Your adjusted gross income (AGI) equals your gross income minus adjustments to that income, which are those amounts that are explicitly exempt from taxation according to the Internal Revenue Code (IRC). Your gross income consists of income from wages and salary plus other forms of income including pensions, interest, dividends, and rental income. Income adjustments include educator expenses, interest on student loans, alimony payments and retirement account contributions.
Taxable income, on the other hand, is the portion of your gross income that's subject to taxation. Tax deductions are subtracted from gross income to arrive at your taxable income. Tax brackets and marginal tax rates are based on taxable income.
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What Is Your Taxable Income?
Taxable income can be equal to your adjusted gross income minus the itemized deductions to which you're entitled, such as the state and local income or sales taxes you've paid, real estate taxes on your home, personal property taxes, interest on your mortgage and any losses you suffered do to a disaster. Other exclusions include charitable gifts and your medical and dental expenses.
Alternatively, your taxable income is equal to your adjusted gross income minus your standard deduction. Your standard deduction is determined by your income, age, whether you're blind and your filing status.
Standard Deductions for 2021
If you claim a standard deduction, rather than itemize you deductible expenses, doing so might decrease your taxable income to a greater degree than will itemizing your deductions. One reason being that the Tax Cuts and Jobs Act (TCJA) of 2018 increased the standard deductions to a significant degree.
The dollar value of your standard deduction depends on multiple factors, such as your filing status, whether you're 65 or older, if you're blind and whether another taxpayer will claim you as a dependent on their tax return. It's also adjusted annually for inflation, so the 2021 standard deduction is larger than it was for 2020, and the 2022 amount will be higher than the 2021 amount.
- For the tax year 2022: Single taxpayers and married individuals filing separately have a standard deduction of $12,950, up $400 from 2021.
- For the tax year 2022: The standard deduction for married people filing jointly is $25,900, up $800 from 2021.
- For the tax year 2022: Heads of households have a standard deduction of $19,400, up $600 from 2021.
Depending on your filing status and other tax-related circumstances, one approach will likely lower your tax liability more than the other.
Understanding Your Adjusted Gross Income
Your Adjusted Gross Income is the cash that remains after you make "above-the-line" adjustments" to your income. For instance, if your contribute to a qualified individual retirement account (IRA,) pay interest on a student loan and contribute to a health savings account, your taxable income is reduced by the amount of those items.
To arrive at your AGI, you can take a standard deduction according to your filing status or itemize those expenses you incur throughout the tax year. The IRS doesn't allow you to use both options. In either event, the result is your adjusted gross income.
Above-the-Line Deductions to Income
Even if you take the standard deduction, you can claim some tax deductions on your tax return. In many cases, an above-the-line deduction has no income limit so you can claim it on Schedule 1 of your Form 1040. What's more, because the deductions lower your AGI, you might claim other tax breaks the impose AGI-based income limits.
For instance, contributing to a traditional individual retirement account (IRA) boosts your retirement savings and trims your tax bill at the same. In 2021 and 2022, your contribution limit is $6,000 or $7,000 if you're 50 or older. And if you don't have a retirement plan at work, each dollar you contribute lowers your taxable income.