Net Income vs. Adjusted Gross Income

Nov 23, 2023 By Triston Martin

The sum of the earnings you earn over a year, includes salary, wages, and capital gains, bonuses, plus interest. We can tell from paychecks it isn't money we take home and deposit to our banks. Gross earned income can be subject to tax and other deductions, lowering gross income to net income, which is our take-home earnings.

Adjusted gross income (AGI) is also referred to as gross income; however, before taxes are paid, Gross income is reduced through certain adjustments made by the Internal Revenue Service (IRS). This decreases gross income and, consequently, the amount of due taxes.

Net Income

Net income is the take-home pay from work; it is the amount you get after tax and other deductions. Deductions, taxes, and tax credits are deducted from your gross income to calculate your net income. The most common taxes taken out of your gross earnings include the federal tax on income and state tax. Social Security tax and Medicare tax. These are the most basic tax deductions that produce net income after deducting them from gross earnings.

Employees can also choose benefits that will further increase their deductions while reducing the net income they earn. Most of the deductions you can claim are tax-free; that is to say, they are deducted from your income before tax is charged, reducing your income and, consequently, the tax you have to pay. These can include dental and health insurance and contributions to corporate-sponsored retirement plans like 401(k)s and flexible spending accounts.

Businesses also have the idea that net earnings are a form of income. The definition of gross income could be called gross revenue or sales. It is the sum of the goods and services sold to customers. After that, they can also deduct gross income expenses to determine net income. These deductions comprise costs of selling goods as well as operational expenses, the cost of interest, and taxes. The subtraction of these expenses from total revenues yields net income for the business. For public companies, the entire details are listed in the income statement of the financial statements of the company.

Adjusted Gross Income

AGI is your total revenue (before taxes) with the exception of certain tax deductions as well as other adjustments. Gross income comprises such kinds of earnings as dividends, wages, and alimony, as well as retirement distributions, government benefits, capital gains, and income from other sources. The adjusted gross earnings are determined by subtracting such adjustments and deductions as alimony and retirement plan contributions, student loan interest, and medical insurance premiums.

How Do You Determine Adjusted Gross Income?

Add your incomes to calculate your gross income and take out any adjustments or above-the-line deductions for taxes. The IRS offers detailed instructions on completing taxes (Schedule 1 for Form 1040), and every tax preparation company can guide you through the procedure. Tax calculators can be found online to help you figure out your deductions more easily. There are many tax deductions above the line to consider when formulating your AGI, which can aid in maximizing your tax return or decreasing the amount you have to pay. Certain tax deductions, however, are subject to limitations. Student credit interest, for instance, is set at $2,500, while expenses for educators have an upper limit of $250.

Affect on Budget

When creating your budget, you need to determine which number to use, either gross or net revenue. Because net income is the amount you take home as pay or the amount you get on your day of pay, it could be better to keep the net income in mind when you create a budget. Once you've determined your earnings, look at how much that total would be for a month. You'll need to know this amount as most bills require monthly installments.

Once you have a clear picture of the amount you earn each month, begin tracking the amount you spend each month. Start with your fixed expenses like your mortgage or rent, student loans, utility bills, and any other item that requires an annual payment. After that, add your variable costs. This could include your monthly bill for groceries, the cost of gas for your vehicle or credit card, and other expenses that are generally variable.

After you've got your fixed and variable expenses tallied, Add the two figures together to determine the amount you're spending each month. Then subtract it from the monthly net income or take-home pay. The remainder is yours to keep or spend. The best way is to keep that money each month or utilize it to pay down high-interest debt. But, if there's no cash left or the figure is negative, you might be thinking about cutting expenses. Look at your spending to determine where you could effectively cut costs.

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