As tax season approaches, it becomes crucial to delve into the complexities of your tax return, shining a spotlight on Adjusted Gross Income (AGI).
While many people concentrate on taxable income, AGI holds significant importance, as it directly impacts available deductions and credits. This guide will delve into the calculation of AGI, revealing the components recognized as gross income by the IRS.
The computation of AGI is a simple procedure that entails subtracting specific deductions, referred to as “adjustments,” from the total income subject to income tax. This encompasses income from employment, self-employment, dividends, and bank interest. Importantly, AGI is established prior to the application of standard or itemized deductions, which are reported in subsequent sections of the tax return.
What is considered gross income by the IRS?
Income adjustments function as direct deductions, reducing the total income to reach the Adjusted Gross Income (AGI). While these adjustments may change each year, certain items consistently feature on tax returns. Examples include half of self-employment taxes, premiums for self-employed health insurance, alimony payments made before 2019, contributions to eligible retirement accounts, and paid student loan interest.
AGI acts as a crucial factor that influences the deductions and credits available on your tax return. Many common deductions and credits are subject to AGI limitations. For instance, when itemizing deductions, medical and dental expenses need to be reduced by 7.5 percent of your AGI. Lower AGI levels may enhance your eligibility for claiming deductions.
While integral to AGI computation, certain adjustments to income are also subject to AGI limitations. The eligibility for deductions related to tuition payments, for example, depends on your modified adjusted gross income (MAGI). The IRS website defines Adjusted Gross Income (AGI) as gross income minus adjustments to income.
Gross income encompasses wages, dividends, capital gains, business income, retirement distributions, and other sources of income.
The IRS further explains, “Adjustments to Income include items such as Educator expenses, Student loan interest, Alimony payments, or contributions to a retirement account. Your AGI will never exceed your Gross Total Income on your return and, in some cases, may be lower.”