How and Why to Manage Your Adjusted Gross Income

Adjusted gross income is an important number that affects not just your tax bracket but whether you qualify for many tax credits and deductions. Here’s how it works.

This post is provided for general information only. Please confirm the details and circumstances of your unique situation with your tax accountant or other appropriate advisor before taking action.

What is adjusted gross income?

Adjusted gross income, or AGI, comes from Line 11 of your Form 1040. It’s your gross income minus adjustments.

Your gross income includes wages, salaries, tips, self-employment income, bank interest, investment income, retirement distributions, and other income sources.

Adjustments to income come from Part II of Schedule 1. These adjustments are also known as above-the-line deductions.

They’re above the line because only certain tax deductions affected your adjusted gross income. Others get subtracted later.

Above-the-line deductions include:

  • Educator expenses
  • The HSA deduction
  • Deductible retirement contributions
  • The self-employed health insurance deduction
  • The student loan interest deduction
  • One-half of your self-employment tax
  • Military moving expenses
  • A few other less common tax deductions.

Is your adjusted gross income on your W-2?

Adjusted gross income does not go on your W-2. Your employer can’t know your adjusted gross income, because your AGI includes other income minus adjustments not related to your job.

Do you pay taxes on adjusted gross income?

There are a couple of more steps after calculating AGI before you can reach your taxable income.

First, you’ll need to subtract your standard deduction or itemized deductions. Next, you may subtract the qualified business income deduction if you have self-employment or pass-through business income.

Your tax bracket and income taxes is based on your taxable income not adjusted gross income.

Why is adjusted gross income important?

Even though you pay income tax on your taxable income not adjusted gross income, most tax credits and deductions with income limits use your Adjusted Gross Income.

These include:

  • Student loan interest deduction
  • Eligibility to contribute to a Roth IRA
  • Whether traditional IRA contributions are deductible or non-deductible
  • Healthcare subsidies
  • Education tax credits
  • Earned Income Tax Credit
  • Whether you pay taxes on Social Security Income

When discussing tax brackets, it’s common advice that increasing your income won’t cost you more in taxes. Tax brackets are marginal, so when you move into a higher tax bracket, you only pay the higher tax rate on the new dollars not all of your income.

In some cases, increasing your adjusted gross income can mean you lose eligibility for a tax deduction, tax credit, or government assistance program and either have to pay more in taxes or lose more in benefits than your added income.

Similarly, lowering your adjusted gross income can help you qualify for more benefits.

How do you manage your adjusted gross income?

There are two ways to manage your adjusted gross income. You can either make less money or find more above-the-line deductions.

Making less money may seem like a drastic step. However, if it’s near the end of the year, working just a little less can help you squeeze in under a cutoff to receive thousands of dollars in deductions or credits.

You should also think about adjusted gross income when doing things like selling stocks or cashing in CDs. If you need your adjusted gross income to be a certain amount, it might make sense to wait until next year.

Finally, there are often easy ways to get more above-the-line deductions. If you haven’t maxed out your HSA or retirement accounts, you can make an extra contribution to lower your adjusted gross income today, while future you will have more in your investment account.

If you’re self-employed or own a business, you may also be able to time business expenses to help get your AGI where you need it to be.

What is modified adjusted gross income?

Some taxes use a modified adjusted gross income rather than your AGI on your tax return. Modified means either adding or subtracting certain income or deductions that don’t normally figure into your AGI.

For example, MAGI for healthcare subsidies is your AGI plus non-taxable Social Security, tax-exempt interest, and certain foreign-earned income.

There is no one modified adjusted gross income. Each benefit that uses MAGI instead of AGI may calculate it differently.

Which year AGI do you use?

Most tax credits and deductions use the AGI from your current year tax return. That is, they use the AGI on the same tax return that you’re claiming them on.

Most government benefits based on your AGI use your prior year AGI from the last tax return that you filed.

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