Adjusted Gross Income or AGI is gross income minus adjustments to income for tax purposes
Why It's Important
AGI is the portion of your income that you are taxed on. I think the best way to explain this term is to provide an example.
Let's say your salary is $50,000 a year. Because you are awesome, you contribute 5% of your salary to a 401k. To keep it simple, we will leave the salary deductions there (in real life, you will probably also deduct medical, dental, and vision benefits as well). 5% of $50,000 = $2,500 so instead of being taxed on your full (gross) salary of $50,000, you would only be taxed on $47,500 of it. $47,500 is your Adjusted Gross Income.
This is why participating in company-sponsored benefits plans (like medical, 401k, HSAs, etc.) are so important. It effectively lowers your tax bill. It is important to note that in order for your gross income to get adjusted, the benefit has to come out PRE-TAX. Otherwise, it will not have an effect. Once you arrive at your AGI, you multiply by the tax rates to get your tax liability. We will discuss that next week!
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