Adjusted gross income is the amount that results after subtracting certain specific deductions from reportable income. This amount is used to determine various tax items. If you follow the instructions and order of the tax return, you arrive at adjusted gross income automatically.
Deductions taken into account in figuring AGI fall into two categories:
- Write-offs taken into account in reporting certain income or losses. For example, if capital losses exceed capital gains, up to $3,000 of such excess losses can be used to offset income (it operates as a subtraction within the income section on Form 1040). Similarly, business losses are reported within the income section as a negative number.
- Deductions enumerated in the adjusted gross income section of Form 1040. These include deductible IRA contributions, alimony payments, moving expenses, health savings account contributions, educator’s deduction, tuition and fees deduction and certain deductions related to self-employment (e.g., one-half of the self-employment tax, health insurance deduction and contributions to a qualified retirement plan).
Adjusted gross income is a pivotal amount in federal income taxes. It is the figure on which many opportunities and limits in the tax law are based. These include:
- The amount of Social Security benefits to include in income, if any. (Aside from taxes, AGI is also used to determine whether Medicare beneficiaries must pay an additional Part B premium.)
- Itemized deductions for medical expenses, charitable contributions, casualty and theft losses and miscellaneous itemized expenses.
- Eligibility to contribute to a deductible IRA when participating in an employer’s retirement plan or to contribute to a Roth IRA.
- Ability to deduct up to $25,000 in losses from rental real estate activities.
- Eligibility for an above-the-line deduction for tuition and fees.
- Eligibility for various tax credits, including the child tax credit, the dependent care credit, earned income credit, credit for the elderly, retirement savers credit and education credits.
Here are the two steps to your adjusted gross income:
1. Figure gross income. This is all income received by you from any source, such as wages, salary, tips, gross business income, income from sales and exchanges of property, interest and dividends, rents, royalties, annuities, pensions, etc. But because of exclusions allowed by the tax law, gross income does not include such items as tax-free interest from state or local bonds, tax-free parsonage allowance, tax-free insurance proceeds, gifts and inheritances, certain home sale gains, Social Security benefits that are not subject to tax, tax-free scholarship grants, tax-free board and lodging and other tax-free fringe benefits.
2. Deduct from your 2010 gross income only the following items:
- Repayment of supplemental unemployment benefits required because of receipt of trade readjustment allowances.
- Forfeiture-of-interest penalties because of premature withdrawals.
- Capital loss deduction up to $3,000.
- IRA contributions.
- Rent and royalty expenses.
- Educator expenses. See the note below.
- Tuition and fees. See the note below.
- 50 percent of self-employment tax liability.
- Health savings account contributions.
- Health insurance premiums if self-employed.
- Jury duty pay turned over to your employer.
- Performing artist’s qualifying expenses.
- Reforestation expenses.
- Reservists’ travel costs.
- State and local official expenses.
- Moving expenses.
- Student loan interest.
- Alimony payments.
- Domestic production activities deduction.
- Business expenses.
- Net operating losses.
- Keogh or SEP retirement plan contributions for yourself.
- Archer MSA contributions.
The difference between step 1 and step 2 is your adjusted gross income.
Remember to always “Maximize your refund by Optimizing your deductions.”