What is adjusted gross income vs gross income

When preparing your tax return, you probably pay more attention to your taxable income than your adjusted gross income (AGI). However, your AGI is also worthy of your attention, since it can directly impact the deductions and credits you’re eligible for—which can wind up reducing the amount of taxable income you report on the return.

AGI calculation

The AGI calculation is relatively straightforward.

• It is equal to the total income you report that’s subject to income tax—such as earnings from your job, self-employment, dividends and interest from a bank account—minus specific deductions, or “adjustments” that you’re eligible to take.
• Your AGI is calculated before you take the standard or itemized deductions —which you report in later sections of your tax return.

Adjustments to income

Adjustments to income are specific deductions that directly reduce your total income to arrive at your AGI. The types of adjustments that you can deduct are subject to change each year, but a number of them consistently show up on tax returns year after year. Some of these adjustments include:

• half of the self-employment taxes you pay
• self-employed health insurance premiums
• alimony payments made to a former spouse (for agreements prior to 2019)
• contributions to certain retirement accounts (such as a traditional IRA)
• student loan interest paid

Impact on deductions and credits

Many of the deductions and credits that taxpayers commonly take advantage of each year are subject to AGI limitations. If you itemize deductions, for example, you must reduce your medical and dental expenses by 7.5% of your AGI. This means that you can only deduct the amount that exceeds 7.5% of your AGI. Therefore, the lower your AGI is, the more of your medical and dental expenses you can deduct.

Even some of your adjustments to income are subject to AGI limitations despite the fact that those deductions are necessary to calculate your AGI. If you’re eligible to deduct some of your tuition payments, your modified adjusted gross income (MAGI) determines whether you qualify.

Other AGI implications

If you live in a state that requires you to file annual income tax returns, your AGI can also impact your state taxable income. This is because many states use your federal AGI as the starting point for calculating your state taxable income. And if you claim a tax credit, such as the lifetime learning credit, for your school expenses, the IRS requires that your MAGI be below certain thresholds in order to claim the credit.

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As a small business owner, you have likely heard of the terms gross or net income. But, are you familiar with adjusted gross income? Learn what is adjusted gross income, how to calculate it, and uses for adjusted gross income below.

What does adjusted gross income mean?

Adjusted gross income, or AGI, is a person’s total gross income minus specific deductions or payments made throughout the year. Your adjusted gross income is the amount of money you receive each month that is subject to taxes. AGI is only used on individual tax returns.

Although AGI is typically referred to as net income, they are not exactly the same. Whereas net income refers to after tax income, AGI is total taxable income.

Gross income vs. adjusted gross income

Although gross income and adjusted gross income may sound similar, they are very different. So, what is gross income?

Gross income refers to the salary or hourly wages set by an employer before deductions. Annual gross income is the money earned during the year before subtracting deductions.

Unlike gross income, adjusted gross income is the total taxable income after deductions and other adjustments. Adjustments to gross income are specific expenses the IRS determines.

AGI deductions and credits

Typically, employers are required to deduct federal taxes from an individual’s paycheck, including Social Security and Medicare taxes. Depending on the state, employers may need to deduct state and local taxes, too. However, federal, state, and local taxes don’t affect AGI.

Along with payroll taxes, other optional deductions may come out of an individual’s paycheck. Before you calculate AGI, you must deduct other deductions like health, life, dental, and vision insurance.

Other deductions and payments will also affect adjusted gross income. The deductions taken from gross income to calculate AGI are referred to as adjustments to income.

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Calculating adjusted gross income

Now that you know what adjusted gross income is, you are probably wondering, How is adjusted gross income calculated?

Calculate AGI by first determining the total gross income. Gross income is the total of all the money earned during the calendar year, including annual wages, interest, and tips.

After you compute total gross income, deduct items such as IRA contributions or student loan interest to calculate AGI.

Example of calculating AGI

Say you earned $50,000 in wages and tips during the year. Your total taxable IRA distributions are $1,000. You also have $500 in moving expenses, $2,000 in student loan interest, and $300 in IRA contributions.

First, calculate gross income by adding together wages, tips, and taxable distributions.

Gross income = $50,000 + $1,000
Gross income = $51,000

Next, deduct the other payments, contributions, and expenses from gross income to calculate AGI.

AGI = $51,000 – $500 – $2,000 – $300
AGI= $48,200

Your AGI is $48,200.

Uses for adjusted gross income

AGI influences an individual’s tax bracket. And, it can determine if a person is eligible to claim additional deductions and credits when filing tax returns.

You may need to report AGI when applying for a loan or submitting paperwork to lenders. Lenders usually look at adjusted gross monthly income to see how much income a person has available to pay bills and purchase necessary items.

Gross income might make it seem like an applicant can afford a loan, while AGI shows a clearer picture of what an individual can afford.

Filing taxes using adjusted gross income

You report adjusted gross income on Form 1040, U.S. Individual Income Tax Return. Form 1040 is the only form that allows you to deduct every adjustment.

Taxpayers who don’t file Form 1040 will not have access to the full extent of credits and deductions that lower AGI.

Adjustments may lower any amount a person owes to the IRS at the end of the year, or make them eligible for a tax refund.

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