When your gross income goes up, it’s a cause for celebration – and perhaps for concern. You don’t want to waste all that extra money on taxes. When is it adjusted gross income (AGI) becomes important. While your gross income is all the money you’ve earned in a year, the AGI is adjusted by subtracting certain allowable deductions.
To calculate your AGI, you must first identify your gross income by adding up all of your earnings. On IRS Form 1040, this is usually your wages, salaries, tips, dividends, and capital gains, plus taxable IRA distributions, interest, pensions, and annuities. Common profits that are also part of your gross income include alimony payments, rental property, business income, unemployment benefits, royalties, and trusts.
Now that you know your income, you adjust it to keep it as low as possible. Common allowable deductions include IRA contributions, student loan interest, job-related moving expenses, half of self-employment tax, self-employed health insurance payments, contributions to certain pension plans, support payments and mortgage interest payments and penalties for early withdrawal of savings. Some deductions, such as tuition fees and national production activities (specific business expenses), require you to submit an additional form with your tax return.
Members of certain professions are entitled to additional deductions. For example, elementary and secondary school teachers can claim classroom materials that they have purchased, such as software and books. Reservists in the armed forces can subtract expenses related to their military responsibilities. People in the performing arts also get additional discounts. When you’ve exhausted your reserve of deductions, subtract the total amount from your gross income on your 1040, and you have your AGI.
If your state collects income taxes, you will likely use your federal AGI on your state form. It is to your benefit to carefully consider what qualifies as income and what is allowed for deductions to determine an accurate adjusted gross income. Much like the dance of limbo, the key tax phrase is, âHow far can you go? “