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November 2, 2023
There are plenty of acronyms when it comes to your personal finances. You likely have come across HSA, COBRA, COLA, ETF, APR, to name a few. But when thinking about your tax situation for the year, there’s one acronym you need to understand: AGI, or Adjusted Gross Income.
Gaining insight into your Adjusted Gross Income, its significance, and the method of calculation can pave the way for a prosperous and tax-smart financial future.
Your Adjusted Gross Income is calculated by taking your total gross income for the year and subtracting certain adjustments.
Before delving deeper into the calculation, it’s helpful to understand how your AGI plays a pivotal role in various aspects of your taxes.
Your AGI is the starting point to arrive at your taxable income, which is the number the IRS uses to calculate your taxes. Reducing your AGI results in a decreased taxable income, leading to a more favorable tax bill – and who wouldn’t appreciate that?
NOTE: There are several tax charts within The NewRetirement Planner where you can gain further insight into your gross taxable income by source (work income, pensions, social security) as well as your net taxable income by federal tax bracket.
AGI determines your eligibility for various tax credits. A tax credit directly reduces the amount of tax you owe. It’s a dollar-for-dollar reduction of your actual tax bill.
To qualify for certain tax credits, your Adjusted Gross Income must not exceed specific limits, which vary based on your filing status (e.g., single, married filing jointly, head of household, or married filing separately).
Some credits where this applies include:
Tax deductions lower your taxable income for the year. A number of tax deductions you may be able to take advantage of are subject to different AGI limitations:
The IRS uses a formula to determine if a portion of your Social Security benefits is subject to federal income tax. This formula is often referred to as the “provisional income” formula.
Provisional income is calculated by adding your AGI, tax-exempt interest (such as interest from municipal bonds), and 50% of your Social Security benefits.
Therefore, an increase in your AGI can subject more of your Social Security income to taxation.
Now that you have an understanding of how AGI impacts certain tax opportunities, you may be curious on what exactly makes up your Adjusted Gross Income.
Before we can arrive at your Adjusted Gross Income, it’s important to understand your gross income. Gross income is generally the starting point for the federal individual income tax return (Form 1040). The IRS defines gross income broadly as all income from any source unless specifically excluded by the tax code.
The general rule is all income is taxable, unless specifically excluded by tax law. These non-taxable income sources are called exclusions – they are exempt from tax and not included in gross income.
Some of the more common types of income that may be excluded from gross income include:
The amount of income remaining after removing any exclusions is your gross income. Some common sources of gross income include:
NOTE: The NewRetirement Planner empowers you to track numerous sources of gross income, ensuring an accurate representation of your taxable income for the year.
It may be helpful to look at an example to better understand your gross income calculation.
In 2023, Jane received the following:
Her total income for 2023 is $171,000, because total income is based on income from all sources. However, her gross income reported on her tax return would be $155,000, the sum of the $150,000 salary and the taxable dividend income of $5,000.
The remaining $1,000 of tax-exempt interest income and $15,000 gift from her mother is excluded from gross income.
After adding up your gross income, it’s time to review your tax deductions for the year.
Two primary categories of deductions with respect to AGI include:
In calculating AGI, you may reduce gross income by above-the-line deductions. Some of the more common deductions include:
With a handle on gross income and above-the line-deductions, it may be helpful to walk through an example of calculating AGI:
Joe and Jane Smith are in their early 60s and file their taxes jointly. They have the following gross income:
Their total gross income is $291,000.Their above-the-line deductions include:
Their total above-the-line deductions are $8,050.
Their AGI would be calculated as follows:
If you utilize a tax professional or tax software to handle your taxes yourself, you fortunately don’t need to delve too deeply into the details of calculating your Adjusted Gross Income independently.
To find your Adjusted Gross Income on your tax return, you can identify it on Line 11 of Form 1040. Here’s the front page of the 2022 Form 1040 where your AGI can be located:
Calculating your AGI (or being able to locate it on your tax return!) is helpful, but having a well documented overall financial plan is key to your overall financial well-being.
The NewRetirement Planner lets you plan for one of the biggest life transitions you may encounter: your retirement. It offers user-friendly features and empowers you to manipulate numerous variables, allowing you to customize a retirement plan that aligns with your preferred lifestyle and financial capabilities. You can set different levels of income, different levels of expenses, understand potential lifetime taxes and so much more.
With a solid grasp of your AGI and the use of this Planner in your retirement planning, you’re paving the way for a prosperous financial journey ahead!
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