Adjusted Gross Income
Originally published in the NTA Encyclopedia of Taxation and Tax Policy, Second Edition, edited by Joseph J. Cordes, Robert D. Ebel, and Jane G. Gravelle. The encyclopedia is available in paperback from the Urban Institute Press. Order online at www.uipress.org or call toll-free 1-877-847-7377
Susan C. Nelson and Julie-Anne Cronin
U.S. Department of the Treasury
A measure of an individual taxpayer’s net income used in calculating personal income taxes.
Section 62 of the Internal Revenue Code defines adjusted gross income (AGI) as gross income from all sources not specifically excluded, minus certain deductions. Because AGI is a creature of the tax code, its components have changed over the years with tax law changes.
AGI can be understood in part by comparison with other measures of income. AGI primarily measures money income, not comprehensive income, and it does not include many forms of money income that are part of comprehensive income. From the perspective of the economy as a whole, AGI is similar to personal income in the National Income and Product Accounts (NIPA) but differs from it primarily in the same ways it differs from comprehensive income. In terms of the income tax system, AGI is the broadest measure of income, but, compared with taxable income (the income to which tax rates are applied), AGI does not reflect the personal differences that affect individuals’ability to pay taxes.
Components of AGI
The major sources of income in AGI in 2004 included wages and salaries; taxable interest and dividends; alimony received; business income from partnerships, Subchapter S corporations, sole proprietorships, and farms; rents and royalties; capital gains; taxable pension and Individual Retirement Account (IRA) distributions; unemployment compensation; and some Social Security benefits. The deductions taken in AGI include trade and business expenses, expenses attributable to rents and royalties, and certain losses from the sale or exchange of property. The Form 1040, on which individuals calculate their income tax, refers to other allowable deductions as "adjustments to income" or as "statutory adjustments." For 2004, these adjustments included primarily educator expenses, qualified education and student loan interest expenses, alimony payments, moving expenses, certain savings for retirement (such as contributions to Keogh plans for the self-employed and to IRAs for employees and their spouses), Medical Savings Account and Health Savings Account contributions, one-half of the self-employment tax, and a health insurance deduction for the self-employed.
Recent changes in the definition of AGI
Tax law amendments have changed the definition of AGI in the past 15 years. The most recent income adjustments were for health- and education-related provisions. Legislation in 1996 and 2004 introduced adjustments for contributions to Medical Savings Accounts and Health Savings Accounts. The Tax Reform Act of 1997 and the Economic Growth and Tax Relief Reconciliation Act of 2001 added adjustments for student loan interest, educator expenses, and for certain higher education expenses.
The most significant revisions, expanding the definition of AGI, came in the Tax Reform Act of 1986 (TRA86). Among these revisions were the full inclusion of long-term capital gains (previously, 40 percent was included in the AGI, and before 1979, 50 percent had been included). TRA86 also imposed limits on "passive losses" that would be allowed in calculating AGI. It changed moving expenses and unreimbursed employee business expenses from income "adjustments" to itemized deductions. (Starting in 1994, moving expenses were again allowed as an adjustment to income instead of as an itemized deduction.) It eliminated the adjustment to income for a married couple with a second earner and the exemption for the first $400 of dividends received. Working to narrow the definition of AGI, TRA86 also allowed self-employed individuals a deduction for up to25 percent of their health insurance premiums.
Other legislation has made more modest changes in the definition of AGI. Legislation in 1991 added the adjustment to income for one-half of an individual’s self-employment tax. In 1984, half of Social Security benefits were for the first time included in the AGI for taxpayers with other income of $25,000 ($32,000 for married couples), and in 1994 the share was increased to 85 percent for individuals with other income of $34,000 ($44,000 if married). Similarly, in 1979 unemployment compensation was initially added to AGI for persons with other income of $20,000 ($25,000 for couples), and in 1987 for all taxpayers regardless of other income. The Economic Recovery Tax Act of 1981 (ERTA) and TRA86 both substantially revised the depreciation schedules, with ERTA liberalizing the deductions and TRA86 tightening them. Consequently, a given amount of business profits (as measured for the company’s records) contributed less to AGI in the early 1980s than it did after 1986. Recent tax revisions have added deductions for self-employed individuals’ health insurance and education deductions, and have restored some of the deduction for IRAs that had been curtailed in 1986.
Comparison with comprehensive income,personal income, and taxable income
AGI can be compared conceptually and quantitatively to other frequently used measures of income. Comprehensive income, or the Haig-Simons definition of income as consumption plus changes in net worth, is a broader concept of income than AGI.
Haig-Simons is a comprehensive measure of income ("economic income") defined as the increase in an individual’s power to consume (sum of consumption plus net wealth). AGI excludes most forms of non-money income as well as some types of money income. Components of comprehensive income not in AGI include imputed rent on owner-occupied housing, unrealized capital gains, and inkind fringe benefits of employees. Including any of these in income for tax purposes would entail substantial valuation problems. Sources of money income that are missing from AGI include welfare payments, interest on state and local government bonds, employer-provided contributions for health and pension plans, and income on savings through life insurance. These forms of income are excluded more for policy than for administrability reasons.
Personal income in the NIPA is also broader, on balance, than AGI (it amounted to $8.4 trillion in 2000, compared with $6.3 trillion of AGI), but AGI includes $1.6 trillion in sources of income that are missing from personal income. The largest of these is net capital gains ($574 billion), followed by taxable private pensions ($413 billion) and personal contributions to Social Security and related programs ($358 billion). Personal income includes the following major items that are not in AGI: nontaxable transfer payments ($946 billion), employer-provided fringe benefits ($541 billion), investment income of life insurance or private pension funds ($470 billion), imputed rental and personal interest income ($350 billion), and differences in accounting treatment between NIPA and tax regulations ($107 billion). In addition, there is a $792 billion discrepancy, or gap, between AGI as reported to the Internal Revenue Service and AGI as the NIPA would calculate it. Some of the gap represents noncompliance with the tax code (Park 2002).
For tax purposes, AGI represents a broad measure of net income; however, in most respects it does not reflect differences in personal circumstances that the public wants to take into account before levying taxes. Such differences include family size, marital circumstances, or particularly large expenditures for purposes that the public either wants to encourage (such as charitable contributions or home ownership) or views as appropriate adjustments to a measure of ability to pay (such as state and local income taxes, extraordinary medical expenses, or extraordinary casualty losses). More specifically, in 2001 AGI ($6.2 trillion) exceeded taxable income ($4.3 trillion) by the amount of personal exemptions ($728 billion) plus the amount of either itemized deductions ($885 billion) or the standard deduction ($482 billion) (Internal Revenue Service, Individual Income Tax Returns 2001, 31).
- Internal Revenue Service. Statistics of Income Bulletin (various years). Washington, DC: Internal Revenue Service.
- Park, Thae S. "Comparison of BEA Estimates of Personal Income and IRS Estimates of Adjusted Gross Income." Survey of Current Business (November 2002): 13-21.
- Pechman, Joseph A. Federal Tax Policy. Washington, DC: The Brookings Institution, 1987.