Net income versus adjusted gross income (AGI): an overview
All income starts with gross income, which is the total of all the money you make in a year. This includes wages, salaries, bonuses, capital gains, and interest income. As we know from our paychecks, it’s not the money we take home and put in our bank accounts. Our gross income is subject to taxes and often other deductions, which reduce gross income to arrive at net income: our take home pay.
Adjusted gross income (AGI) also begins as gross income, but before taxes are paid, gross income is reduced by certain adjustments authorized by the Internal Revenue Service (IRS). This reduces the gross income, and therefore the amount of taxes that are paid.
Key points to remember
- Gross income is the total amount of money an individual earns, including wages, salaries, bonuses, and capital gains.
- Adjusted gross income (AGI) is the taxable income of an individual after taking into account deductions and adjustments.
- For businesses, net income is profit after taking into account all expenses and taxes; also called net profit or after-tax income.
- Net income is used for both businesses and individuals, while the AGI only applies to individuals.
- Adjusted gross income is reported and calculated on Internal Revenue Service (IRS) documents Schedule 1 and Schedule A of Form 1040.
Net income is your net pay from your job; the amount of money that goes into your pocket after paying taxes and any other deductions. Taxes and deductions are taken from your gross income to arrive at net income.
Current taxes that are deducted from gross income include federal income tax, state tax, social security tax, and health insurance tax. These are the bases which, when deducted from gross income, results in net income.
Employees can also choose benefits that would further increase their deductions, thereby reducing the net income they receive. Many of these deductions are pre-tax, which means they are deducted from your gross income before taxes, which reduces your gross income and, therefore, the taxes you pay. These items can include health and dental insurance, contributions to company-sponsored retirement plans such as 401 (k), and flexible expense accounts.
Businesses also have the concept of net income. Their version of gross income would be sales or gross income. This is the total value of goods and services sold to customers. From that point on, they also make deductions from gross income to arrive at net income.
These deductions include cost of goods sold (COGS), operating expenses, interest expense and taxes. Subtracting these costs from total income provides net income for a business.
For public enterprises, all this information is found on the income statement in the financial statements of the enterprise.
Adjusted gross income (AGI)
The AGI is gross income adjusted by allowable deductions authorized by the Internal Revenue Service (IRS). These allowable deductions reduce an individual’s gross income, thereby reducing the taxes he has to pay.
For example, a person with gross income of $ 88,000 would be in the 24% tax bracket. If this number were reduced in the manner allowed by the IRS, the result could be an adjusted gross income of $ 84,000. The individual would now be in the 22% tax bracket and pay 22% tax on $ 84,000 instead of 24% on $ 88,000.
The AGI is probably the most important number on Form 1040 because it is the reference number the IRS uses to determine how your taxes are treated, how much tax you owe, and your qualifying benefits.
The items that can be deducted from gross income are described as follows:
Eligible educators can deduct up to $ 250 in unreimbursed expenses. For the 2020 tax year, this may include the costs of COVID-19 protective items purchased since March 12, 2020.??
All of these expenses are standard above-the-line deductions that can take some time to sort out, but it’s worth taking advantage of all the tax breaks you can find.
Deductions below the line, such as charitable donations or medical expenses, may be subtracted from your AGI after it has already been calculated. These deductions are listed in Schedule A and reported on Form 1040.
Medical expenses must exceed 7.5% of the AGI to be eligible for the deduction. In addition, deductions for cash contributions to charities are generally limited to 60% of the AGI. But in some cases 20%, 30% or 50% may apply. These deductions likely determine whether you use the standard deduction or whether you itemize your deductions.
Calculation of adjusted gross income (AGI)
To determine the AGI, start with your gross income, or all the money you have accumulated during the calendar year, and subtract any qualified adjustments. The IRS allows specific deductions to be taken out of your total gross income.
As of January 1, 2019, alimony is no longer an authorized deduction to be used in the calculation of adjustable gross income (AGI).
These deductions are estimated and listed when you file your taxes. Most deductions, or deductions above the line, are listed in Schedule 1 and reported on Form 1040. Itemized deductions, which may not apply to every person, are listed in the schedule A and also reported on Form 1040.
Adjusted gross income (AGI) is a term used only for individuals, not for businesses. Net income, as mentioned above, is a term used for both individuals and businesses. The AGI is only used on personal income tax returns.
If you have a sole proprietorship, the profit and loss is completed on Schedule C and attached to Form 1040.
Net Income vs. Adjusted Gross Income (AGI) FAQ
What is the difference between gross income and adjusted gross income (AGI)?
Gross income is the starting point for all the money you make, including salary, wages, bonuses, and capital gains. From there, the IRS allows you to make certain deductions that reduce your gross income, thereby reducing the amount of taxes you pay. This is called adjusted gross income (AGI).
Is the net or the gross higher?
Gross income is always greater than net income.
What is the meaning of annual net income?
Annual net income is the money you bring home in one year after all deductions have been made, including taxes, pension contributions, and health care costs.
How is adjusted gross income (AGI) calculated?
To calculate Adjusted Gross Income (AGI), you must start with your gross income (all the money you have earned in a year) and subtract any allowable deductions. These deductions can be found on Schedule 1 of Form 1040.