When preparing your tax return, you probably pay more attention to your taxable income than your adjusted gross income (AGI). However, your AGI is also worthy of your attention, since it can directly impact the deductions and credits you’re eligible for—which can wind up reducing the amount of taxable income you report on the return.
The AGI calculation is relatively straightforward. It is equal to the total income you report that’s subject to income tax—such as earnings from your job, self-employment, alimony income and interest from a bank account—minus specific deductions, or “adjustments” that you’re eligible to take. Your AGI is calculated before you take exemptions and the standard or itemized deduction—which you report in later sections of the return.
Adjustments to income
Adjustments to income are specific deductions that directly reduce your total income to arrive at your AGI. The types of adjustments that you can deduct are subject to change each year, but a number of them consistently show up on tax returns year after year. Some of these adjustments include half of the self-employment taxes you pay, alimony payments made to a former spouse, contributions to certain retirement accounts (such as a traditional IRA) and the deduction for tuition and fees.
The 1040 is the only form that allows you to deduct every possible adjustment. Using form 1040A significantly reduces the number of available adjustments you can take. And if you're filing on the 1040EZ, your AGI is the same as your total income, since the form doesn’t allow you to deduct any adjustments to income.
Impact on deductions
Many of the deductions that taxpayers commonly take advantage of each year are subject to AGI limitations. If you itemize deductions, for example, you must reduce your medical and dental expenses by 7.5 percent of your AGI—meaning that you can only deduct the amount that exceeds 7.5 percent of your AGI. Therefore, the lower your AGI is, the more of your medical and dental expenses you can deduct.
Even your adjustments to income are subject to AGI limitations despite the fact that those deductions are necessary to calculate your AGI. If you’re eligible to deduct some of your tuition payments, your modified adjusted gross income (MAGI) determines whether you qualify.
Other AGI implications
If you live in a state that requires you to file annual income tax returns, your AGI can also impact your state taxable income. This is because many states use your federal AGI as the starting point for calculating your state taxable income. And if you claim a tax credit, such as the lifetime learning credit, for your school expenses, the IRS requires that your MAGI be below certain thresholds in order to claim the credit.
When you use TurboTax to prepare your taxes, we’ll ask you simple questions about your income and walk you step-by-step through the available adjustments to income and other deductions. We handle all the calculations for AGI and MAGI and determine exactly how this impacts your other deductions.