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Question: How does “adjusted gross income” differ from “gross income”? Answer: For income tax purposes, there are three levels of income: gross income, adjusted gross income, and taxable income.

Adjusted Gross Income. 

Firstly, to arrive at adjusted gross income (AGI), you are allowed a long list of deductions from gross income. For example, business expenses, certain losses, and retirement account contributions. These deductions, also called above-the-line deductions, are allowed even if you don’t itemize your personal deductions (if you choose instead to use the standard deduction). AGI is an important number. It is used to determine certain other tax benefits.

Adjusted Gross Income (AGI) is one of the core tax terms used by Federal and many State taxing authorities. So what is it and why is it important?

The Federal formula for AGI is:

AGI = Gross Income – Adjustments from Gross Income

Taxable Income. 

Taxable income is AGI minus your itemized deductions (or standard deduction) and your personal and dependency exemptions. It is used to determine your tax bracket, your tax rate, and your ultimate tax liability. AGI is not Taxable Income. Before you can determine the tax you will pay, you need to subtract deductions (either the Standard Deduction or Itemized Deductions) and Personal Exemptions for you and your family members. So do not confuse the term AGI with Taxable Income, they are not the same thing.

Gross Income.

For most of us, Gross Income is our wages as shown on a W-2 at the end of the year. Also includes taxable interest income, retirement income (including Social Security benefits), and dividends. But there are many other components to Gross Income. Here is a list of the most common;

  • Alimony received
  • Annuities and pensions
  • Commissions, tips, bonuses
  • Dividends
  • Farm income (net)
  • Gains on sales and exchanges
  • Business income (loss)
  • Illegal gains
  • Interest income
  • Net rental and royalty activity
  • Prizes and awards
  • Rents and royalty income (net)
  • Retirement plan distributions
  • S Corp and partnership income
  • Social Security income
  • State and local tax refunds
  • Trust and estate distributions
  • Unemployment compensation
  • Wages and salaries
  • Loss from sale or exchange
Common Deductions from Gross Income.

To get to AGI, a number of reductions are allowed. For instance alimony paid to someone else. Others are less common. Therefore,  here is a brief list of the most likely adjustments you may experience.

  • Alimony paid
  • Contributions to IRAs
  • Domestic Production Activities Deduction
  • Educator expense
  • Medical/Health Savings Account contributions
  • Moving expense
  • Qualified educational expense
  • Qualified student loan interest
  • Repayments: Unemployment compensation and jury duty pay
  • Savings early withdrawal penalties
  • Self-employed health insurance
  • Self-employed retirement plan contributions
  • Trade and business expense
  • Most states use AGI as the starting point to determine your tax obligation to them. They will use this figure and then make adjustments to get to their state basis taxable income.
  • Federal tax legislation reintroduced tax code that reduces your Deductions and Exemptions. Because of this reduction  it raises your Taxable Income and is based upon your AGI. Therefore, understanding and managing your AGI can have a real impact on how much of your Exemptions and Deductions you will be able to use.
  • The IRS and writers of the tax code like to use AGI as the starting point for other tax provisions. You may see the term “Modified AGI” when this occurs . The actual definition of Modified AGI will vary depending on the tax calculation being constructed. Typical add backs to AGI are tax exempt interest, excluded portions of Social Security benefits and other tax-free income.

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