Some technical terms that you have to deal with throughout your life can be difficult to understand. Some of the more common terms that appear primarily in relation to taxes include gross income, adjusted gross income (AGI), and modified adjusted gross income (MAGI).
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Knowing the difference between gross income and adjusted gross income will help you better understand how your taxes and finances work. And, once you understand this, you’ll be in better shape to navigate it all.
What is adjusted gross income?
Your gross income, according to the Internal Revenue Service, consists of all of your income from all sources. Gross annual income includes obvious sources of income, such as your wages, bonuses, self-employment income, and passive income, which includes rental income, capital gains, interest, and dividends.
So what is AGI? Your AGI is your gross income minus any income adjustments you claim on your tax return.
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How to calculate AGI
You don’t need an adjusted gross income calculator to determine your AGI. It’s very simple – for example, if your gross income is $ 47,000 and you claim $ 2,000 in income adjustments, your AGI is $ 45,000.
You will not find your AGI on your W-2, but you can find it on line 37 of Form 1040. Learning how to calculate your adjusted gross income allows you to determine which tax bracket you are in and what your federal tax rate will be.
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What is an income adjustment?
An income adjustment is a tax deduction that you can claim whether you are claiming the standard deduction or itemizing your deductions. Sometimes income adjustments are called âabove-line deductionsâ because they reduce your gross income even if you don’t itemize.
Expenses considered income adjustments include traditional IRA contributions, HSA contributions, interest on student loans, educator expenses, and any penalties you paid for early withdrawals from a CD. For example, if you made a deductible contribution of $ 1,500 to your traditional IRA and paid $ 500 in student loan interest, you would have $ 2,000 in income adjustments.
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What is modified adjusted gross income?
Different deductions and tax credits affect what the modified AGI means for everyone. For example, if you are calculating your MAGI to see if you are eligible to deduct your traditional IRA, you must first add back your IRA deduction, student loan interest, tuition fees, and several other adjustments to your income. However, if you are calculating your adjusted adjusted gross income to see if you qualify for the Lifetime Learning Credit, you do not have to add back the amounts you are claiming for IRA or interest deductions on them. student loans.
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Why are AGI and MAGI important?
The AGI and MAGI are important because many deductions and tax credits are only available if your AGI or MAGI falls below a certain number. Additionally, Social Security uses your adjusted gross income to help calculate how much of your Social Security benefits are taxable. Planning ahead can help you plan your expenses to get as much tax relief as possible and maximize your reimbursement.
This article is part of GOBankingRates’ âEconomy Explainedâ series to help readers navigate the complexities of our financial system.
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Chris Jennings contributed to the writing of this article.
This article originally appeared on GOBankingRates.com: What is adjusted gross income and why does it matter?