Net Income vs. 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 salaries, wages, bonuses, capital gains, and interest income. As we know from our paychecks, this is not the money that we take home and put into 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 starts out as gross income, but before any taxes are paid, gross income is reduced by certain adjustments allowed by the Internal Revenue Service (IRS). This reduces gross income, and therefore, the amount of taxes that are paid.
- Gross income is the entire amount of money an individual makes, including wages, salaries, bonuses, and capital gains.
- Adjusted gross income (AGI) is an individual's taxable income after accounting for deductions and adjustments.
- For companies, net income is the profit after accounting for all expenses and taxes; also called net profit or after-tax income.
- Net income is used for both businesses and individuals, while AGI is only applicable 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 take-home 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.
Common taxes that are taken out of gross income include federal income tax, state tax, Social Security tax, and Medicare tax. These are the basics that, once deducted from gross income, result in net income.
Employees can also choose benefits that would further increase their deductions, reducing the net income they receive. Many of these deductions are pretax, meaning they are deducted from your gross income before taxes are charged, reducing your gross income and, therefore, the taxes you pay. These items may include health and dental insurance, contributions to company-sponsored retirement plans such as 401(k)s, and flexible spending accounts.
Businesses also have the concept of net income. Their version of gross income would be gross sales or revenues. This is the total value of goods and services sold to customers. From that point, they also make deductions to gross income to arrive at net income.
These deductions include the cost of goods sold (COGS), operating expenses, interest expense, and taxes. Subtracting these costs from total revenues provides net income for a business.
Adjusted Gross Income (AGI)
AGI is gross income that is adjusted through qualified deductions that are permitted by the Internal Revenue Service (IRS). These qualified deductions reduce an individual's gross income, thus reducing the taxes they need to pay.
For example, an individual with a gross income of $88,000 would be in the 24% tax bracket. If that figure was reduced in ways permitted by the IRS, it might result in an adjusted gross income of $84,000. The individual would now be in the 22% tax bracket and would pay 22% tax on $84,000 instead of 24% on $88,000.
Items that are eligible to be deducted from gross income are described as follows:
- Self-employed individuals can deduct several expenses, including health insurance premiums and half of the self-employment tax.
- Those who make contributions to individual retirement accounts (IRAs) and qualified retirement plans can reduce their gross income by the amount contributed, up to yearly limits.
- Reservists, qualified performing artists, and government workers paid on a fee-basis may claim certain business expenses via Form 2106.
- Those investing in a Health Savings Account (HSA) can deduct that cost.
- The interest on student loans, but not the principal balance, is tax-deductible.
- Educator expenses are deductible up to $250 a year.
Eligible educators can deduct up to $250 of unreimbursed expenses. For the 2020 tax year, that can 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 a while to sort through, but it is well worth taking advantage of every tax break you can find.
Below-the-line deductions, such as charitable donations or medical expenses, can be subtracted from your AGI after it has already been calculated. These deductions are listed on Schedule A and reported on Form 1040.
Medical expenses must exceed 7.5% of AGI to qualify for the deduction. In addition, deductions for cash contributions to charities are generally limited to 60% of AGI. But in some cases, 20%, 30%, or 50%, may apply. These deductions likely determine whether you use the standard deduction or itemize your deductions.
Calculating Adjusted Gross Income (AGI)
To figure out AGI, start with your gross income, or all the money you've accrued during the course of the calendar year, and subtract all qualified adjustments. The IRS allows for specific deductions to be taken from your total gross income.
From Jan. 1, 2019, alimony is no longer an allowed deduction to be used in the calculation for adjustable gross income (AGI).
These deductions are estimated and listed when you file your taxes. Most deductions, or the above-the-line deductions, are listed on Schedule 1 and reported on Form 1040. Itemized deductions, which may not apply to every person, are listed on 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 both for individuals and businesses. AGI is used only on individual tax returns.
If you have a business as a sole proprietor, the profit and loss are filled out on Schedule C and attached to Form 1040.
Net Income vs. Adjusted Gross Income (AGI) FAQs
What Is the Difference Between Gross Income and Adjusted Gross Income (AGI)?
Gross income is the starting point of all the money you make, including salary, wages, bonuses, and capital gains. From there, the IRS allows certain deductions to be made that reduce your gross income, which in turn reduces the amount of taxes you pay. This is known as adjusted gross income (AGI).
Is Net or Gross Higher?
Gross income is always higher than net income.
What Is the Meaning of Annual Net Income?
Annual net income is the money you take home in a year after all deductions have been made, including taxes, contributions to retirement plans, and healthcare 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 earned within a year) and subtract all qualified deductions. These deductions can be found on Schedule 1 of Form 1040.