When tax season comes around, it’s easy to get lost in the terminology. The lingo can throw you off, especially when tax professionals expect you to know each word. Gross income and adjusted gross income can be some of the most complicated items, but this breakdown can make it easier to understand both terms.
Gross Income Defined
For an individual, the gross income is the total amount of money you earned throughout the year before taxes and other deductions are removed. Sometimes, gross income is defined as “total income” because it’s the total amount you made. For businesses, the gross income or total income is the company’s revenue for the year.
The gross income reflects how much money you made during the year, but this isn’t the number most tax professionals use to file your taxes. They use the adjusted gross income because it reflects how much you owe after expenses and deductions.
Adjusted Gross Income Defined
Your adjusted gross income is your gross income minus any eligible deductions and expenses for which you may be eligible. This is the number that most tax professionals use to file your taxes because it allows you to save money in the end.
Tax deductions and expenses help reduce the amount of money you owe at the end of the year based on money you’ve spent. There are two different types of deductions: standard and itemized. Standard deductions are easy and based on your situation. A common standard deduction is dependents.
Itemized tax deductions require more work, but can equate to major savings. For example, you can save money by listing any medical expenses as an itemized deduction. Other common deductions include:
- State and local income taxes or sales taxes
- Property taxes
- Mortgage interest
- Personal property taxes (such as vehicle registration fees)
- Interest paid on certain investments
- Charitable contributions
- Personal losses due to theft or casualty
- Job-related expenses
- Union dues
- Tax preparation fees
- Home office expenses
- Gambling losses
- Moving expenses
Be sure to ask your tax professional or the IRS if any other itemized deductions apply to your situation. You may also not be eligible for some of the above examples because there are often restrictions. For example, you can only list moving expenses as a deduction if your new workplace is 50 miles or more from your old home and your job.
Modified Adjusted Gross Income
Sometimes taxpayers may confuse modified adjusted gross income and adjusted gross income. Modified adjusted gross income is when some adjustments are added back to the total. These modifications can include tuition costs and education deductions, any eligible IRA contributions, losses from rental properties, and interest paid on student loans.
For most taxpayers, AGI and MAGI are very similar and calculated in a very similar way. However, MAGI is used to determine whether certain deductions are allowed, including contributions to an individual retirement plan. Most tax professionals will go over AGI with you and then make modifications if you’ve accidentally counted a deduction for which you aren’t eligible.
