated. To get from AGI to taxable income, you must subtract either the standard deduction or your itemized deductions. This subsequent reduction is why these are often called “below-the-line” deductions, as they are taken after the AGI line on Form 1040.

The standard deduction is a fixed dollar amount, determined by your filing status, that you can subtract from your AGI. Alternatively, you can choose to itemize deductions, which involves tallying up specific expenses like mortgage interest, state and local taxes, and charitable contributions. You would choose to itemize only if your total itemized deductions exceed the standard deduction amount for your filing status.

After subtracting either the standard deduction or your total itemized deductions from your AGI, you arrive at your taxable income. This is the final income figure that is used, along with the tax brackets, to determine your actual tax liability for the year.