Explaining Tax and Accounting Services Terminology: AGI vs. Taxable Income

What is AGI?

Adjusted gross income (AGI) is your total income—not including nontaxable income such as gifts, disability wages, and life insurance payouts—minus all of your above-the-line tax deductions. 

AGI = Total Income − Above-the-Line Deductions

So, what can you include in your above-the-line deductions, anyway? Let’s take a peek. 

Standard Above-the-Line Deductions

The IRS allows you to subtract above-the-line deductions from your annual gross income to determine your AGI and reduce your tax responsibility. Common deductions include:

• Contributions to a traditional IRA
• Self-employed retirement plan savings
• Penalty paid on early withdrawal(s) from savings 
• Contributions to a health savings account
• Student loan interest
• 50 percent of self-employment tax
  
  

Many types of tax deductions and exemptions vary based on qualifying circumstances. That’s where you have a choice: Take the standard deduction based on your filing status, or take the itemized deductions you qualify for. To decide which is right for you, consult with your tax and accounting services provider and compare your projected itemized deductions to the standard deduction.

Why is AGI important?

Your AGI is important for your taxes. First off, it's a figure you’ll run into later on line 7 of Form 1040 as part of your tax calculations. But your AGI is also the figure that is a deciding factor used to determine your eligibility for further tax credits and deductions. Some of these credits include:

• Earned Income Tax Credit
• American Opportunity Tax Credit 
• Child and Dependent Care Credit

Wouldn’t you want to potentially reduce the amount of taxes you owe? 

What is taxable income?

Taxable income is the total amount of earnings you made in the past fiscal year that qualifies for taxation. Your taxable income is your AGI minus the greater of your standard or itemized deductions. 

Taxable Income = AGI − Standard or Itemized Deductions

You can use itemized deductions to lower your taxable income, thereby reducing how much you pay in taxes.

Examples of Taxable Income

What if you win big on The Price is Right? Your prizes are treated as taxable income. That’s because taxable income includes both earned and unearned income (even that NEW car!). A few other examples that your tax and accounting services partner will help you identify include: 

• Wages and salaries earned
• Investment earnings
• Stock dividends
• Savings account interest
• Capital gains
• Business income
• Retirement distributions
• Bonuses and tips
  
  

Examples of Itemized Tax Deductions

Deductions are big helpers in reducing your tax responsibility. Your taxable income is usually less than your AGI because of deductions. Some deductions that lower your taxes include:

• Charitable contributions
• Medical and dental expenses
• Home mortgage interest
• Income, sales, and property taxes

Tax deductions can quickly get confusing, especially as business taxes are more complex than personal ones. Deductions vary dramatically depending on specific qualifying circumstances—conditions that change pretty frequently over time. On top of that, companies make much larger numbers of transactions each year than individuals and have to contend with employer taxes and state-specific rules.

Why is taxable income important?

Taxable income is used to calculate how much tax you owe the government in federal income taxes each year. How taxes are taken from your pay depends on whether you are a W-2 employee or self-employed.

If you collect a regular paycheck from a steady job, your annual taxable income is based on your income and withholdings from your W-4, which factors in income tax, Social Security tax, and Medicare tax. 

If you’re self-employed, you may be required to pay 15.3 percent in self-employment taxes quarterly. This applies if you expect to owe more than $1,000 in taxes for the year and acts as your contribution to income, Social Security, and Medicare taxes. 

The one figure that may change, no matter your employment type, is income tax. That’s because income tax varies depending on your salary/wages for each year.

How do AGI and taxable income go together?

Adjusted gross income and taxable income go hand in hand. To review, AGI factors in above-the-line deductions, whereas taxable income paints a bigger picture to impact your tax responsibilities, reflecting your AGI minus itemized deductions. Once you and your tax and accounting services provider know your taxable income, you can compare that figure to the IRS’ tax brackets to determine how much income tax you owe. 

Partner with expert tax accountants.

AGI and taxable income might be a little confusing at the outset but remember: They’re designed to make your taxes easier. Once you get the hang of aspects such as deductions and credits, you’ll be well on your way toward successful tax filing. 

Don’t feel ready to dive into the deep end of the tax world just yet? Get in touch with our experts for answers to your burning questions, or request your free 30-minute tax planning session. Partner with Ignite Spot today for expert outsourced small-business tax and accounting services—no strings attached and no contracts.