For tax purposes, the main difference between gross income and adjusted gross income (AGI) is that AGI is your gross income minus certain allowable adjustments, which can reduce your taxable income.
Ultimately, you want to pay the lowest effective tax rate possible so you can keep more of your money. The more money you get to keep, the sooner you get to reach financial freedom and do what you want.
Definition Of Gross Income
This is your total income before any deductions or adjustments. Gross income includes all sources of income, such as:
- Wages or salary
- Business income
- Rental income
- Interest and dividends
- Capital gains
- Other types of income (e.g., alimony, retirement distributions, and side income)
Definition Of Adjusted Gross Income (AGI):
This is your gross income after “adjustments to income.” These adjustments are specific deductions that lower your income before calculating taxable income. Common adjustments include:
- Contributions to a traditional IRA
- Student loan interest deduction
- Health Savings Account (HSA) contributions
- Self-employed retirement plan contributions and health insurance premiums
- Educator expenses
AGI is an important figure because it’s often used to determine eligibility for various tax deductions and credits. Once adjustments are applied to your gross income, the result is your AGI, which then serves as the starting point for further deductions and credits, leading to your taxable income.
Let me share a couple examples of the difference between the two incomes to provide further clarity.
Example 1: Single Filer with Standard Income Adjustments
Gross Income Calculation:
- Salary: $70,000
- Interest from savings: $500
- Total Gross Income = $70,000 + $500 = $70,500
Adjustments to Income:
- Student loan interest deduction: $2,000
- IRA contribution (traditional IRA): $3,000
- Health Savings Account (HSA) contribution: $1,500
Adjusted Gross Income (AGI):
- Total Adjustments = $2,000 + $3,000 + $1,500 = $6,500
- AGI = Gross Income – Adjustments = $70,500 – $6,500 = $64,000
In this example, the taxpayer’s AGI is reduced to $64,000 from a gross income of $70,500 due to allowable adjustments. The lower AGI may help them qualify for additional deductions and credits.
Example 2: Married Couple Filing Jointly with Additional Income Sources
Gross Income Calculation:
- Spouse A's Salary: $90,000
- Spouse B's Salary: $85,000
- Freelance income: $10,000
- Investment dividends: $2,000
- Total Gross Income = $90,000 + $85,000 + $10,000 + $2,000 = $187,000
Adjustments to Income:
- Student loan interest deduction: $2,500
- IRA contribution for each spouse: $6,000
- Self-employed health insurance deduction (from freelance income): $4,000
- Total Adjustments = $2,500 + $6,000 + $6,000 + $4,000 = $18,500
AGI:
- AGI = Gross Income – Adjustments = $187,000 – $18,500 = $168,500
Here, the couple’s AGI is reduced to $168,500 from a gross income of $187,000. Lowering their AGI can make them eligible for credits or deductions that have AGI limits, such as child tax credits or education credits, ultimately reducing their taxable income and potential tax liability.
In both examples, the adjustments are used to calculate a lower AGI, which can have tax-saving benefits and influence eligibility for various tax deductions and credits.
The Lowest Taxable Income And Effective Tax Rate Legally Possible
Once you've calculated your taxable income, you can then properly calculate your tax liability. Ultimately, you want to pay the lowest overall effective tax rate as possible.
Here are the 2025 tax brackets and ideal incomes to earn for workers and retirees.
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