What Is Adjusted Gross Income (AGI)?

Adjusted Gross Income (AGI) is a fundamental concept in personal finance and taxation, serving as a cornerstone for determining an individual’s tax liability in the United States. It is a figure that appears on your federal income tax return and is used by the Internal Revenue Service (IRS) to calculate how much of your income is taxable after accounting for specific adjustments. Understanding AGI is essential for taxpayers, as it affects everything from the amount of taxes owed to eligibility for certain tax credits and deductions. In this article, we’ll explore what AGI is, how it’s calculated, why it matters, and its broader implications for financial planning.

Defining Adjusted Gross Income

At its core, Adjusted Gross Income (AGI) is the total gross income an individual earns in a year, minus specific deductions allowed by the IRS. Gross income includes all income from various sources, such as wages, salaries, tips, interest, dividends, business income, capital gains, retirement distributions, and more. Essentially, it’s the sum of all money you’ve earned before any taxes or deductions are applied.

However, not all of that income is subject to taxation. The IRS allows certain adjustments to be subtracted from gross income to arrive at AGI. These adjustments, often referred to as “above-the-line” deductions, reduce the amount of income that is ultimately taxed. AGI is a critical figure because it serves as the starting point for determining your taxable income, which is calculated after applying additional deductions (either standard or itemized) and exemptions.

In simpler terms, AGI is like a filter: it takes your total income and strains out specific expenses or contributions to give a clearer picture of what portion of your earnings will be subject to federal income tax.

Why AGI Matters

AGI is more than just a number on your tax return—it’s a pivotal figure that influences multiple aspects of your financial life. Here are some key reasons why AGI is so important:

Determines Taxable Income: AGI is the foundation for calculating your taxable income, which is the amount used to determine how much federal income tax you owe. After calculating AGI, you subtract either the standard deduction or itemized deductions, and any applicable personal exemptions (though exemptions were eliminated under the Tax Cuts and Jobs Act of 2017 for tax years 2018–2025), to arrive at taxable income.
Eligibility for Tax Credits and Deductions: Many tax credits and deductions are tied to AGI or a related metric called Modified Adjusted Gross Income (MAGI). For example, credits like the Earned Income Tax Credit (EITC), Child Tax Credit, and education credits (such as the American Opportunity Credit) have income phase-out ranges based on AGI or MAGI. Similarly, deductions like those for medical expenses or charitable contributions may be limited based on a percentage of your AGI.
Impact on State Taxes: In many states, your federal AGI is used as the starting point for calculating state income taxes. Adjustments made at the federal level can therefore influence your state tax liability as well.
Qualification for Financial Programs: Beyond taxes, AGI is often used to determine eligibility for certain government programs or financial benefits. For instance, income-driven repayment plans for federal student loans are based on AGI, as are subsidies for health insurance purchased through the Affordable Care Act marketplace.
Retirement Account Contributions: Your AGI affects your ability to contribute to certain retirement accounts, such as a Roth IRA, or to deduct contributions to a traditional IRA if you’re covered by an employer-sponsored retirement plan. High AGI levels can phase out these opportunities, limiting your ability to save for retirement in tax-advantaged accounts.

Given its wide-reaching implications, understanding and managing your AGI can lead to significant tax savings and better financial planning.

How to Calculate AGI

Calculating AGI involves a straightforward process, but it requires gathering all relevant financial information. The steps below outline how AGI is determined, typically using IRS Form 1040, the standard form for individual income tax returns.

Step 1: Calculate Gross Income

The first step is to tally up all sources of income for the tax year. According to the IRS, gross income includes, but is not limited to:

Wages and Salaries: Earnings from employment, reported on a W-2 form.
Tips and Bonuses: Any additional compensation from work.
Self-Employment Income: Net earnings from a business or freelance work, reported on Schedule C.
Investment Income: Interest, dividends, and capital gains from investments.
Retirement Income: Distributions from pensions, annuities, or retirement accounts like 401(k)s or IRAs.
Rental Income: Money earned from renting out property.
Alimony: Payments received under divorce agreements finalized before 2019 (alimony is no longer includable for agreements after 2018 due to tax law changes).
Unemployment Compensation: Payments received from unemployment benefits.
Social Security Benefits: A portion of these may be taxable, depending on your total income.
Other Income: Miscellaneous sources like gambling winnings, jury duty pay, or canceled debts.

This list isn’t exhaustive, but it covers the most common income sources. You’ll report these amounts on the first page of Form 1040, summing them to arrive at your total gross income.

Step 2: Subtract Above-the-Line Deductions

Once you’ve calculated your gross income, the next step is to subtract specific adjustments to income, known as above-the-line deductions. These deductions are called “above-the-line” because they are subtracted before you calculate AGI, as opposed to “below-the-line” deductions (like the standard or itemized deductions) that come later.

Common above-the-line deductions include:

Contributions to Retirement Accounts: Contributions to a traditional IRA, SEP-IRA, or certain other retirement plans, if eligible.
Health Savings Account (HSA) Contributions: Contributions to an HSA, which are tax-deductible if made with after-tax dollars.
Student Loan Interest: Up to $2,500 of interest paid on qualified student loans, subject to income limits.
Educator Expenses: Up to $300 (as of 2025) for out-of-pocket classroom expenses for eligible educators.
Self-Employment Deductions: Half of the self-employment tax, self-employed health insurance premiums, and contributions to qualified retirement plans.
Alimony Paid: For divorce agreements finalized before 2019, alimony payments are deductible (no longer applicable for newer agreements).
Moving Expenses for Military Members: Limited to active-duty military personnel relocating due to service.
Certain Business Expenses: For specific professions, like performing artists or reservists.

