Adjusted Gross Income Definition
Adjusted Gross Income (AGI) is calculated from the gross income and represents the net amount of income earned by an individual in a year including wages, capital gains, and retirement distributions, etc. after deducting above-the-line deductions. We use it to find out the taxable income of the individual, which is a way of determining deductions or credits a person is eligible to receive.
Explanation
Adjusted gross income is a modified version of gross income as the gross incomeGross IncomeThe difference between revenue and cost of goods sold is gross income, which is a profit margin made by a corporation from its operating activities. It is the amount of money an entity makes before paying non-operating expenses like interest, rent, and electricity.read more is the total amount of money earned by an individual in a year, including dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more, wages, capital gains, rental income, etc. In contrast, there are some above-the-line deductions in the calculation and therefore, more useful for the individual who pays tax as it makes the individual eligible to receive deductions and credits.
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Source: Adjusted Gross Income (wallstreetmojo.com)
How to Calculate Adjusted Gross Income?
The first step in calculating the adjusted gross income is finding out the accurate gross income of the individual by adding other sources of income to the total income earned in a particular year. Other sources of income include unemployment compensation, social security payments, profit from the sale of the estate, pensions, and so on.
On ascertaining the gross income, we deduct above-the-line deductions from it. Above-the-line deductionsAbove-the-line DeductionsAbove-the-line deductions are those that are allowed from an individual's total income to calculate the adjusted gross income of a tax filing and thus reduce the tax payable by the individual. These deductions are itemized in Form 1040 (from line 23 to line 35), which is filled by US taxpayers in accordance with IRS guidelines.read more are the deductions applicable to the taxpayer; we can find a complete list of such applicable deductions on the website of Internal revenue service (IRS). After deducting these applicable deductions from the gross income, the resultant value is the adjusted gross income (AGI).
Example of Adjusted Gross Income
Suppose, an individual breaks down the deductions and summary ophthalmology expenses which can’t be repaid by insurance. The individual may have grabbed a deduction of the ophthalmology expenses surpassing the mark of 10% of average gross income for the year 2018.
If the individual reports about the unrepaid amount of $12,000 as the ophthalmology expenses while having an average gross income of $100,000, then he must reduce the deductions by the amount of $7500. Doing so will leave the individual with $4,500 deduction. And if the average gross income of the individual is $50,000, then the individual has to reduce $3,750 ending up with an $8,250 deduction.
Implications
The adjusted gross income AGI, calculated by deducting applicable deductions from the gross income, has a significant impact on the deductions and credits, as due to it an individual can get deductions and credits on the tax return. The value of these deductions and credits depend upon the average gross income, which means if the AGI is low, the individual will enjoy more deductions or credits and vice-versa.
Benefits
- Helpful in finding the taxable income: The adjusted gross income helps in finding the accurate taxable incomeTaxable IncomeThe taxable income formula calculates the total income taxable under the income tax. It differs based on whether you are calculating the taxable income for an individual or a business corporation.read more of an individual as the applicable deductions are deducted from the gross income in it.
- A source of deductions and credits: It helps individuals by making them eligible to receive deductions and credits.
- Legal acceptance: The adjusted gross income is calculated on Form 1040 (on the very first page of the U.S federal tax return by using the information from schedule 1).
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