Your Adjusted Gross Income (AGI) only comes into play when working on your taxes – it’s strictly a tax term.
It’s a misleading term because as a self-employed person, it’s our net income that is reported on our personal taxes – and then suddenly it becomes gross income?! Yup.
The Adjusted Gross Income (AGI) is part of your taxable income. I think it will be easier to see how it plays into your whole tax return, so see below.
There are 6 main parts to a tax return:
1.) Income – this is where you enter your W2s, any business flow-through income or loss, interest income, dividends earned, and the like.
2.) Top-Line Deductions – deductions that you can claim (not business deductions) before calculating your AGI. Top-line deductions are the cream of the crop deductions – this is because there are a number of tax breaks that phase-out based on your AGI, so the lower you can get your AGI (without actually reducing your income) the better. Some examples of top-line deductions are self-employed retirement contributions, self-employed health insurance expenses, 50% of your self-employment tax, and the educator deduction. See how most of these are for self-employed folk? It makes sense – think of it this way – if you had a job on a W2 and you had a 401k and health insurance, those expenses would be deducted from your paycheck, so self-employed folk get the same thing.
3.) Your AGI – this is your income from Line 1 above, less your top-line deductions from Line 2 above, and is the baseline for the rest of your taxes. The term makes sense – it’s your adjusted income.
From here, there are some other deductions that will be deducted from your AGI before calculating how much tax you owe.
4.) Your standard/itemized deductions + any qualified business deduction (QBI).
5.) Taxable Income – your taxable income is your AGI less your standard/itemized deductions/QBI.
6.) Taxes + Credits – the tax you owe is calculated based on your taxable income, and any credits you may be eligible for are generally deducted from the tax you owe.