Legal Definitions - adjusted gross income (AGI)

Adjusted Gross Income (AGI) is a fundamental figure on a U.S. income tax return that represents an individual's total income after certain specific deductions have been applied, but *before* other common deductions (like the standard deduction or itemized deductions) are taken into account.

To calculate AGI, you start with your gross income, which includes nearly all income sources such as wages, salaries, tips, interest, dividends, capital gains, business profits, and retirement distributions. From this gross income, you then subtract specific, IRS-approved adjustments. These adjustments are often referred to as "above-the-line" deductions because they are subtracted directly from gross income to arrive at AGI.

Common adjustments that reduce gross income to AGI include:

• Contributions to traditional Individual Retirement Accounts (IRAs)
• Student loan interest payments
• Deductible portions of self-employment taxes
• Health Savings Account (HSA) contributions
• Alimony payments (for divorce agreements executed before 2019)
• Educator expenses

AGI is a critical figure because it serves as a baseline for determining eligibility for many other tax credits, deductions, and various tax benefits. Many tax rules, such as the deductibility of medical expenses, charitable contributions, or the phase-out of certain tax credits, are directly tied to an individual's AGI.

Here are a few examples illustrating how AGI works:

• Example 1: Salaried Employee with Common Adjustments

  Maria works a full-time job, earning $70,000 in salary. She also received $500 in dividend income from her investments. Throughout the year, she paid $1,500 in student loan interest and contributed $6,000 to her traditional IRA. To calculate her AGI, she would start with her gross income ($70,000 salary + $500 dividends = $70,500). From this, she would subtract her student loan interest ($1,500) and her IRA contribution ($6,000). Her AGI would therefore be $70,500 - $1,500 - $6,000 = $63,000. This lower AGI of $63,000, rather than her gross income of $70,500, would be used to determine her eligibility for various tax credits or the threshold for other itemized deductions.

• Example 2: Small Business Owner's Deductions

  David runs a freelance graphic design business. His business generated $90,000 in income before expenses. As a self-employed individual, he paid $8,000 in self-employment taxes, of which half ($4,000) is deductible. He also paid $5,000 in health insurance premiums for himself, which is deductible for self-employed individuals. Additionally, he contributed $10,000 to a Simplified Employee Pension (SEP) IRA. To find his AGI, David would take his business income ($90,000) and subtract the deductible portion of his self-employment tax ($4,000), his self-employed health insurance premiums ($5,000), and his SEP IRA contribution ($10,000). His AGI would be $90,000 - $4,000 - $5,000 - $10,000 = $71,000. This demonstrates how business-related deductions can significantly reduce a self-employed individual's AGI.

• Example 3: Impact on Medical Expense Deduction Threshold

  The Rodriguez family incurred substantial medical expenses totaling $12,000 during the year. The IRS allows taxpayers to deduct medical expenses only to the extent they exceed 7.5% of their AGI. If the Rodriguez family's AGI is $80,000, their deduction threshold would be $80,000 * 0.075 = $6,000. This means they could deduct $12,000 - $6,000 = $6,000 of their medical expenses. However, if their AGI was higher, say $100,000, their threshold would be $100,000 * 0.075 = $7,500, allowing them to deduct only $12,000 - $7,500 = $4,500. This illustrates how a lower AGI can increase the amount of medical expenses a taxpayer can deduct, highlighting AGI's role in determining the limits of other deductions.