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Gross Income To Taxable Income. What Is The Difference, And What Factors Are Involved?

Updated: Jul 7, 2021

We admit financial terminology can be complicated and confusing. Taxes are a perfect example. There are books upon books of rules and regulations that are written in what often feels like another language. To add to that, those rules are ever changing and it can be difficult to keep up with the newest laws. Frustrating, to say the least.

Since taxes and income affect so many things in our life, we thought we could try to simplify a few terms. For example, this last year the government sent out stimulus checks to individuals under certain income thresholds. However, when referring to the "income" threshold, what income is used? Gross income, adjusted gross income (AGI), modified adjusted gross income (MAGI), or taxable income? And what's the difference?

Here is a brief description of each one to help clarify how the IRS views your finances.

  • Total Income. Often referred to as gross income. This is all income that is considered to be taxable, added together. For example, wages, interest, dividends, retirement account distributions, capital gains, unemployment benefits, business income, or alimony received. Basically, any income that isn't considered tax exempt. This is currently found on line 9 of the 2020 1040 tax form.

  • Adjusted gross income (AGI). This is the total gross income minus some adjustments. Some common examples of adjustments are educator expenses, HSA (health savings account) contributions, retirement account contributions, student loan interest, alimony payments (not alimony income), and the deductible part of self-employment tax. AGI is usually lower than total income. This is currently found on line 11 of the 2020 1040.

  • Modified adjusted gross income (MAGI). This is your AGI with some of the adjustments added back, but not all. Some of the adjustments added back are tax-exempt interest, student loan interest, IRA contributions, rental losses, and passive income or loss. MAGI is most often used to see if -- and how much -- you can contribute to a Roth IRA, and whether Traditional IRA contributions are deductible. This figure is not on the 1040 tax form and generally not used as often as AGI.

  • Taxable income. This is the AGI minus either the standard deduction, or an itemized deduction. This figure is currently found on line 15 of the 2020 1040. Taxable income is the amount that is actually taxed and the figure to use when referring to tax brackets. You do not use gross income when figuring out which bracket you are in.

We hear about so many income figures that it's easy to get confused. To get qualified for certain benefits, programs or loans, it's easier when you understand which figure puts you either over or under a threshold. For instance, the stimulus checks are based on the taxpayer's adjusted gross income (AGI). So, even if a taxpayer made more in gross income, they could still qualify after figuring their AGI.

Knowing which figure is used and understanding the difference is beneficial when planning ahead and applying for programs and loans. At times it may be overwhelming, but understanding some basics can give a little peace of mind and then in turn make understanding the harder things a little easier.


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