Tax season can feel like a jumble of alphabet soup with all the acronyms of letters and numbers being thrown around including AGI and W-2. But, with a little background knowledge, all those tax terms can become a lot clearer. Each year, employers report your taxable income to you and to the IRS on a form known as a W-2. Then, you file your tax return using that information on Form 1040, 1040A or Form 1040-EZ. Though you need the information on your W-2 to calculate your adjusted gross income, you also need additional information to complete the calculations.
Your adjusted gross income for tax purposes equals your total taxable income reduced by any adjustments for which you qualify. Your taxable income includes not only income reported on a W-2, but also any other taxable income you earned during the year, such as any side jobs, other self-employment income, interest, dividends and other investment income. It can also include income you receive in a form other than money, such as bartering income. If you have self-employment income, you get to deduct your business expenses like the cost of goods sold before you determine the portion that adds to your adjusted gross income.
Adjustments to income are a special category of deductions that you can claim even if you don't itemize. These include student loan interest, contributions to traditional individual retirement accounts, educator expenses, the tuition and fees deduction as well as half of your self-employment taxes. Make sure you meet all of the qualifications for a deduction before claiming it on your tax return.
Calculating Your AGI
To calculate your AGI, start with the amount shown in Box 1 of your W-2, labeled "Wages, Tips, Other Compensation." Then, add any other taxable income you have for the year to calculate your total taxable income. Often, this income will be reported to you on another form, such as interest on a 1099-INT or dividends on a Form 1099-DIV. Finally, subtract any adjustments to income you qualify to claim.
For example, say that your W-2 shows that you earned $61,000 in taxable wages and you have $1,000 in investment income and $500 in taxable interest. You also contributed $2,000 to a traditional IRA and paid $1,200 in student loan interest. Add $61,000 plus $1,000 plus $500 to find your total taxable income is $62,500. Then, subtract the $3,200 in total adjustments to income to find your adjusted gross income is $59,300.