When filing your tax return, you would always spot a column to figure out your adjusted gross income, or more commonly known as AGI. This is a crucial step in calculating and arriving at your taxable income and tax liability for a given tax year.
Knowing how to calculate AGI from W-2 form is an essential skill every taxpayer should possess. As a non-tax-professional, you could come across some misconceptions when learning how to figure out your AGI. Let’s have a look and go into detail about the concept of adjusted gross income.
Additionally, we recommend you to read “Paystub Abbreviations and Acronyms Decoding Tips” to get you familiarized with the abbreviations and acronyms you see in paycheck stubs.
What is Adjusted Gross Income (AGI)?
The Internal Revenue Service defines Adjusted Gross Income (AGI) as gross income deducted with “adjustments to income.” The IRS uses AGI to determine your income tax liability for the year.
Gross income is the sum of all the money you earned within a year including amounts such as your wage, dividends, business income, retirement distributions, capital gains, and other forms of income.
Adjustments to income could include alimony payments, health savings account contributions, and student loan interest, among other items. The AGI would never be more than the total gross income on your return and more often lower.
After determining your AGI, the next step would be to subtract deductions to calculate your taxable income, thus giving your tax liability. Additionally, you could use your AGI if you want to qualify for credits and deductions. The IRS also uses other forms of income metrics, including the “Modified Adjusted Gross Income (MAGI)” for specific programs and retirement accounts.
To put it simply, adjusted gross income is a modification of your gross income with certain adjustments to reach a figure that would be used to calculate your tax liability. Many U.S. states use the AGI from federal returns to determine how much an individual owes in state income taxes. States could also modify the AGI with state-specific deductions and credits.
Does your W-2 show your AGI?
IRS form W-2, also known as the Wage and Tax Statement Form, is a tax form used by employers to report their employees’ wages and the taxes withheld from their paycheck at the end of a tax year. Employers are required to complete a W-2 for each employee in their business or company who receives a wage, salary, or other compensation.
When looking at a W-2 form, you would see both lettered and numbered boxes that an employer must fill out correctly and adequately. Numerous boxes on the W-2 Form identify a specific value related to your wages and taxes. There is no box for AGI on W-2 forms, but you could always use the information on your W-2 on how to figure out AGI.
- Box 1 contains your annual salary
- Box 2 shows how much your employer withheld for taxes
- Box 3 tells you your social security wages (if applicable)
- Box 4 shows you how much tax an employer withheld from social security wages (if applicable)
To get a better grasp of your IRS form W-2, visit “W-2 Wage and Tax Statement Form For Small Business.”
What is included in AGI?
To estimate your adjusted gross income from W-2, you need to identify your total annual income, above-the-line deductions, and, if applicable, your standard deductions or itemized deductions.
As stated earlier, you could determine your total gross income using your W-2 or paystub. Gross income is the sum of all the money you earn within a year.
Above-the-line deductions refer to reductions utilized by the IRS to allow you to deduct from your annual gross income to reach your adjusted gross income.
If you do not itemize your deductions using Form 1040 schedule A, the IRS allows you to take the standard deduction to calculate your taxable income. The standard deduction refers to the portion of your income not subjected to tax, which could be used to decrease your tax bill.
Depending on your filing status, the amount of your standard deduction would vary. Your filing status includes your age, marital status, or whether you claimed as a dependent or are disabled.
Meanwhile, itemized deductions are expenses that come after your adjusted gross income. They are also called below-the-line deductions that reduce your taxable income and are computed on the IRS Schedule A with the total carried over to your Form 1040. After subtracting itemized deductions from your income, the remaining amount is your actual taxable income.
How Do I Calculate AGI?
If you utilize software to prepare your tax returns, it would automatically calculate your AGI once you enter the necessary information. Meanwhile, the W-2 form would help you with the needed amounts to calculate AGI. Follow the steps below:
- Begin identifying your reported salary by your employer inside Box 1 of your wages and tax statement for the year. Box 1 is labeled “Wages, Tips, Other Compensation.”
- Next, add additional taxable income such as dividends, prizes, lottery, unemployment benefits, rents, etc. It could also include miscellaneous income reported on 1099 forms.
- Then, sum up all adjustments to income, also known as above-the-line deductions, that you made in the last year.
- Lastly, subtract the total above-the-line deductions from your final annual income. The amount you get is your adjusted gross income (AGI).
To better understand, let’s take a look at an example. If your W-2 shows:
- Your taxable wages earned are $100,000
- and you have $500 in taxable interest,
- $800 in dividends,
- and an additional $1,000 in investment income,
- Your total taxable income is $100,000 + $1,000 + $800 + $500 = $102,300.
However, suppose you have:
- paid off a student loan interest of $900,
- spent $700 on educator expenses,
- contributed $1800 to a traditional IRA and
- $10,000 to a retirement account.