Not every taxpayer will qualify for all of these deductions, and some have income phase-outs or other restrictions. You’ll list these deductions on Form 1040, Schedule 1, and subtract them from your gross income.

Step 3: Arrive at AGI

After subtracting the above-the-line deductions from your gross income, the resulting figure is your AGI. This number is reported on Form 1040 and carried forward to calculate your taxable income.

For example, let’s say an individual has the following financial profile for 2025:

Wages: $75,000
Interest income: $2,000
Self-employment income: $10,000
Total gross income: $87,000

They qualify for the following above-the-line deductions:

Student loan interest: $2,000
HSA contribution: $3,600
Half of self-employment tax: $706

Total deductions: $2,000 + $3,600 + $706 = $6,306

AGI = $87,000 – $6,306 = $80,694

This AGI would then be used to calculate taxable income by subtracting the standard deduction ($14,600 for single filers in 2025) or itemized deductions, depending on which is higher.

Modified Adjusted Gross Income (MAGI)

In some cases, the IRS uses a variation of AGI called Modified Adjusted Gross Income (MAGI) to determine eligibility for certain tax benefits or programs. MAGI is calculated by taking your AGI and “adding back” specific deductions or exclusions that were subtracted earlier. Common add-backs include:

Student loan interest deduction
Foreign earned income exclusion
Tax-exempt interest (e.g., from municipal bonds)
Half of self-employment tax deducted
IRA contributions (for certain calculations)

For example, MAGI is used to determine eligibility for:

Roth IRA contributions
Premium tax credits for health insurance
Deductibility of traditional IRA contributions if you’re covered by an employer plan

Because MAGI can differ from AGI, it’s worth calculating both if you’re applying for income-based benefits or planning retirement contributions.

Strategies to Lower AGI

Since AGI plays such a significant role in taxes and financial eligibility, taxpayers often seek ways to reduce it legally. Lowering AGI can increase eligibility for tax credits, deductions, or other benefits, and potentially reduce taxable income. Here are some strategies to consider:

Maximize Retirement Contributions: Contributing to a traditional IRA, 401(k), or other qualified retirement plans reduces your gross income directly. For 2025, the 401(k) contribution limit is $23,500 (plus a $7,500 catch-up for those over 50), and the IRA limit is $7,000 (plus $1,000 catch-up).
Contribute to an HSA: If you have a high-deductible health plan, HSA contributions are deductible up to $4,300 for individuals or $8,550 for families in 2025 (plus $1,000 catch-up for those 55+).
Leverage Self-Employment Deductions: Self-employed individuals can deduct health insurance premiums, half of self-employment tax, and contributions to SEP-IRAs or solo 401(k)s.
Pay Student Loan Interest Early: If you’re close to the income phase-out for the student loan interest deduction, paying interest before year-end can reduce AGI.
Bunch Deductible Expenses: If you’re self-employed or have significant unreimbursed business expenses, consider timing them to maximize deductions in a single tax year.
Consider Tax-Loss Harvesting: Selling investments at a loss can offset capital gains and up to $3,000 of ordinary income, reducing gross income.

Always consult a tax professional before implementing these strategies, as tax laws are complex and individual circumstances vary.

Common Misconceptions About AGI

Despite its importance, AGI is often misunderstood. Here are some common myths:

AGI Is the Same as Taxable Income: AGI is an intermediate step, not the final taxable amount. Taxable income is calculated after subtracting standard or itemized deductions from AGI.
All Income Is Included in AGI: Certain types of income, like tax-exempt interest or gifts, may not be included in gross income and thus don’t affect AGI.
AGI Only Matters for Taxes: As noted, AGI influences eligibility for non-tax programs like student loan repayment plans and health insurance subsidies.

Clarifying these misconceptions can help taxpayers make informed decisions.

AGI in Context: A Broader Financial Picture

While AGI is primarily a tax concept, it’s also a useful metric for assessing your financial health. A high AGI might indicate strong earnings but could also push you into higher tax brackets or phase you out of valuable credits. Conversely, a low AGI might qualify you for benefits but could signal underemployment or missed income opportunities.

When planning your finances, consider how AGI interacts with other metrics, like net worth, cash flow, and investment income. For example, retirees with low AGI due to tax-free Roth IRA withdrawals might still have significant wealth, while a high-earning professional with substantial deductions might have a lower AGI than expected.

Conclusion

Adjusted Gross Income (AGI) is a critical figure in the U.S. tax system, serving as the foundation for calculating taxable income and determining eligibility for a wide range of tax benefits and financial programs. By understanding how AGI is calculated—gross income minus above-the-line deductions—taxpayers can better navigate the complexities of tax season and make strategic financial decisions.

Whether you’re aiming to lower your AGI to qualify for credits, maximize deductions, or plan for retirement, staying informed about this metric is essential. With careful planning and, if needed, professional guidance, you can leverage AGI to optimize your tax situation and achieve your broader financial goals. As tax laws evolve, keeping up with changes to deductions, credits, and income limits will ensure you’re making the most of your Adjusted Gross Income.