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 that, you’ll be better able 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 salaries, 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 do not 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 won’t 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 helps you determine what tax bracket you’re in and what tax rate you’re in. federal income tax will be.
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What is an income adjustment?
An income adjustment is a tax deduction that you can claim whether you claim the standard deduction or itemize your deductions. Sometimes income adjustments are called “above the line deductions” because they reduce your gross income even if you don’t itemize.
Expenses that are considered income adjustments include traditional IRA contributions, HSA contributions, student loan interest, educator expenses, and any penalties you paid for early CD withdrawals. . For example, if you made a deductible contribution of $1,500 to your traditional IRA and paid $500 in interest on a student loan, 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 your IRA deduction, student loan interest, tuition and fees, and several other adjustments to your revenue. If you’re calculating your adjusted adjusted gross income to see if you qualify for the Lifetime Learning Credit, however, you don’t have to add back any amounts you claim as IRA or interest deductions on student loans.
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Why are AGI and MAGI important?
AGI and MAGI are important because many deductions and tax credits are only available if your AGI or MAGI falls below a certain number. Also, Social Security uses your adjusted gross income to help calculate the amount of your Social Security benefits that is taxable. Planning ahead can help you plan your expenses to get as much tax relief as possible and maximize your refund.
This article is part of GOBankingRates’ “Economy Explained” series to help readers navigate the complexities of our financial system.
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Chris Jennings contributed reporting for this article.
This article originally appeared on GOBankingRates.com: What is Adjusted Gross Income and why is it important?