Back to: ACCOUNTING, TAX, & REPORTING
Adjusted Gross Income (AGI) Definition
Adjusted gross income is ascertained from your gross income and used to ascertain how much tax you need to pay on your income. In the U.S., it is the premises for ascertaining the tax bill of a filer, and one can receive many credits and deductions based on AGI. There are many softwares that help in assessing AGI at the time you do tax filing.
A Little More on What is Adjusted Gross Income (AGI)
Adjusted gross income represents a part of gross income in U.S. tax laws. Whereas gross income refers to the total income earned by an individual in a year. This income consists of dividends, wages, salaries, capital gains, interest earned, royalty, income earned from rental property, etc. AGI accounts for many deductions from an individual’s gross income in order to ascertain the amount on which the income tax will be ascertained. AGI is more effective than gross income when it comes to considering personal tax activities. Every deduction that converts gross income to adjusted gross income is considered before making tax exemptions for military service, dependent status, etc. In U.S., adjusted gross income is considered for filing a tax bill of an individual. After this step, the state taxable income of a person is affected by state-specific deductions and credits.
Adjusted Gross Income (AGI) Deductions and Credits
Adjustments to income are made in the form of deductions while ascertaining adjusted gross income. A few significant deductions used to find the adjusted gross income of an individual are:
- Specific retirement plans including SIMPLE IRA, SEP IRA, Individual Retirement Accounts, etc.
- Expenses borne and not reimbursed by companies. These expenses usually include rental costs, and are not available for employees
- 50% of self-employment tax
- Medical expenses and deductions related to Healthcare savings account
- Alimony that is considered a part of gross income of the recipient
- Moving expenses. This deduction was started in 2018 and is valid only if the militant receive special order to move.
- Losses faced due to selling of property.
- Tuition fees, and interest charged on student loan with certain limitations and restrictions
- Jury duty paid to the employer of filer
- Expenses borne in the course of business activities by entrepreneurs, teachers, government officers, etc.
Calculation of Adjusted Gross Income
The first step for calculating AGI involves double-checking or verifying the reported financial statements for the specific year, and including the sources of taxable income such as profit earned on selling property, pensions, compensation for unemployment, and other income that is not included in tax return. You can deduct genuine deductions and payments made from the total amount of earnings/income, and the final amount will be adjusted gross income which is the premises for ascertaining the taxable income of a taxpayer.
One can look for the enlisted requirements for deductions in the Internal Revenue Code (IRC) or on the official website of Internal Revenue Service. The requirements are clear and to-the-point, and one should be very attentive while they analyze the federal tax code in order to ensure they fulfil conditions for deductions they wish to take.
Once AGI is calculated, the income taxpayer can assess their taxable income by implementing the eligible deductions thereon. Or, they can be eligible for getting itemized deductions by itemizing their expenses. As The Tax Cuts and Jobs Act is implemented, the filers making use of itemized deductions have reduced pertaining to rise in standard deduction. However, affluent tax filers can still use itemization as an effective strategy for cutting down their tax.
AGI has a direct impact on the deductions and credits that an individual taxpayer can get benefits from. If your adjusted gross income is less, you will receive more deductions and credits. For instance, a taxpayer itemizing deductions and reporting dental expenses should lower down his/her total expenses by 7.5% of adjusted gross income for 2018. So, if AGI is $100,000 and dental expenses are reported $10,000, the deduction needs to be reduced by $7,500. In case, the AGI was $50,000, reduction will be again 7.5% of AGI, leading to $3,750.
Adjusted Gross Income vs Modified Adjusted Gross Income
In order to calculate individual income tax, AGI helps in ascertaining the amount of gross income that is taxable. The concept of AGI is different from Modified Adjusted Gross Income that changes the AGI by including foreign earned income, tax-exempt interest, and the portion of Social Security Benefits that is not included.
Adjusted Gross Income (AGI) and IRS Form 1040
Adjusted gross income gets reported on IRS Form 1040 which is also referred to as U.S. Individual Income Tax Return. Prior to 2018, tax filers had to go through several versions of 1040 in order to find the right one to use. However, in 2018, things changed with the implementation of Tax Cuts and Jobs Act, making 1040 more brief and easy-to-understand. Form 1040-EZ and 1040A are not in picture anymore. The latest 1040 form consists of 2 pages, and is applicable for recapping income, deductions, and credits.
There are cases when more forms and schedules are needed for itemized files, or the ones covering specific business operations, or having specific income type or deductions. For instance, Schedule B covers interest and dividends, Schedule F covers Farms, and Schedule E includes rental income.
As per the IRS, Adjusted Gross Income refers to the difference between gross income and adjustments made to it. Tax filers who wish to receive a steady estimate of their adjusted gross income for 2018 tax returns can view line 37 on Form 1040. For the ones who use Married-Filing Jointly option for filing purposes, there is a defined restriction of $66,000 on AGI which is applicable to both persons. If you’re planning to file a federal tax return online, you must authenticate your identity either with AGI or a self-selected PIN from the tax return filed in 2018.
Reference for “Adjusted Gross Income (AGI)”
Academics research on “Adjusted Gross Income (AGI)”
The effect of marginal tax rates on taxable income: a panel study of the 1986 Tax Reform Act, Feldstein, M. (1995). The effect of marginal tax rates on taxable income: a panel study of the 1986 Tax Reform Act. Journal of Political Economy, 103(3), 551-572. This paper uses a Treasury Department panel of more than 4,000 taxpayers to estimate the sensitivity of taxable income to changes in tax rates on the basis of a comparison of the tax returns of the same individual taxpayers before and after the 1986 tax reform. The analysis emphasizes that the response of taxable income involves much more than a change in the traditional measures of labor supply. The evidence shows an elasticity of taxable income with respect to the marginal net-of-tax rate that is at least one and could be substantially higher. The implications for recent tax rate changes are discussed.
Average marginal tax rates from social security and the individual income tax, Barro, R. J., & Sahasakul, C. (1983). Average marginal tax rates from social security and the individual income tax.
Direct evidence on the marginal rate of taxation on dividend income, Peterson, P. P., Peterson, D. R., & Ang, J. S. (1985). Direct evidence on the marginal rate of taxation on dividend income. Journal of Financial Economics, 14(2), 267-282. Miller and Scholes (1978) hypothesize that the marginal tax rate on dividend income may be less than the marginal rate of tax on capital gains. Their hypothesis is dependent upon individuals utilizing existing provisions of the Code which serve to reduce the taxation of dividends. In this study, estimates of the marginal and effective rates of tax on dividend income for the year 1979 are presented using the Statistics of Income sample of returns. The average marginal rate of tax on dividend income is estimated to be 40%, while the average effective rate of tax is estimated to be 30%.
Income creation or income shifting? Behavioral responses to the Tax Reform Act of 1986, Slemrod, J. (1995). Income creation or income shifting? Behavioral responses to the Tax Reform Act of 1986. The American Economic Review, 85(2), 175-180.
Individual income taxation and inflation, Von Furstenberg, G. M. (1975). Individual income taxation and inflation. National Tax Journal, 117-125. Point estimates of the effective individual income tax rates are shown for four real adjusted gross income levels from 1944 through 1972. Summary measures of liability progression are then calculated for each year, and the effects of past and prospective inflation is raising the level of tax rates and lowering the progressivity of the tax structure under given schedules are explored. It is found that the elasticity of the income tax rates with respect to inflation is at least 0.6 on average. This implies that taxes are raised by more than 16 per cent after one year of 10 per cent inflation.