- Your total deductions would equal $900 + $700 + $1,800 + $10,000 = $13,400.
Subtract that amount to the total taxable income, and you would find that your adjusted gross income is $102,300 - $13,400 = $88,900 (AGI)
How to calculate AGI from paystub?
If you do not have your W-2 or it is missing, you need to calculate AGI from your paystub. Worry not, as figuring out your AGI using your paystub is still possible. However, it is still best to wait until you have received your wage and tax statement form to file your tax return.
You could use your final paystub for the year to calculate your adjusted gross income for the year. You would also need records of any other income you received during the year and records of any deductions you want to claim.
Here are the steps to estimate your AGI using your paystub.
- On your final paystub, locate the total YTD earnings amount, usually listed under “Earnings.” Total YTD earnings could include regular wage, bonuses, and other sources of income your job provides.
- Search for any pretax deductions on your paystub. Common deductions include health insurance, your 401k, and public transportation costs.
- Take away the amount of the before-tax deductions from your total YTD earnings.
- Add other sources of income (if any) to the year-to-date paystub amount. This could include alimony or taxable interest, unemployment, or any income you gain from renting property or working as an independent contractor.
- Total the amount of any deductions you could claim. This could include paid student loan interest, tuition (if you attended school), educator expenses, and other deductions.
- Subtract the total amount of your deductions from your total income to reach your adjusted gross income for the year.
Is AGI after standard deduction?
A standard tax deduction is a certain amount, which decreases your taxable income on tax returns, effectively reducing your tax liability. A taxpayer could choose either a standard deduction or itemized deduction, which would reduce the amount they pay for taxes.
So, is AGI after standard deduction? The answer is no. Your AGI is determined before you take the standard deduction or itemized deductions, which you need to report in later sections of the return.
What reduces your adjusted gross income?
The IRS gives many opportunities for individuals to take deductions that could reduce the amount of income taxed to determine your AGI on W-2. TheseThese deductions, referred to as “adjustments to income,” are specific expenses based on certain activities that allow you to reduce your total income to reach AGI effectively.
The ability to give deductions allows the IRS to extend tax advantages to those in poverty, empower students and educators, and incentivize charitable donations, among other things. These reductions are also referred to as “above-the-line” deductions.
Claiming deductions save you hundreds or even thousands on your tax bill, especially for business owners having close ties with education or charity or pay a huge interest in a given year.
Above The Line Deductions to Estimate AGI
Tax laws change every year, but here are some examples of above-the-line deductions based on IRS schedule 1.
- Educator expenses
- Certain business expenses of reservists, performing artists, and fee-based government officials.
- Health savings account contributions
- Moving expenses for Armed Forces members
- A portion of self-employment tax
- Self-Employed SEP, SIMPLE, and qualified plans
- Self-employed health insurance deduction
- Penalty on early withdrawal of savings
- Alimony paid
- IRA contributions
- Interest paid on student loans
- Educational tuition and fees
Modified Adjusted Gross Income (MAGI)
Throughout your tax return, you would notice that the IRS also uses the term “modified adjusted gross income,” or more commonly known as MAGI. Your MAGI is what you get after your AGI increases or decreases by certain amounts unique to specific deductions. This figure begins with your AGI plus particular exclusions such as foreign earned income exclusion and deductions such as your student loan interest or tuition fees.
The MAGI is used to determine how much (if applicable) you could contribute to a Roth IRA, an individual retirement account offering tax-free growth and tax-free withdrawals in retirement, in a given year. You could also use your modified adjusted gross income if you want to apply for Marketplace health insurance under the Affordable Care Act.
To calculate your Modified Adjusted Gross Income, you would need to include your AGI and put back the following adjustments:
- IRA deduction
- Student loan interest deduction
- Domestic production activities deduction
- Foreign earned income exclusion
- Foreign housing exclusion or deduction
- Exclusion of qualified savings bond interest
- Exclusion of employer-provided adoption benefits
Anyway, your MAGI is one of the essential figures that you could enter on your federal income tax return. Among other things, your modified adjusted gross income:
- Establishes your suitability for income-based health insurance assistance or Medicaid coverage;
- Decreases your taxable income to consider your retirement account contributions;
- Takes in your eligibility for benefits such as the child tax credit and student loan interest.
Why is Adjusted Gross Income Important?
The advantage of calculating your adjusted gross income before choosing between standard or itemized deductions is that even if you select the standard deduction, you could still get subsidiaries for participating in education, self-employment, or health savings account contributions. This incentivizes specific activities, even if you choose standard deduction over itemizing.
Beyond tax benefits, your adjusted gross income is used throughout IRS forms and tax codes for calculations. Estimating your AGI allows someone to know their tax liability without getting very specific.
As with most of the tax code, ensuring that you have a good understanding of basic definitions goes a long way in helping you grasp more significant concepts such as calculating AGI from W-2s.
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