Tax deductions, also called "below the line" deductions, can only be taken if the taxpayer chooses to itemize; otherwise, he or she takes the standard deduction.
Adjustments to income can be taken whether or not the taxpayer itemizes. Your adjusted gross income is important for a few reasons. First, it's the number that determines whether you qualify for certain tax breaks. AGI is also used by many lenders when you apply for a loan in order to determine your ability to repay. Some government assistance programs also use AGI to determine whether or not you qualify. This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors.
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Investing Best Accounts. Develop and improve products. List of Partners vendors. In calculating personal income tax, it's important to understand the relationship between the terms adjusted gross income AGI and modified adjusted gross income MAGI , as they can affect the amount of taxes that you owe. By subtracting certain deductions from your gross income , AGI can reduce the amount of your taxable income. MAGI, on the other hand, can take away some of those deductions because, as your income increases, the Internal Revenue Service IRS begins to disallow certain deductions and credits.
However, these calculation tools may result in small differences that can greatly affect an individual's tax return. Gross income is the sum of all that you earn in a year, including wages, dividends, alimony, capital gains, interest income, royalties, rental income, and retirement distributions.
Adjusted gross income is a modification of gross income; it factors in allowable deductions from your gross income to reach the figure for which your income taxes will be calculated.
Generally, AGI is more useful than gross income for individual tax purposes. To reach AGI, you add all income earned during the year and subtract any allowable adjustments, such as educator expenses, self-employed retirement or individual retirement account IRA contributions, interest on student loans, and alimony paid under a divorce agreement entered into on or before December 31, Your AGI directly influences your eligibility to claim many of the deductions and credits available on your tax return.
Both the earned-income credit and the child and dependent care credit depend on AGI calculations. Similarly, tax deductions, including mortgage insurance premiums and medical expense deduction thresholds, are based on your AGI. Adjusted gross income is an important but intermediate step in determining how much of one's gross income is taxable. MAGI modifies the adjusted gross income by adding back certain items such as foreign earned income, student loan interest, and the excluded portion of adoption expenses.
At certain income levels, the IRS begins to phase out deductions for items such as IRA contributions and expenses related to education. If this happens, you can still contribute to an IRA plan, but cannot deduct any of the contributions on your taxes.
Additionally, MAGI will dictate whether an individual is eligible for certain benefits as outlined by the Affordable Care Act , as it stands today. Internal Revenue Service. Intuit TurboTax. While both deductions ultimately reduce your taxable income, some can have a more favorable impact on your tax bill than others. In most cases, above-the-line deductions are the better choice.
The standard deduction is a fixed amount based primarily on your filing status, which reduces your taxable income. This amount is higher if you or your spouse are over the age of 65 or blind. Each tax season, you have the choice to deduct your actual itemized deductions or take the standard deduction.
Typically the choice is determined by whichever amount is higher. If your total itemized deductions are less than the standard deduction, you may not receive any benefit from a tentative itemized deduction. Your adjusted gross income is the amount listed on the bottom line of page 1 of your tax return.
It includes all of your total income, including wages, business and rental income, capital gains, unemployment income, and so on. It also factors in any allowances for personal exemptions and itemized deductions.
Above-the-line deductions, while commonly referred to as a deduction, are technically adjustments to your income. These adjustments include traditional IRA contributions, moving and education expenses, alimony payments and the deductible portion of self-employment tax. Above-the-line deductions can also refer to business deductions and losses. For example, a business expense reduces your net business income, which therefore reduces your total income. For example, you can only deduct medical expenses as itemized deductions to the extent they exceed 10 percent of your AGI 7.
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