While filing tax returns, the two most important parts of your calculation are gross income and adjusted gross income. Let’s discuss in detail the two.
Gross Income = Total income before deductions
Annual Gross Income is the money that an individual has earned in a year before taxes, while for a business it is the company’s revenue after deducting any expenses related to the business. Gross income is the most important factor in determining if tax returns need to be filed or not.
As per the Internal Revenue Service (IRS), if you’re a U.S. citizen, whether or not you must file a federal income tax return depends on your gross income, your filing status, your age, and whether you are a dependent.
Besides salary, gross income includes other sources of income that a individual earns. These include bonuses, interest income, dividends, rental income, royalties, alimony and capital gains.
Adjusted Gross Income (AGI)
It is defined as gross income minus any adjustments to income. Adjustments to income include IRS allowed items such as educator expenses, student loan interest, alimony payments or contributions to a retirement account.
If an individual is filing his/her own taxes, annual gross income can be ascertained using many online calculators or DYI tax programs for filing both federal and state tax returns.
AGI is an important calculation as it influences an individual’s tax bracket and may also determine eligibility to claim additional deductions and credits that may be available when filing tax returns. Also, some states use AGI as a base for calculating state taxable income.
Modified Adjusted Gross Income (MAGI)
MAGI is modifying the adjusted gross income further by adding back certain items such as foreign earned income and tax-exempt student loan interest. It is used in the calculation of certain tax benefits, credits, and exclusions.
For example, MAGI is used to determine how much of your annual IRA contributions is deductible and whether you are eligible for premium tax credits.
There are many types of deductions like trade and business deductions for individual business owners for services performed as owners, trade and business deductions of employees, retirement savings, penalties for forfeiture of savings account, health savings accounts, higher education expenses and interest on student loans.
The trade and business deductions of employees include any reimbursed expenses of employees, certain expenses of performing artists, officials, school teachers and armed force reserves.
AGI and IRS Form 1040
Adjusted gross income is reported on IRS Form 1040 or U.S. Individual Income Tax Return Additional forms and schedules are required for filers who itemize, are involved in certain trades and business activities, or have certain types of income or deductions.
Schedule A is used to report itemized deductions. Schedule B is used for interest and dividends. Schedule C is used by small business owners, such as those with business income from a sole proprietorship or those who are the sole owner of a limited liability company. Schedule D reports capital gains and losses. For rental income, there is Schedule E, and for farms there is Schedule F.
Also, if a married couple is filing jointly, the $69,000 AGI limitation to be allowed to use IRS free file applies to both you and your spouse combined.
To e-file, a federal tax return, identity verification for the IRS is required, either through AGI from last year’s return or a self-selected personal identification number (PIN). The IRS has stopped issuing new PINs due to cyber attacks, you can still use yours if you selected it in the previous year.