AGI vs. Net Income: What’s the Difference?

Net income and Adjusted Gross Income (AGI) are two figures in personal finance. While both begin with your total earnings, they represent different financial realities and serve distinct purposes. Net income is the cash you have for expenses and savings, making it an indicator for personal budgeting. In contrast, AGI is a calculation for federal income tax purposes, impacting your tax liability and eligibility for certain tax benefits.

Understanding Net Income

Net income, often called take-home pay, is the money you have left after all deductions are subtracted from your gross earnings. This is the figure that appears on your paycheck as the final deposit amount. It provides the clearest picture of your disposable income, which is the money available for monthly bills, savings, and discretionary spending. For this reason, net income is the most practical number to use when creating a personal budget.

The calculation of net income starts with your gross income, which includes your salary, wages, and any bonuses. From this total, several mandatory and voluntary deductions are subtracted. These include:

• Federal and state income taxes
• Social Security and Medicare taxes (FICA)
• Contributions to retirement plans, like a 401(k)
• Premiums for health, dental, or life insurance
• Any other authorized withholdings

Consider an employee with a gross monthly salary of $5,000. Deductions might include $600 for federal income tax, $250 for state income tax, $382.50 for FICA taxes, $200 for health insurance premiums, and a $250 contribution to a 401(k) plan. After subtracting these total deductions of $1,682.50 from the gross pay, the employee’s net income for the month is $3,317.50. This is the amount they can use to cover living expenses.

When considering a major purchase, such as a car or a home, your net income determines what you can realistically afford for a monthly payment. While lenders may look at gross income, your personal budget should be based on your net income to avoid financial strain.

Calculating Adjusted Gross Income

Adjusted Gross Income (AGI) is a calculation for your federal tax return, found on line 11 of IRS Form 1040. The starting point for AGI is your gross income, which for tax purposes encompasses all income from all sources, including wages, dividends, interest, and capital gains. From this figure, you subtract specific, allowable deductions, often referred to as “above-the-line” deductions.

These adjustments to income are listed on Schedule 1 of Form 1040. Some of the most common deductions include:

• Contributions to a traditional IRA, which for 2024 allows a deduction of up to $7,000 (or $8,000 if age 50 or over)
• Student loan interest paid, with a maximum deduction of $2,500 per year
• Contributions to a Health Savings Account (HSA) for those with a high-deductible health plan
• One-half of self-employment taxes for self-employed individuals
• Contributions to self-employed retirement plans, such as a SEP IRA or SIMPLE IRA
• Educator expenses for eligible K-12 teachers
• Penalties on the early withdrawal of savings

Unlike the deductions that determine net income, these adjustments are not related to payroll withholdings. They are specific expenses and contributions that the tax code allows you to subtract regardless of whether you itemize other deductions later on your return. The resulting AGI is an intermediate step in the tax calculation process.

The Function of AGI in Your Tax Return

The AGI calculated on your tax return serves two primary functions. First, it is the starting point for determining your taxable income. After calculating AGI, you subtract either the standard deduction or your total itemized deductions to arrive at your taxable income. This final number is what is used with the tax brackets to figure out your income tax liability.

The second function of AGI is to serve as a threshold for determining eligibility for a wide range of tax credits and deductions. Many tax benefits are phased out or eliminated as a taxpayer’s AGI increases. This means your AGI level can directly impact the total amount of tax you owe or the size of the refund you receive.

For example, eligibility for contributing to a Roth IRA is subject to AGI limitations. The ability to deduct contributions to a traditional IRA is also phased out for taxpayers covered by a workplace retirement plan, based on their AGI. Many tax credits, such as the American Opportunity Tax Credit and the Child Tax Credit, have AGI-based phase-out ranges that reduce or eliminate the credit for higher-income taxpayers.

This makes managing your AGI a point of interest in tax planning. By making tax-deductible contributions to an IRA or an HSA, you can lower your AGI. This reduction might not only lower your taxable income but could also make you eligible for other credits or deductions.

Key Distinctions and Uses

While both figures start with gross income, the items subtracted to reach them are very different. Net income accounts for all withholdings, including the actual taxes taken from your pay. AGI is calculated before the main income tax is determined and does not include deductions for things like health insurance premiums paid via payroll. This distinction is why your AGI can be significantly higher than the total of your net paychecks over a year.