When you fill out your tax return, you pay the most attention to your total taxable income. However, there is an equally important indicator. It is adjusted gross income (AGI). It directly affects the number of deductions and credits that apply to you. It reduces the amount of taxable income you report on your return.
What is AGI?
Adjusted gross income is gross income minus its adjustments. Gross income is all of your wages, business income, dividends, retirement distributions, capital gains, and other earnings. When we talk about income adjustments, we mean, for example, student loan interest, teacher expenses, retirement account contributions, or child support payments. AGI can never be more than total gross income. Usually, it is even lower.
At first glance, you may suppose this is not easy, but it is not. To calculate your adjusted gross income, you must subtract any possible adjustments you participate in from your gross income, which is an object to income tax.
Using software will make preparing your tax return much easier because it will calculate your adjusted gross income as soon as you enter the numbers.
However, if you want to learn how to calculate your AGI on your own, you should start by calculating your gross income. For this purpose, you can use your paystubs, the amount of income already calculated by your employer on your Form W-2, and add other income, such as dividends or income from a 1099 MISC form filed by an independent contractor.
What adjustments can lower my total income?
It could be:
- Alimony to an ex-spouse (for pre-2019 agreements)
- Half of your self-employment taxes
- Traditional IRA contributions
- Penalties for early withdrawal of your savings
- Military relocation expenses
- Student loan interest deduction and more.
The number of many deductions and adjustments is limited by law.
For illustration, you can only deduct the part of medical and dental expenses for a year that exceeds 7.5% of your AGI.
You should calculate your AGI before the standard deductions (you should also report them in the appropriate sections of your return). It would be best if you further deducted the standard, itemized deductions from your AGI to determine your taxable income. Either way, choose whichever is better for you.
The standard deduction is an exact dollar amount of money that can reduce the amount of your income by which the state taxes you. It consists of the amount of the basic standard deduction and any additional standard deductions for age or blindness. Generally, the standard deduction is adjusted annually for inflation. It varies depending on your filing status, whether you are over 65 or blind, and whether another taxpayer can declare you a dependent. The standard deduction is not available to some employees. You cannot use the standard deduction if you itemize your deductions.
You can claim an additional deduction if you are 65 or older at the end of the tax year. The state treats you as a 65-year-old the day before your 65th birthday. You can claim an additional deduction for blindness if you happen to be blind on the last day of the tax year. For example, one taxpayer who is 65 and blind would be eligible for the primary and additional standard deduction similar to the sum of the other beliefs for both age and blindness simultaneously.
It means it is in your best interest to claim an additional standard deduction if you or your spouse were over 65 or blind at the end of the year.
Some taxpayers are not suitable for the standard deduction:
- A person who files for less than 12 months because of a change in their annual reporting period
- A married individual filing separately whose mate itemizes deductions
- A person who was a non-resident foreigner or dual-status foreigner during the year
However, some individuals who were non-resident foreigners or dual-status foreigners during the year can take the standard deduction in the following points:
- A non-resident foreigner who is married to a U.S. citizen or resident foreigner at the end of the tax period and makes a joint election with their spouse to apply as a U.S. resident throughout the tax year;
- Students and business students who are residents of India are entitled to the benefits provided under section 21(2) of the U.S.-India Income Tax Treaty (Payments received by students and students)
- A non-resident foreigner is married to a U.S. citizen at the beginning of the tax year, who is a U.S. resident or U.S. citizen by the end of the tax period.
- A resident at the end of the tax year who makes a joint election with their spouse to treat as a U.S. resident for the entire tax year
The itemized deduction.
You must itemize deductions if your allowable itemized deductions are more significant than your standard deduction or if you must itemize deductions because you cannot use the standard deduction.
You can reduce your tax by itemizing deductions on Form 1040. Itemized deductions include the amounts you paid for state and local income or sales taxes, property taxes, personal property taxes, mortgage interest, and losses from natural disasters. You can also include gifts to charity and a portion of the amount you paid for medical and dental expenses. You can benefit by itemizing deductions if you:
- Can’t use the standard deduction, or that amount is limited
- You had significant medical and dental expenses that are not covered by insurance
- Paid mortgage interest or property taxes during the tax period
- Had any retained any losses that were not covered by insurance as a result of a federally declared disaster
- Were the victim of theft
- Made significant contributions to charitable organizations
Individual itemized deductions may be limited.
Carefully review the information we have given you. It will help you do the calculations necessary for your tax return and ultimately sum up your taxable income.
However, be careful. The law is changing all the time. So don’t limit yourself to the information you read. Be sure to check that the tax regulations are up to date so that you will not be held liable in the form of fines for violations. Always seek help from professionals, which can be accountants and financial advisors.