Your adjusted gross income, or AGI, is a very special tax term. It means your gross income minus certain types of deductions. You don’t figure your tax on your AGI, but the amount is used to determine eligibility rules and limitations for many deductions and credits. That’s why it’s worth keeping an eye on it—and understanding how to calculate AGI. (Note, however, that eligibility for IRA contributions is based on your modified adjusted gross income [MAGI], although for many individuals, this is the same as AGI.)
The instructions to Form 1040 do not clearly define AGI, but once you’ve filled out the form, you will see what goes into the computation.
Some Deductions Don’t Count
It’s easier to explain the deductions that are used to figure AGI by naming the deductions that aren’t factored into the calculation of AGI. These are:
- Personal and dependency exemptions
- Itemized deductions (medical expenses, home mortgage interest and other allowable interest, state and local taxes, charitable deductions, casualty and theft losses and miscellaneous itemized deductions)
All other deductions are used to figure AGI, which is the amount reported on line 37 of Form 1040.
The Deductions That Do Count for AGI
There are two types of deductions that are subtracted from gross income to arrive at AGI:
- Deductions that are offsets to income and are reported in the Income section of Form 1040
- Deductions that are subtracted from the total amount of income reported. You list these in the Adjusted Gross Income section of Form 1040 (lines 23 through 36).
Some types of income can be offset by deductions so that only the net amount of income (or loss) is actually entered in the Income section of the return. Examples of deductions taken into account here include:
- Business deductions for sole proprietors and independent contractors filing Schedule C. The deductions are reported on this schedule and the net profit (or loss) is then reported on the return.
- Capital losses are reported on Schedule D before they are entered on the return.
- Certain other losses from business property are reported on Form 4797 before they are listed in the Income section of the return.
- Losses from rental real estate, royalties, partnership, S corporation, trust and other activities, to the extent allowed; they are first listed on Schedule E.
- Farm losses are described on Schedule F before they are entered on Form 1040.
- Net operating losses that may result from business activities or personal casualty and theft losses are entered as a negative number in the Income section of the return.
Deductions in the Adjusted Gross Income Section of the Return
Some deductions can be claimed by individuals whether or not they itemize other personal deductions. These include:
- Educator expenses. These are entered directly on Form 1040.
- Certain business expenses of reservists, performing artists and fee-based government officials. These expenses are first figured on Form 2106 or 2016-EZ.
- Health savings account. The deduction is first figured on Form 8889.
- Moving expenses for work-related moves. Form 3903 is used to figure deductible amounts.
- One-half of self-employment tax paid by self-employed individuals. This amount is taken from Schedule SE.
- Contributions to self-employed SEP, SIMPLE or other qualified retirement plans are entered directly on Form 1040.
- Self-employed health insurance deduction, for premiums paid by self-employed individuals and more-than-2%-S corporation shareholders, is entered directly on Form 1040.
- Alimony payments, along with the recipient’s Social Security number, are entered directly on Form 1040.
- Traditional IRA contributions are deducted directly on Form 1040. (Roth IRA contributions will not lower your AGI, of course, since they are made with after-tax income.)
- Student loan interest deduction is reported directly on Form 1040.
- Tuition and fees deduction, which expired at the end of 2016 but could be extended retroactively for 2017, would be figured on Form 8917 and then reported Form 1040.
- Domestic production activities deduction for certain business owners is figured on Form 8903 before being entered on the return.
- Other adjustments to gross income do not have their own lines on the return. Instead, they should be explained in a schedule created by the taxpayer and attached to the return, along with the appropriate IRS code for the type of deduction. These other deductions and their codes can be found in the instructions to Form 1040. For example, contributions to Archer MSAs are denoted by “MSA.” Jury duty pay that a taxpayer remits to an employer is identified as “Jury Pay,” and attorney fees and court costs for actions involving certain discrimination are described as “UDC.”
Why Bother Understanding AGI?
Figuring AGI isn’t technically performed by a taxpayer when preparing returns using software, online solutions or a return preparer. The entries for appropriate write-offs are essentially automatic; those taken into account for figuring AGI are appropriately factored in. However, understanding the makeup of AGI can be helpful in determining your eligibility for other deductions and credits, such as the $25,000 rental loss allowance and the percentage of qualifying expenses you’ll be able to take for the dependent care tax credit.