When it comes to filing your taxes, it seems there is another language that only CPA’s and IRS employees understand. One of these baffling tax terms is “adjusted gross income”, which is apparently different than the amount of money you make every year and also different than the modified adjusted gross income. What exactly is the adjusted gross income and how is it different than the amount of money you bring home every month?
The Internal Revenue Service, in its infinite wisdom, decided it would be too simple to rely on your actual income for tax purposes; it had to concoct a new way to calculate your income. However, this can actually be a very good thing for you. Why? Your adjusted gross income is usually considerably less than your actual income, and you, therefore, pay less in taxes.
First, let’s look at your actual income. This includes your salary, certain interest you have earned, income from real estate, income from investments, income from businesses – basically any money you were paid or earned for any reason during the tax year. The good thing about your income is there are some circumstances you can reduce your income based on losses you received from a business or farm. All of these numbers added up equals your actual income.
Once you have this number, you can go through and subtract all kinds of things to reduce your taxable income. For example, one of the best ways to reduce your income is by contributing to an Individual Retirement Account. For the purposes of calculating your adjusted gross income (AGI), you can subtract between $4,000 and $4,500 in 2005. Other deductions may be taken in calculating your AGI, such as tuition expenses, moving expenses, student loan interest, and many others.
Many deductions are included on schedule A and to reap the benefits of those deductions, you must itemize your deductions instead of utilizing standard deductions. However, many people do not want the added hassle of itemizing and many more would not benefit even if they did itemize. The good news is that many deductions are becoming factors in calculating your AGI instead of being included on schedule A. Some examples were listed early, such as the tuition and fees deduction and the student loan interest deduction. What this means is that you can benefit even more from those deductions regardless of if you itemize or not. You simply include this information in the section calculating your adjusted gross income and your taxable income is reduced.
Although it may seem complicated, once you look past all of the minute details, it is fairly simple. Your adjusted gross income is your bare taxable income minus all the extra debris. Although your taxable income will be reduced more, calculating your adjusted gross income is the first round of clearing off deductions. This is the amount that is used in analyzing other deductions and credits on your return.