Financial Word of the Day: Adjusted Gross Income (AGI)
Understanding this important financial number can help you lower your tax bill, qualify for valuable tax breaks, and keep more of your hard-earned money.
What Is Adjusted Gross Income (AGI)?
When it comes to taxes, what you earn and what the IRS considers your income aren't always the same thing. That's where Adjusted Gross Income (AGI) comes into play.
Definition: Adjusted Gross Income (AGI) is your total taxable income from all sources minus certain IRS-approved adjustments to income. It's an important number used to determine your eligibility for various tax deductions, credits, and other financial benefits.
Think of AGI as the IRS's starting point for figuring out how much of your income may ultimately be subject to federal income taxes.
And here's the good news: Understanding how AGI works could help you save thousands of dollars over time!
How Does AGI Work?
Let's say you and your spouse earn a combined $120,000 annually.
However, you also qualify for several adjustments to income:
Total annual income: $120,000
Deductible traditional IRA contribution: $7,000
Eligible Health Savings Account contribution: $4,000
Total adjustments: $11,000
Your Adjusted Gross Income would be: $120,000 − $11,000 = $109,000 AGI
Even though you earned $120,000, your AGI is only $109,000. That's an $11,000 difference that could significantly impact your tax situation!
Keep in mind that not every contribution qualifies for an adjustment. Eligibility depends on IRS rules and your individual circumstances.
Why Is AGI Important?
Your AGI affects several important areas of your financial life.
1. Your Tax Bill: A lower AGI can reduce the income used in calculating your federal income taxes. Your standard deduction or itemized deductions generally come afterward.
2. Tax Credits and Deductions: Certain education credits, retirement-related tax benefits, and other deductions have income limits. A lower AGI could help you qualify, although some benefits use a modified AGI calculation.
3. Retirement Planning: Strategic contributions to eligible retirement accounts may help reduce your current AGI while building wealth for retirement.
4. Healthcare Savings: Contributions to eligible Health Savings Accounts (HSAs) can potentially lower your AGI while helping you save for future medical expenses.
How Can You Use Adjusted Gross Income to Build Wealth?
Here's where understanding AGI becomes especially valuable.
Rather than simply accepting your tax bill every April, consider ways to manage your AGI throughout the year.
For example, contributing to a deductible traditional IRA or an eligible HSA could offer two financial advantages: reducing your current tax burden and building savings for the future. That's a financial win-win!
Just remember that traditional 401(k) salary deferrals generally reduce taxable wages before they're reported on your tax return, rather than appearing as a separate AGI adjustment.
The Bottom Line on Adjusted Gross Income
Your AGI is more than just another number on your tax return. It's an important financial planning tool.
You can find your AGI on Line 11 of IRS Form 1040.
Understanding how that number is calculated puts you in a better position to make smart financial decisions, potentially reduce your taxes, and keep more money working for you.
After all, building wealth isn't just about how much money you make.
It's about how much money you keep, save, and invest!
Today's Financial Challenge
Pull out last year's federal tax return and locate your Adjusted Gross Income.
Then ask yourself: "Am I taking advantage of every legitimate opportunity to lower my AGI?"
A conversation with a qualified tax professional could uncover opportunities you've been overlooking.
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